Why Most People Pick The Wrong Asset Allocation For An Early Retirement

Ever wondered how to bend the rules of traditional retirement planning to fit your unique early retirement dreams? Join me as we dismantle the one-size-fits-all approach to asset allocation, and instead, tailor an investment strategy that thrives on your personal circumstances. Through an engaging story about a client who confidently strides with a hefty equity portfolio and a reassuring pension, we unlock the truth behind 'conservative' investments and how that definition can shift dramatically from one retiree to another.

In the realm of retirement, one must artfully juggle the growth of their investments with the imperative of capital preservation. Our discussion traverses through a hypothetical retiree's financial landscape, illustrating how additional income streams, like rental revenue or a partner's earnings, can have a profound impact on where you allocate your assets. We equip you with a framework to craft an investment strategy that not only fits your unique financial situation but also stands resilient against the ebb and flow of market tides, ensuring a stable and comfortable retirement.

As the curtains fall on this episode, I extend an invitation for you to shape our next conversation. Submit your burning questions to earlyretirementpodcast.com, and become a part of a community passionate about paving their own path to financial freedom. And remember, while we offer you the map to navigate the complex world of retirement planning, it's essential to consult with your financial advisor to chart a course that's truly your own.

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Ari Taublieb, CFP ®, MBA is the Vice President of Root Financial Partners and a Fiduciary Financial Planner specializing in helping clients navigate the nuances of an early retirement.

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PS: Before anyone decides to move forward with our services, I want to ensure we're the best fit to help you reach your goals and I personally have the first conversation with you.

Transcript

Speaker 0: 0:00

The majority of people that are coming to me have an investment portfolio that might show 60% equities and 40% fixed income. Maybe it's 70% equities and 30% fixed income. Sometimes it's even 100% equities and 0% fixed income. None of them are right or wrong, but it depends on your situation, and here's a very simple example to illustrate. This. Client came to me with $3 million and they were 100% equities and they said Ari, isn't this crazy? Like, how did my initial advisor even recommend this? And I said it depends. How much do you want to spend in your retirement? They said $8,000 a month. I said that's $96,000 a year. They go yeah, that's right. I said it's about $100,000 a year and you've got a $3 million portfolio and 100% equities. Do I have that right? They go yep, you've got that right. This is a rocket science. I go how much does your pension cover? And they go well, about $6,000 a month. I go okay, so your pension covers about $6,000 a month. You want to spend $8,000 a month. $2,000 a month needs to come from your portfolio. Do I have that right? They go yep, you've got that right. I say great. Here's what I need you to think about that $3 million can fluctuate a whole lot more than someone who doesn't have a pension. But it doesn't need to be 100% in cash, because the reality is you have the pension that's helping out, which means you can be able to take on a little bit more risk than your traditional retiree. Does that make sense? They said yes, but once again, does 100% equities just sound really aggressive.

Speaker 0: 1:22

And what we ended up having a long conversation on is the fact that most people are getting older and think they need to be more conservative, and so I like to break it down like this. I'll say what does conservative mean to you? And someone said conservative means to me that my money's not going to go up and down a whole bunch because, as I'm getting into retirement, I don't have the ability to recover in the same way I did when I was younger. I said that's true. They said then, what do you recommend? I go well, why don't you hear this other definition from my client, who I asked about what does conservative mean to you? And they said conservative means they don't want to unnecessarily leave any money on the table, but at the same time, they recognize, if their plan shows, that they're in a position to spend and do everything they want to do that, they're okay with it. And so I said which definition resonates more with you? They said, well, I just want to make sure I don't run out of money.

Speaker 0: 2:12

And so the reason I'm telling you this quick story is because the truth is, most of you have a cookie cutter portfolio. Maybe you're getting older and you're going, yeah, maybe I need to have a little bit more in bonds and cash. Maybe some of you are going, no, I really like how much I have in equities. It's done really well for me, but I know I should start tapering that down. But I'm interested in early retirement. So I don't really know the timing of this because I'm not retiring at 65. I'm retiring in my early 50s or late 50s or early 60s. So I don't really know what that means in terms of a timing perspective for shifting the allocation. So what I want all of you to know is that I don't believe in cookie cutter planning. So I don't say hey, what's your age and your risk tolerance? On a scale of one to 10, you might be a two today and a 10 tomorrow. That does not give you the confidence to retire early with confidence, the first thing you need to do when it's coming up with your asset allocation is understanding how much do you want to spend in retirement?

