Investing for total returns before one retires is fairly uncontroversial. It only makes sense to have one’s goal be to get the best returns possible.
There are a few objections to total return investing during retirement that are reasonable, though, like sequence of return risk.
In this article, I explain why I plan to keep investing for total returns during retirement, and I’ll share some strategies to help deal with common fears investors have.
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pinkomelet/iStock via Getty Images Introduction
I am a 46-year-old total return investor. What that means in its simplest form is that I try to place my money in investments with the best risk/reward over the medium-term in order to maximize my portfolio’s reward over the long-term. In terms of reward, I want the best capital gains + dividends, minus taxes, fees, expenses, time, and transaction cost investments I can consistently identify. Importantly, I define risk, not as volatility, but instead as underperformance compared to broad market indices or loss of capital over the medium-to-long term of 5-10 years at the portfolio level. In other words, I want to maximize the amount of money I make via my investments before I retire.
As far as I’m concerned, this is the most rational approach for investing during one’s working years, and I have yet to hear a compelling argument against it. It almost goes without saying that maximizing medium-term returns relative to risk should lead to good long-term returns and be an investor’s basic goal when building a retirement portfolio. The question of whether total return investing is the best approach during retirement, when funds are being drawn down, is more debatable. In this article, I’m going to explain my reasoning for planning to continue my total return investing approach even after I retire.
By far the most common challenge I hear against total return investing during retirement is sequence of return risk, so let’s examine that objection first. Sequence of Return Risk
According to Investopedia : Sequence risk is the danger that the timing of withdrawals from a retirement account will have a negative impact on the overall rate of return available to the investor. This can have a significant impact on a retiree who depends on the income from a lifetime of investing and is no longer contributing new capital that could offset losses. Basically what this means is that if you retire near a market peak and start withdrawing funds, if the peak is high enough, the drawdown in asset values low enough, and the recovery of asset values slow enough, you could run out of money in retirement if your withdrawal rate is too high.
In reality, if you have adequate money going into retirement, lot of things have to go wrong for you to run out of money during retirement because of sequence of return risk, and so the probability of this risk actually causing one to run out of cash in retirement is low. The worst time other than 1929 to retire with bad sequence of return risk was in the year 2000. The market would have been negative for much of the following decade for someone who retired in January of 2000, and if one’s money needed to be withdrawn for retirement during this time, returns would have been even worse. Yet even during the worst historical retirement time in history, if a person would have withdrawn $4,000 per year from an initial portfolio of $100,000 invested in the S&P 500 index, and adjusted for inflation, they still wouldn’t have run out of money by 2021. Source: Portfolio Visualizer
Before adjusting for inflation, a portfolio 100% invested in the S&P 500 index ETF ( SPY ) could have paid out $4,000 per year and still have a balance of $48,588 in 2021. After adjusting for inflation, it would have a current value of $29,892. Assuming the person was 65 years old when they retired, they would be 86 or 87 now, and they would have survived the worst period for sequence of return risk in modern history. If a person would have retired during any other year during this period, returns would have been much better. Historically speaking, the odds are that you have around a 1 in 15 chance (give or take) of retiring during a very risky period as we had […]