In this episode, podcast host and author of “Control Your Retirement Destiny” covers Chapter 5 of the 2nd edition of the book titled, “Investing.”

If you want to learn even more than what there is time to cover in the podcast series, you can find the book “Control Your Retirement Destiny” on Amazon.

Or, if you are looking for a customized plan for your retirement, visit us at sensiblemoney.com to see how we can help.

Chapter 5 – Podcast Script

Hi, this is Dana Anspach. I’m the founder and CEO of Sensible Money, a fee-only financial planning firm. I’m also the author of "Control Your Retirement Destiny," a book that covers all the decisions you need to make as you plan for a transition into retirement.

The book has outstanding 5-stars reviews on Amazon. If you like what you hear today, go to Amazon and search for "Control Your Retirement Destiny." Or, if you are looking for a customized plan, visit sensiblemoney.com to see how we can help.

In this podcast, I’ll be covering the material in Chapter 5 on investing. We’ll continue the case study of Wally and Sally, and look at how the plan we created for them in Chapters 2 through 4 becomes the blueprint for how they should invest.

Let’s get started.

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When I meet someone new, almost without fail, the conversation goes something like this.

They ask, “What do you do for a living?”

“I’m a financial advisor,” I say, or “I own and run a financial planning firm.”

From there the typical reply is along the lines of,

“Oh, what do you think of the markets right now? What should I be buying? What are your thoughts on Apple stock? What will happen if so and so wins the next election? What should I be investing in?”

“You should be investing in a good financial planner,” is what goes through my mind.

Investing is like a prescription. It’s what you do after you’ve gone through a thorough exam and diagnosis.

This where I think most of the financial services industry gets it wrong.

Take a thirty-year-old as an example. They are investing in their 401k. They are nervous about losing money. They either fill out an online risk questionnaire or meet with a financial advisor - and this is supposedly the exam part. They express their concern about losing money if the market goes down. Then the diagnosis part. The computer model or advisor recommends they invest in a balanced fund that maintains an allocation of about 60% stocks and 40% bonds.

This is not a terrible recommendation - but to me - it seems like a recommendation made for all the wrong reasons.

At age 30, under normal circumstances, the earliest you can withdraw from your 401k is age 59 1/2 - about thirty years in the future. You would think the primary goal would be the investment mix that maximizes the potential for return over a thirty-year time horizon. Yet, almost the entire financial services industry focuses instead on minimizing the downside risk, or volatility, that you might experience in any one year.

Why? It makes no sense to me.

Why would I structure my investments to reduce short term volatility for an account I’m not going to touch for thirty years?

Contrast this with someone who is age 65 and about to retire. One popular rule of thumb says take 100 minus your age and that is what you should have in bonds. I’ve also heard a version of this rule that says take 110 minus your age. Following this type of rule, you come out with a 65 - 75% allocation to stocks and a 25-35% allocation to bonds. In many cases, it is the same recommendation made to the thirty-year-old. Is this recommendation aligned to your goals? It might be. But in many cases it still doesn’t add up.

For example, suppose in your plan you are drawing out of a taxable brokerage account first - then your IRA when you reach age 70, then your spouse’s IRA, and he or she is five years younger than you. Suppose you also each have a Roth IRA, but you don’t plan on touching that account at all. Should all of these accounts be invested with the same risk profile, with about 60% in stocks and 40% in bonds? In my mind that makes no sense at all, yet that is the type of investment recommendation most often given.

What does make sense to me is to assign each account a job description and invest that account according to the job it needs to do. That means if your spouse is age 60 and won’t be touching their IRA until age 70, which is ten years away, that account can be invested differently than the account you’ll be drawing out of next year.

To make better investing choices that are more aligned to your goals, there are a few key things to know. Here are the ones we’ll be covering in this podcast.

How to measure risk - And the two most important questions you can ask before making any investment.

Something called “The Big Investment Lie” - and why we are so prone to believing it.

The importance of tracking results relative to your plan.

We’ll start with measuring risk.

There are two questions I’d love to hear everyone ask before making an investment. The first question is “Can I lose any money?”

If you are retiring next year, and will need to withdraw $50,000 to help cover your living expenses, when it comes to HOW that $50,000 is invested you want the answer to the question “Can I lose any money?” to be NO. In most cases, if it is money you need to use in the next five years, you want it invested safely.

On a scale of 1 to 5, I think of this as a Level 1 risk. A Level 1 Risk represents a safe investment. it may not earn much interest. But you also know it won’t go down in value.

The next question to ask is “Can I lose all my money?” This question is more difficult to answer. What if you bought 100 shares of a stock? Can you lose all your money? Yes. Many great publicly traded companies have gone bust over the years. I call this a LEVEL 5 RISK. I recommend most retirees avoid taking Level 5 risks.

Now, what about a Level 4 risk? This one is trickier. Let’s look at an example.

Suppose I told you of an investment that for over 90 years has an average return of 10% a year? Sounds good, doesn’t it. You invest $100,000. A year later it is worth $60,000. You sell it, fearful you’ll incur more losses. You call me a liar, and decide investing doesn’t work. From that day forward, you keep your money in the bank, where it safely earns a few percent a year.

Now, instead, suppose I describe an investment that gives you the potential to earn more than double what bank savings accounts are paying. I explain to you that this investment is not something you should use if you need your money in the next few years. I also tell you that in any single year, this investment could be down as much as 40%, or, up as much as 40%. I also explain that your results can vary widely depending on how the next 20 years turns out. I show you that in the past, during the worst 20 years this investment earned a return about the same as safe investments, and over the best 20 years, it earned returns much, much higher.

You are now taking a calculated risk with the expectation of volatility. You invest $100,000. A year later it is worth $60,000. You don’t like it, but you knew this could happen and you’re in it for the long term. You hang on, and by the end of ten years it is worth $191,000.

Both scenarios reflect the same investment - an investment in an S&P 500 Index Fund. The difference in the results are due to investor behavior - not due to the investment.

The S&P 500 measures the performance of the stocks of 500 of the largest companies in the U.S. When you own an S&P 500 Index fund, you own a little piece of each of the 500 stocks. Can you lose all your money in this investment?

Hypothetically, yes. All 500 companies would have to go bankrupt at once for this to happen. If that happens, I believe the world as we know it has ended, and we’ve got much worse problems on our hand than how much is in our 401k account.

With a risk level 4 investment, like an index fund, you know you’ll experience ups and downs. The primary factor in how well you do, will be your behavior - how you use this investment. When used with reasonable expectations, level 4 investments usually help you achieve your goals.

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In the earlier chapters of the book we began following a couple, Wally and Sally, who were planning their retirement. Let’s see how this concept of risk levels and aligning investments to a goal works for Wally and Sally.

After projecting several potential withdrawal plans, Wally and Sally could see that drawing funds out of their non-retirement account in their first four years of retirement would be the most tax-efficient choice. As they will need these funds soon, they invest this account, about $250,000, all in safe investments.

Next, their plan has them withdrawing from Wally’s retirement accounts starting in about year five of retirement. When they get to year five, they don’t want to be concerned about the market being down – instead they want to know the first five full years of planned withdrawals from this account are safe. Those withdrawal amounts add up to $105,000. The total account value is $365,000. They invest the $105,000, or 29% of the account, in safe choices. The remaining 71% of the account is invested to growth, or Risk Level 4 choices.

They don’t plan to touch Sally’s retirement account for at least six years. But when they get out to year seven, where they will need to use it, they want her first three years of withdrawals in sa