Speaker 0: 3:00

And some of you are like, listen, I'm five, 10 years out from retirement. I don't even know what I'm going to get to that. And I say we have to start with your expenses, because it makes a really big difference. Doesn't need to be perfect, but if you want to spend $100,000 a month or $10,000 a month, it's going to really change the plan. Now, 100,000 a month is an extreme example, but some of you know I'm from Malibu, california. There's some characters in Malibu Okay, that's me putting it nicely and a lot of you know this and my clients that are characters that are listening right now. They know who they are and there's nothing wrong with spending 40, 50, 60, 1000 a month, but you better have a portfolio that's able to support that.

Speaker 0: 3:34

Now some of you are going hey, I don't want to spend anything like that. Like that doesn't even remotely. I mean it would be interesting, but I don't need that to live Four or 5,000, 6,000 a month. I've got all my essentials met. Yeah, I want a little bit more for travel and I'd be good. I say great. What I need for you is to have a portfolio that actually is dictated based on what you want your life to look like. This is why I don't love target date funds in your 401K. This is because they don't know how much you want to spend. They don't know that you might not have any children that you want to leave money to. They don't know your situation.

Speaker 0: 4:04

So today, a little bit of a longer intro, is me going through a full analysis and sample of how I create an asset allocation for someone that's trying to retire early, before age 65, and how should that change throughout retirement. So, with that being said, my name is Ari Talbleeb. I'm a certified financial planner, host of the early retirement podcast and vice president here at Root. Now let's hop right in. A large majority of you are not simply going to retire at 60 and go great, I've got an IRA time to turn on my income. The reality is, maybe you're doing part-time income, maybe there's rental income, maybe you're debating turning on Social Security in a few years, maybe your spouse already has turned on Social Security. You're going to have various income sources, and so your asset allocation should absolutely change based on that. So I tell everyone hope you marry your partner forever unless it's not a healthy relationship. But don't marry your asset allocation. No, simple dopey jokes. But I do this in a way to hopefully resonate with all of you.

Speaker 0: 5:00

So what I always like to do is break down what is an asset allocation. It's essentially saying what's the right amount should you have of things that are growing for you versus things that are there to preserve your capital. It's pretty simple and what you want to make sure is your asset allocation is talking to what I call your asset location, and I don't just call this. Lots of advisors call it this, so I did not coin the term by any means. But asset allocation is what's the right amount? Should I have an equities, fixed income and cash versus asset location is saying where should I own those assets?

Speaker 0: 5:28

So, for example, let's assume someone comes to me and we determine that, after determining their goals and their travel and their healthcare expenses and all these things that they want to spend, let's say, say, I don't even know, I'm picking a number 5000 a month, that's $60,000 a year. Now let's assume they have a million dollars. To keep it really simple, they want to spend $60,000 a year. Now, it's not going to be every single year, because a lot of you know this. But there's something called the retirement smile, which is the reality is, you're going to retire early. You're going to have your energy and health, you're going to want to spend more and I'm going to want you to spend more. Then what's going to happen is, naturally, you're going to spend less and then maybe in your late 80s, early 90s, you're going to spend a whole lot more when you go. Well, I don't want to pass away with five or $10 million, so don't feel like you're marrying your expense strategy in retirement. I want it to be dynamic, but it's important as it relates to your asset allocation.

Speaker 0: 6:16

So let's go back to my example. Let's assume you'll spend 5000 a month or 60,000 a year, every single year, just for example purposes, and you have a million dollars. Well, what that tells me right off the bat is I need to have enough income on the side so that if markets are going wild, you don't have to worry. You're not going. Oh my gosh, market changed. Does my income change? What I like to do is have a minimum of X number of years of expenses, and I'll explain that in just a second. So let's assume that you want to spend $60,000 a year. I'll ask someone. I'll say what's the average? Market downturn until it just fully recovers, just just back where you make your money and they go. I don't know, a few years ago it's actually you're pretty close, two to two and a half years, but that's the average.

