Here’s a dirty little secret of the financial planning industry: most financial planning rules are so dumbed down you can’t even use them.
In fact, I would argue they’re downright harmful, and following them might very well cost you your retirement.
Let’s start with perhaps the biggest offender of all: the rule that says your allocation to stocks should equal 100 minus your age. The rest, you should put toward cash and bonds.
It’s a terrible rule that completely ignores the fundamentals of investing.
This rule doesn’t so much as consider how relatively cheap or expensive stocks and bonds are.
That’s just basic common sense!
And never mind the fact that there is a broad world of investments completely outside the stock and bond markets.
There’s real estate… options strategies… commodity trading funds…and a whole list of alternatives.
The smart money that manages the Harvard and Yale endowment funds heavily favors alternative investments. Why shouldn’t we follow their lead?
Then there’s this one: the 4% Rule.
The idea here is that 4% is the highest “safe” withdrawal rate that will survive a 30-year retirement without depleting your portfolio.
Under the rule, which became standard planning practice in the 1990s, you take a 4% withdrawal in the first year of retirement and adjust the figure up by the rate of inflation.
There’s one major problem here. The model assumed a 50/50 or 60/40 mix of stocks and bonds, and bond yields were a lot higher in the 1990s.
At current prices, bonds aren’t going to generate enough income to meet the 4% rule. And given that stocks are very expensive right now, that’s a risky move to rely on as well.
So, what’s an investor to do?
To start, you should have an open mind when it comes to choosing asset classes. If traditional assets classes like stocks and bonds are not attractive – welcome to today! – you’ve got to look elsewhere.
It also pays to be flexible in concern to income.
When it comes to paying your bills in retirement, it doesn’t really matter where that dollar comes from. It can be an “income” dollar paid via dividends or interest, or a “capital gains” dollar generated from trading or growth strategies.
Your decision here will have a lot to do with what the market is offering. If you can’t realistically pay your bills given the yields in safe income investments, then creating “synthetic dividends” by trading stocks and options might be your only option.
As a general rule, I prefer to use income dollars for personal expenses to avoid selling shares. If you’re looking to sell long-term, buy-and-hold investments, you can really get yourself into a mess.
And in a prolonged bear market, selling your shares can be akin to a farmer eating his seed capital. Shares sold at depressed prices are shares that won’t grow in value when the market turns around.
But this doesn’t mean I buy overpriced income securities just for the income, either.
In the end, you should invest where you believe you can earn the best return. And if that means a larger allocation than usual to shorter-term trading strategies, so be it.
Editor, Dent 401k Advisor