Tom Talks Stock/Bond Mix and Risk Tolerance for Retirement
Transcript:
Easan Arulanantham:
I have a mix of stocks and bonds in my portfolio. I’m getting close to 60. And you know, as I age, should I change how my my allocation is? Should I be more conservative? As I get older?
Tom Vaughan:
I get asked this all the time, and then people actually assume that they should do. And that may not be accurate. So here’s here’s what I would say that I think is really interesting. two things. Number one is, when we do our financial plans, one of the things that we do, we do this Monte Carlo simulation, so you’re heading into your retirement or in retirement or your way wave wherever it is. And so now I got a 60 year old that’s asking this question. And so you know, we’re going to look at that financial plan, we’re going to run the Monte Carlo simulation. And we’re going to model different mixtures of stock and bond and find the amount of stock that that person has to have to achieve their goals. So that’s the first thing. So let’s say we run a financial plan, and you’ve got to have 60% to make your goals work. Or maybe it’s 20%. So that’s the first one, what mixture of stock and bond Do you need. So let’s just say the plan says 60, in that 60 year old we just talked to is that 40. Theoretically, the plan says they need to increase their exposure at retirement, or now to to accomplish their goals, they need to increase their stock market exposure. So that’s number one.
Now, but much more importantly, is number two, which is just what risk tolerance Can you handle. And so you want to understand for all these different amounts of stock and bond, how much you could lose, at any point in time over a one year period, or a three year period, or whatever it might be look back historical Vanguard has some great pieces, where you can take a look at 10 different portfolios, going back to 1926. Actually, 11, zero stock, you know, 10%, stock 2030 4050, and it shows you what’s the worst one year in that timeframe. And until you can take a look at that and say, Hey, you know, I’m really comfortable 10% drop over a year, I can do it, you know, and so that’ll tell you, okay, these portfolios work and these other ones that drop 20% won’t work. And there’s, that’s a very simplified version of what you’d want to do. There’s a lot of other things. But it is important, if you end up in a portfolio, let’s just say for example, we just said that that 60 year old maybe has a 40%, the plan says they need 60%. But when we look at what that person’s risk tolerance is, and really get into it, we realize that 60% is just too high, they can’t do it. Because if you are in the wrong portfolio with too much risk, when the market falls, which it will inevitably do, you will bail out in a panic because it fell past your risk tolerance, you exceeded your pain threshold, and you gave up and you course did that at the bottom.
And so in order to stay in, you need to find the portfolio that matches your risk tolerance. Now, in that scenario, we need to go back and take a look at that plan and figure it out. Because basically, you might have to adjust something when they’re going to retire, or how much they’re going to spend. Or maybe they have some assets, we didn’t count like a house that maybe they should, you know, consider moving down to something smaller or into a cheaper area or something along those lines to try to solve that. Because if that person can only handle a certain level of risk, and the plan says more that don’t that won’t work, you can’t do it. It’s good to know, it’s important to know what the plan says. But your personal risk tolerance dominates, that you’re not going to care what the plan says, when the market is falling like a stone and everybody thinks it’s the end of the world. And you’re falling more than you can handle so that risk tolerance is critical as far as that goes. So to answer the question, real succinctly, that concept kind of rule of thumb of moving down based on your age. Yeah, if you can, that’s not a bad thing. If your plan, if you’re at 40%, your plan says you could be at 20%, then you have the ability to move down especially if your risk tolerance is already above 40, you know, or at 40.
Then there’s nothing wrong with that as far as that goes. But you have to look at it from a different standpoint. It’s not just because of your age, you’re trying to accomplish your goals. You’re trying to identify who you are. And all of these different things fit into one piece. It’s not that easy. It’s not just some rule with, hey, I’m retiring, then I reduce my risk. I and then in the real world, and dealing I’ve done 6000 plus financial plans I’ve dealt with 1000s of households. I’ve very rarely seen anybody move down especially early in retirement maybe later on Some of my most aggressive clients are very old 80s and 90s. Because they have a very high risk tolerance. And and they believe that the stock market is substantially better than the bond market. And that belief has has created their wealth. And that’s what they want to keep doing. So lots of other aspects come into play besides age. Oh, so usually risk tolerances kind of, you’d say doesn’t change too much. Do you? Is there any events? That can’t change, though? Because I know probably me when my are my like, retirement accounts go to like, bigger values? I definitely have my tolerances coming down more and more that say, yeah, yeah, that happened for clients. And then also, when there’s no more income, when you’re reach retirement, when you’re not putting out into it, does tolerance ever change them too?
I haven’t seen times change as much based on retirement and income needs, as I have what you just mentioned, which is size, so you have a $5,000. IRA, you lose 50%, they’re down 2500. Oh, that’s not great. But it’s 20 $500, there is $1 amount that matters, you have a $500,000 IRA, you lose 50%. Now you’re down 250,000, the number of years it takes to get that back is ridiculous. And so yes, size of account and size of wealth. But it isn’t a perfect scenario, it isn’t a perfect correlation. I buy other clients who said just the opposite. Because I have more money, I can take more risk, I can afford more downturn, you know, hey, I have $5 million. Now, I only need 2 million to live off of I can take more risk. So again, it comes back to your own personal risk tolerance and kind of what you’re willing to deal with. But I have seen some people, just a couple of places where I’ve seen people adjust their risk tolerance, I would say long term over the entire retirement, we do see some movement down and restarts and some movement down in stocks. But that the question before, you know is 60 year old looking at, you know, retirement right away, maybe not until they’re 80 or something where something would change. But the other aspect, of course, has to do with the size of the account. But here’s the weird thing, I’ve actually seen restarts go up, when the markets go up, people start to want more of that. So you know, hey, they got their stocks made 30% of bonds made two, and I want more of the 30. And so they go from 60 to 70%. You know, we try really hard to make sure people understand that they’re increasing their risk and what that means. And so you know, we use a program called Riskalyze, it sends out an email every quarter that shows for their portfolio right now, the way it stands, if we had another big downturn, here’s how much you’d lose, here’s how long it would take to get back. And so just a constant reminder, which is what you know, and we didn’t have these tools before 2008.
And so, you know, I haven’t had as much movement up since we started using that program, because people are realizing what they could lose, and they can settle in. And kind of, you know, if you know, you could lose 15% and you lose 15% you’re probably okay, if you lose 40 you’re gonna maybe freak out. So, you know, anyway, that I’ve seen more people move up, and then they end up, you know, kind of in trouble with the down actually. But yeah, and then we see small changes, like before the election last year, everybody thought there was gonna be all these problems. And there was ironically, and so a few people move down, you know, some from 60 to 50%, or something along those lines. Of course, we had the one of the I think from the mere fact from the election itself to the inauguration, it was a greatest run in in that history. Going back to the 1900s, that was the best between election inauguration run in the history of the stock market. So obviously, it didn’t work, you know, getting more conservative, and we had all these problems and insurrection and, you know, all these things that happen, and yet the market still went up, at least in that timeframe. So that’s why you got to be careful with those movements based on your thought process for what’s going to happen. It almost always goes the other way. So find your risk tolerance stick with that. Maybe make some changes within the portfolio, if you’re going to be at 60% stay at 60. But you can maybe change the aggressiveness of that 61 way or another so it’s a good question. It’s a it’s a topic of conversation pretty much constantly within the practice. And so it’s worth it’s worth covering here too. It’s a good thank you for asking that.