Speaker 0: 6:55

What if a 2008 occurs? What if there are so many variables out there that actually freak you out, which, to a lot of you, you are going to go? Yeah, it is going to freak me out if markets don't do well and all of a sudden I need income. I don't want that to impact the next 40, 50 plus years of my life, and I'd say reasonably so. What I want you to do is have enough on the side to have to sell something at a loss.

Speaker 0: 7:16

So, for example, let's assume you want to spend 60,000 a year and there's no other income sources and double that, that's 120,000. So I want at a minimum 120,000 out of the million in some super safe asset, not just cash, because I want it getting interest for you Could be CDs, could be an inflation protected security fund, could be any fixed income alternative asset that I deem is most fit for that particular client. Now, that's the average. I don't like the average. I want to double that, so let's double it. So, instead of two years of living expenses, let's have four years. So that's $240,000 that we're going to have on the side essentially four years of living expenses. So, no matter what happens, markets are doing well, markets not doing well, you are okay, you're not going to have to go tap those accounts, sell something at a loss to create your income.

Speaker 0: 8:01

So why am I giving you this super basic example? Well, $240,000 out of a million dollars that's nearly. That's technically a 76% equity, 24% fixed income portfolio. So, right off the bat, I'm looking at 76% equities and 24% fixed income or cash. Most people go, yeah, that makes sense, it's pretty straightforward. And they'll go what if I have $2 million? Well, once again now imagine you have $2 million, but the same exact example you wanna spend $5,000 a month or $60,000 a year, but you have $2 million. Well, now you don't need a 76, 24% asset allocation. The truth is, you now still need $240,000, but you have $2 million. So now we have a whole lot more flexibility. And that's kind of the premise of why I'm doing this, and I'm just using my calculator right here to give you the exact number. That's essentially saying that you need 12% of your portfolio in fixed income, cash type of alternative assets so that you have your income to whether there's four years of a market downturn, and then you've got 88% of your assets growing for you and you're in a great spot.

Speaker 0: 9:03

Some people go, hey, I just feel better with five years or six years of living expenses. I say, great, let's show you those alternatives. Other people go you know what? No, already. The truth is, this makes sense. I get the analysis, but I've got rental income and I'm still working today and my spouse is still gonna bring in some income.

Speaker 0: 9:18

So how does that change the asset allocation? I go okay, let's assume you have $2 million and you wanna spend $5,000 a month and you've got $3,000 a month that's already coming in from a spouse who's working some part-time income. Well, that now tells me 2,000 a month needs to come from somewhere. $2,000 a month, $24,000 a year. We wanna add a minimum if we want four years of living expenses, have about $100,000, just about in some super safe asset. So if you have a million dollars, that tells me that if you have some part-time income, there's no reason you couldn't have 90% equities and 10% fixed income and cash.

Speaker 0: 9:54

Now some of you are like, oh my gosh, this is just. I never even thought that I could have this amount in aggressive funds because I thought it was more risky. And that's when it's all about redefining risk. Some people go, hey, I just couldn't sleep at night Seeing my funds go up 30, 40% and down 30, 40%. Say great, you don't have to. Maybe it means you're working two, three, four, five more years. But if you're gonna sleep better doing that, then I'd rather you do that Once again.

Speaker 0: 10:18

I'm like the meanest early retirement planner. I don't want anyone to ever retire too early, but I also wanna make sure that you're not unnecessarily leaving money on the table. So a good job of as an advisor is someone who's gonna actually quantify the trade-off so you can understand the magnitude of each decision and then from there help you determine what makes most sense. I'll give you a fun example. Client came to me and they wanted to pay off their mortgage and I could tell if they wanted to pay off their mortgage based on the way they were talking about it and they were gonna feel a whole lot better paying off the mortgage. I mean, they were gonna sleep better and I could tell they were gonna sleep better, even though it was clear that they should invest instead of paying off their mortgage. I mean, what they should do financially is pay the minimum to the mortgage, invest the rest and get a whole lot more growth. And that's the financial spreadsheet answer. But I don't work with robots, I work with people, and so what's actually happening is that they're gonna sleep a whole lot better when they pay off their mortgage. They already weren't in great health. They don't need to add more stress unnecessarily, since they were in a good spot anyway. So could they have invested and done a whole lot better? Yes, but they understood the trade-offs and went hey, I'm gonna sleep better paying off the mortgage. So they did that and we understood that there's gonna be money left on the table and they were still okay.

