Should you change your investment strategy in retirement?
The way that you have managed your investments during the asset accumulation phase really should not be that different when you retire. This advice might contrast what you may have previously learned. The textbook advice is that in retirement, you need to focus on income and keeping pace with the increasing cost of living. Your investments in retirement should be liquid and conservative. In the earlier accumulation years, your portfolio should be aggressive and be overweighed towards growth companies. Young investors should buy growth stocks and older investors should buy value stocks. Many large investment companies, mutual fund companies, and financial planners have built their entire businesses providing this lousy advice. Their solution is to put you in a model portfolio based on your age or invest you in a particular market style.
I believe that better advice can best be summarized by what Warren Buffett wrote in his letter to Berkshire Hathaway shareholders in 2000:
Market commentators and investment managers who glibly refer to “growth” and “value” styles as contrasting approaches to investment are displaying their ignorance, not their sophistication. Growth is simply a component – usually a plus, sometimes a minus – in the value equation.
Buffett also wrote about this argument back in his letter to the Berkshire Hathaway shareholders in 1992,
We view that as fuzzy thinking (in which, it must be confessed, I myself engaged some years ago). In our opinion, the two approaches are joined at the hip: Growth is always a component in the calculation of value, constituting a variable whose importance can range from negligible to enormous and whose impact can be negative as well as positive.
Buffett’s advice is that you need to understand the value of the investment that you are buying. It doesn’t matter if you are entering retirement or saving for retirement. In just the past 10 years, many retirees have been burned twice chasing yield. Many nest eggs have been destroyed chasing dividends. In 2008-2009, the market sectors known for paying the highest dividend yields fell the most. Banks and REITs where among the worst performing sectors dropping well over 70%. In 2014-2015, many retirees got caught again buying energy MLPs. These high dividend paying energy companies fell over 80%. All you need to do is search for MLPs and arbitration awards and you can see the amount of pending litigation.
The companies that pay the highest dividends are often the most leveraged companies. They have a combination of high amounts of debt on the balance sheet and very low growth rates. These businesses are viewed as more conservation because they generate their profits in highly regulated industries.
This week many analysts began to warn about the high valuations in the Utility Sector. Historically, this sector has done very well when interest rates fall, but struggles when rates begin to rise. It may be no coincidence that the Utilities Select Sector ETF fell 3% this week as the 10-year Treasury began to move higher. Time will tell whether Utilities will appreciate in value if interest rates continue to move higher.
If you are either saving for retirement or already in retirement, I recommend that you pay more attention to the price of what you are buying rather than whether it pays you a large dividend or has a high growth rate. Many of the portfolios that I manage for clients whether young or old, have similar allocations. There does tend to be more bonds and conservative investments in my retirees’ portfolios, but the equity positions are the same. If I believe an investment is undervalued, the only difference is the size of the position that I will hold. Retirees have less time to recover from difficult markets. The market risk can be somewhat managed by taking smaller positions and through diversification.
The next time a wealth advisor or financial planner tries to put you in a model portfolio or tells you to buy only dividend sectors, your next questions should be: is this at a good price and what is the interest rate risk?
If you would like to speak with me about building a diversified portfolio through customized portfolio management that aligns your risk tolerance with your financial goals, feel free to send an email to mitch@cgfadvisor.com.
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