In this post I’ll discuss whether an early retiree should change their asset allocation in order to have a more conservative portfolio in retirement. It’s helpful to define what a conservative portfolio is and weigh the upside and downside of either portfolio adjustment.
In summary, a more conservative portfolio isn’t needed if your retirement horizon is longer, if you remain productive, and especially if you continue to earn some money in retirement.
Saving for Retirement
Most medical professionals start saving for retirement as soon as they have a 401k or 403b option. They later advance to cash balance plans, keoghs, or money purchase plans.
Of course just stashing your money into a retirement account isn’t enough. Just like it’s not enough to just walk into a gym, you will need to lift the weights and sweat on the rowing machine.
I’ve discussed the basics of asset allocations in the past. Briefly, it’s the ratio of the different assets in your retirement portfolio such as stocks and bonds.
You can have real estate investments in form of REITs or individual, private real estate investments such as rental income properties.
Purpose of Retirement Investments
The purpose of retirement investments is twofold: to grow with a lesser tax-burden and to provide you with passive income when you retire.
The more you’re able to save and the less you can live off in retirement, the less investment returns you need. This is an important point. Greed will fuck with your portfolio. If you don’t need the extra portfolio returns then why take the risk?
After all, risk is correlated with investment returns. In order for returns to be higher, the risks have to be higher.
Investments in Retirement
Once you retire, taxes become less of an issue due to the lower income you earn and the fact that income in retirement isn’t earned income but capital gains profits. Capital gains is taxed more favorable than earned income.
Passive income can come from bonds and stocks. It can come from REIT dividend yields or from rental income properties.
I’m certain that most physicians end up with excess assets in retirement. A recent colleague who retired from Kaiser Permanente at the age of 62 had $3.5M in his retirement accounts and we were discussing how it was going to be way more than he needed with all his kids married off.
Excess isn’t always good. In retirement, excess can also mean higher taxes due to RMD’s and more complicated estate planning.
You might find yourself in a situation where you could have all the money in cash or fixed income assets like bonds and you would have more than enough money to last you a lifetime.
Even bonds can provide you with passive income through their dividend yields. You don’t have to be invested in stocks which have a higher risk associated with them.
It’s not that bonds are better than stocks but they have certain benefits for the right person with the appropriate risk tolerance.
A Conservative Portfolio
Let’s say you have 100% stock index funds in your retirement portfolio and you decide to retire, as in, you will no longer earn an income from wages. Is this 100% stock portfolio wise, safe, or sustainable?
On a long enough time horizon, yes, it’s safe and sustainable. The basic concept of the whole stock market is that it goes up in value over time. But it has a lot of fluctuations and can swing wildly up and down.
A conservative portfolio might be something with more bonds or all bonds. It could be made up of only CD’s or for the uber conservative, it might be mostly an annuity.
Your risk tolerance will change from year to year. Especially when your circumstances change, such as when you get divorced, get married, have kids, enter retirement, stop earning an income, start a business, or become disabled.
So what’s your risk tolerance in retirement? If you $1M portfolio dropped down to $600k and stayed that way for 5 years, could you handle that drop or would you freak out? Would it affect the quality of your lifestyle or could you adjust easily?
Another factor to consider is what your income needs are.
Let’s say you need $30,000 a year to live off. You have a rental income property, mostly stocks in your retirement accounts, and a small amount of bonds. If your portfolio is yielding around 3% a year and has a balance of $1M then any stock market fluctuations might drop your income from $30k down to $25k. Do you have the spending flexibility to forego $5k a year of income?
Earning Income in Retirement
I was convinced in 2012 that as soon as I became financially independent I would stop practicing medicine and live off of my investment. No fucking way did I want to continue seeing patients.
Then I got into some consulting, teaching, and telemedicine and realized that I liked having an earned income and the work was pleasant.
The point here is that if you are going to continue earning an income in your supposed retirement then you don’t need a conservative portfolio. You can take on more risk and absorb more investment fluctuations.
Duration of Retirement
A longer retirement is considered by personal finance experts to be a more risky retirement. The idea is that you will need more money to support your non-productive years and a longer time horizon brings more risk.
I disagree. I think personal finance experts are approaching the topic from an economist’s perspective which tends to often exist in a bubble. Individuality of the retiree is disregarded in this analysis.
Take a medical professional who was able to make it through all the schooling and bureaucracy. They are productive people even if they are lazy. They are creative even if they can’t draw. They are perseverant even if they constantly whine at work.
If you look over a stock and bond portfolio stretched out over a 100 years then you’ll see that there are far fewer financial disaster events. There are more booms than busts.
On top of that, the busts are short-lived and the booms are prolonged.
A medical professional retiring early is not going to stop being productive. They are going to produce one thing or another. Whether it’s intellectual productivity or a physical one.
At the very least they will be helping others around them. That creates a network which is probably more stable than any investment out there.
The more time elapses in retirement the more opportunities one comes across. A good business opportunity, an investment property, or even a successful speculation.
More time brings more opportunity. More attempts increases the chance of success.
I’m not big on real estate but appreciate its power and this physician writes really interesting stuff about real estate investing. If you hold on to a property long enough, there is a chance that it will go through many cycles of bubble-like prices.
For a person who is retired, and if they are positioned well, they can eventually capitalize on such bubble events.