Speaker 0: 11:28

Most people go well, I've got a mortgage at four, five, six, seven, eight percent in crazy cases, but shouldn't I invest instead? Like, couldn't I get 10, 11, 12%? I go, yes, but you're guaranteeing that return when you pay off the mortgage. So you're guaranteeing a 6% return versus trying to get eight, nine, 10, 11, 12 plus percent, which is certainly doable, but as an average over time and averages don't exactly size up to a traditional retirement. Because let's assume that, very simply, you have a million dollars and it goes down to 50%. Well, now you have $500,000. A 50% gain on $500,000 does not get you near that million dollars. So you actually have to do a whole lot better than 50% just to get back to even.

Speaker 0: 12:10

And that's where I tell clients hey, the way you win in retirement, in an early retirement specifically, is by not losing. I'm okay with you trying to hit home runs Up until retirement. I'd like to start to smooth it out with doubles and triples of a baseball analogy along the way. But once you're in retirement, it's all about consistent singles and doubles. You don't need a home run to be okay. Now, some people do.

Speaker 0: 12:30

Some people are like, hey, I want to spend 10, 15, 20,000 a month in retirement, and if I can't do that, it's not even worth being in retirement. I say that's fine. What you need to do is have a plan that tells you you're in a great spot to be able to support that income. The last thing I want to leave you with and this will be a shorter episode than most Now I say that now, but I might keep going. But the reason I want to bring this to your attention is most people go well. Once I get older, I'm like 70s and 80s, shouldn't? I have so much in conservative assets that I never run out. I go well, absolutely.

Speaker 0: 12:59

If you're not able to stomach the downturns due to education or due to the fact that you just don't feel comfortable investing in retirement, not only is that okay, it's really not a bad thing at all. Some people are like, no, no, I know, I need to invest. They go. Investing can be helpful. But I have a client that has north of $8 million and they just cannot stomach investing in the stock market, and so, whether it's using a real estate fund or using any other alternative asset, that's just gonna let them sleep better at night. Now that particular client has a pension that covers the majority of their needs. But the premise here is simple you should have an investment portfolio that lets you sleep at night, and if you don't understand the strategy, then don't invest in it, because you're gonna kind of trust an advisor is doing the right thing. Whether they're doing the thing or not. You need to understand why they're doing what they're doing.

Speaker 0: 13:46

So let me give you another example. This is specifically with Social Security, and I could use any example, but I find this one works with people. So what I'll tell someone is I'll say hey, what's your Social Security strategy? Like, when are you gonna collect? And they're like, well, thinking about collecting earlier, because if I collect earlier, even though it's a smaller amount, I'm gonna get it for more years. I don't know how long I'm gonna live. I go, that's fair.

Speaker 0: 14:05

Another person comes and says hey, I'm thinking about collecting later. Yes, I know I'm not getting it as early, but it's gonna be a larger amount, and so it might be for fewer years, but that's what I wanna do. And if something happens, those dollars go to my spouse, meaning they would get the larger benefit for the rest of her life. I go once again, sounds fair. And then I'll say how is your asset allocation gonna change based on your decision? And they're like, well, and I can tell they don't really have an answer prepared for it, which, how could they? But they go yeah, I'll just get more conservative. And I go, I would consider doing something the opposite. They're like what do you mean? I thought, getting older, more conservative. I go once again.

Speaker 0: 14:38

Let's look at another example. Let's assume you have a million dollars and you wanna spend 5,000 a month in retirement, that's $60,000 a year. Now what if Social Security gets turned on and Social Security is providing four of the $5,000? Meaning, $4,000 a month come from Social Security. 5,000 a month is what you need. Now 1,000 a month is needed from your portfolio. Does that make sense? And they go yep, that makes sense, I go. So are you gonna become more conservative? And they go yes, and I go.

Speaker 0: 15:03

Let me make sure I understood my point here, or I'll ask them, of course. I'll say make sure you understood my point here, which is, as you get older and more guaranteed income gets turned on, less needs to come from your portfolio Doesn't mean you need to make it more aggressive, but it certainly means you could and still be in a good spot. What I don't wanna have happen is that my clients get mad at me when they're in their 70s and 80s going hey, I see I was in a fine spot to invest well and do well, that even if markets went down 20, 35, 40%, I was still gonna be okay. Why didn't you give me the confidence to spend more when the money would have been worth more when I was in my late 50s, early 60s, when I have my energy and health. So the premise here is I wanna make sure that, as more guaranteed income sources get turned on, your investment allocation is actually reflecting that. Now, the really basic point here is as there's more income whether it be pension or rental income or social security less has to come from your portfolio, and so your portfolio should be reflective of that.

Speaker 0: 16:02

Most people don't make that adjustment. Most people get into retirement and they've got 60% in equities, 40% in fixed income. Maybe they're thinking about 65, 35. Maybe they're thinking 70, 30. I don't think it should be any of that. I think it should be based on how much you wanna spend in retirement. Do you have enough set on the side to be able to ride those waves? So if something does happen, you are okay.

Speaker 0: 16:21

And then this is all. Level. One Like this is all asset allocation, early retirement planning. If you need this income for 40, 50 plus years, the truth is you're tiring in your early to mid 50s or even early 60s. You might need this money for 30, 40 years. So I don't want you to be so conservative that the first 15 years of retirement are smooth and the latter 15 aren't so smooth. I want you to have consistent income the rest of your life.

Speaker 0: 16:43

Now, this is all, like I said. Level one this is asset allocation. Asset location is essentially saying if you want to have an 80% equity and 20% fixed income portfolio, don't just put 80, 20 in your brokerage account which I call the superhero your IRA, your Roth IRA, your 401k, your HSA. That's what most people do, is they go yeah, I think I'm 80, 20 or 70, 30, or I go, you're not any of those things, you're an individual person. I'm just kidding. I'll make that joke with clients. I'll say and I stole that from another advisor who uses that joke, let me say, but I thought it was funny. So you're your own person. You're not an asset allocation, which is true, obviously, but stupid joke.

Speaker 0: 17:22

Let's get back to my point. My point here is, with asset location, I want to make sure that if you are saying I want an 80, 20 portfolio, you don't just put 80, 20 in every account. That's not tax efficient. Here's why what you want to do is say, okay, I've got a Roth IRA worth $200,000 and I've got a 401k worth $800,000 and it's all pre-tax. So I have a million put together, but 200,000 Roth, 800,000 is pre-tax. You want the 200,000 in Roth to be 100% equities because that's the best account for tax-free growth over time. Then you want the $800,000 to be even more conservative so that you get to an overall allocation of 80, 20. So sometimes it's 100% Roth IRAs, with 50% in an IRA, depending on how much the IRA makes up of the whole portfolio. Sometimes it's you have a brokerage account and it's got some really healthy gains in it and you don't want to just make a switch all at once because there's tax implications. So what we'll recommend is saying let's do a portion over time and let's identify each security to understand the potential drawdowns.

Speaker 0: 18:23

Last example here and then I promise this is the final one, for the episode today is a client came to me and they had about $1.4 million in Apple Stock. I said what's the worst case scenario? Like just absolute worst case scenario. They said well, worst case scenario is it goes to zero. Technically, I go, that's right, I go. What's the worst case scenario? Tax wise? They go, well, I'm in the 15% capital gains bracket. There's that net investment income tax of 3.8%. So 18.8% let's call it 20 to make it easy I go, that's right. 20% taxes is kind of the worst case scenario. If you sold today, they go. Are you trying to tell me to sell today? I go. No, I'm trying to help you understand what are the potential kind of drawdowns.

Speaker 0: 18:59

Some people go hey, I've got this company, I've worked there many years, I'm comfortable with this level of an allocation, but when I retire, I want to know how to use. You know, the tax gain harvesting you talk about to pay 0% taxes on the gains and I say, great, I've got another episode and if you guys haven't heard that, go ahead and check that out on YouTube or the podcast where I talk about tax gain harvesting to pay 0% in taxes in an early retirement. But the premise of what I'm talking about now is I want to make sure that you don't go. Well, I'm going to hope that my stock keeps going up and up and up and if it does, happy days. But if it doesn't, it's hey, now I can't retire on time. So why am I bringing this up?

Speaker 0: 19:36

The truth is, no one really loves their individual stock position. What I find is people want to make sure they can retire if they want to, but they also don't want to leave money on the table unnecessarily. So what we'll do is we'll identify the specific position and sometime it's tens, if not hundreds of positions and say here's exactly when we should sell each position, based on the potential drawdowns and how much you want to spend in the first years of retirement. So the premise is we want to connect all of this investments, taxes, state withdrawal strategy. It's a holistic approach. That's the approach we take here at Root Financial.

Speaker 0: 20:07

I don't find there's another approach that works, so that's why I do it this way. I need every single thing connected and I want to make sure that nothing's being left on the side unnecessarily. I don't want you leaving money on the table needlessly. That's what I want to go through in today's episode an example of how to even think through an asset allocation. But to summarize, make sure you understand what you want to spend in retirement, but don't marry it. In the first few years. You might want to spend more on travel and you might want to do some fun stuff. Great, I want you to do the fun stuff. I just want you to do it without that little thing in the back of your head going hey, mind a good spot to actually do this. Then I want you to go.

Speaker 0: 20:42

Okay, based on my current investments, am I allocated appropriately Meaning? Should I have more conservative investments to help weather the dancers? Am I overly conservative? How is this going to change? Based on my income strategy? How am I making sure that if I do make changes, there's no tax implications that are going to create a big burden, whether it be today or down the line? So just making sure you have a holistic approach with this is going to put you in an amazing spot to retire early.

Speaker 0: 21:06

So I love talking about this stuff because the truth is, if you're good with numbers, you can retire earlier. And good luck quantifying the impact with friends and family and your health. On a spreadsheet you just can't do it. So that's why I love doing what I do. If you guys, of course, are interested in creating a custom strategy, it's what we love to do. We focus on retirement planning and specifically early retirement planning. So anyone retiring before 65, there's more nuance involved health insurance, withdrawal rates, tax planning. That's the real value, and I've said this on previous episodes I don't think it's worth paying an advisor for investment management.

Speaker 0: 21:37

I think it's worth paying an advisor for holistic planning, and I have a video on YouTube where I go through the pros and cons and help you understand the difference. If it even makes sense to hire an advisor and sometimes I say it doesn't make sense to and people are like shooting me emails that are other advisors and like, hey, don't say that, you know it's bad for my business I'm like I don't care. The truth is it just depends what stage of life you're in, what experience you're looking for. Some people are reaching out like, hey, I think I could do all this on my own. I say, great, what's the ROD of that? And they're like what do you mean I go?

Speaker 0: 22:03

Rod stands for return on desire Meaning. Is that what you want to do, not just can you do it? How many years would it take to figure it out? And is that what you want to do the whole time? And some people are like, yes, I say great, then don't pay me. Like watch my videos and podcasts and you're good to go.

Speaker 0: 22:17

Other people are like, no, I want to make sure, in case something happens to my spouse, we're taken care of, or you know what? I just want an objective third party to run ideas by, say, okay, then there's reasons, but I only want someone hiring us if they're over the moon excited. Not, I think I should do this. I've been putting it off for some time. I know I need an advisor. We don't do that, we don't do. Your advisor is going to talk about boring numbers and graphs. We say, hey, you know how much can you spend in retirement? What's the most that you can spend without running the risk of running out of money, not what's the least, so really helping you get the most life out of your money.

Speaker 0: 22:46

So hopefully this episode was helpful and I'll have a new episode for you all next week. I just realized that I forgot to go over a review of the week at the beginning of the episode. I do that each week, so I'm going to go over one briefly, and this is going to come from KD 22522. I'm just pulling up my phone here. Ari has a wonderful way of explaining complicated retirement financial planning topics. Thank you for your expertise. You're very welcome. I love doing it. Kd 22522. Guys, that's it for today's episode. Love you.

Speaker 0: 23:15

Thank you for listening to another episode of the early retirement show. If you have a question that you want answered in a future episode, you can always go to my website, earlyretirementpodcastcom. That's earlyretirementpodcastcom and you can go ahead and submit a question that I'll look to answer in a future episode. Thank you all for listening. Please do rate it, review it and share it with someone who you think would benefit from this information. If there's anyone out there that you know, I certainly appreciate it and I will see you all each week. Hey guys, it's me again. Please be smart about this. Nothing in this podcast should be construed as financial, tax or legal advice. Consult with your tax preparer or financial advisor before taking any action. This podcast is for informational purposes only.