Oh, retirement. Imagine long pleasant walks on the beach. Or you watch the sunset from the balcony of your cruise ship and think to yourself: this is how life should be. Then you casually check your smartphone to see how your investment accounts are doing and, gasp! You may not be as rich as you thought.
Retirees are facing major headwinds right now when it comes to investing: problems in Ukraine, rising inflation and stock market turmoil to name a few. If you’re retired or close to retirement and wondering what you can do with your portfolio, here are three ideas I share with some of my clients:
1. Consumption defensive actions
I want customers to be as diverse as possible. However, I can tilt their portfolio towards consumer defensive stocks for retired or more conservative clients. Defensive stocks typically include utility companies like natural gas and electricity providers, healthcare providers, and the companies whose products we use every day, like toothpaste companies or grocery stores and grocery stores.
According to the Center for Corporate Finance, a leading financial educator for finance professionals, defensive stocks tend to be less volatile than other types of stocks. Less volatility can mean less upside potential, but it can also mean less downside risk, which I find is what many retirees want – less downside (and hopefully better sleep at night).
2. Obligations for retirees – but not just any
I like municipal bonds for retirees. Municipal bonds are issued by states, cities or local municipalities. There are many types of municipal bonds. General obligation municipal bonds are guaranteed by the tax authority of the issuer, which means that the state or municipality uses taxes to pay interest to bondholders. Revenue bonds are municipal bonds backed by a specific project. A toll road uses tolls as revenue to pay bondholders.
Municipal bond interest is generally exempt from federal taxes (although there may be alternative minimum tax (AMT) considerations for certain types of investors). If you live in the state where the bond is issued, the interest may also be exempt from state taxes.
I like tax-free interest for retirees for several reasons. Retirees may have other sources of taxable income, such as pensions, annuities, or rental income, the income from which may push them into a higher tax bracket than expected. Retirees can also withdraw money from 401(k)s and traditional IRAs in retirement for required minimum distributions, which are taxable as ordinary income. Having tax-free interest can prevent the retiree’s income from climbing into the next higher tax bracket in retirement.
Findings from the 2019 Municipal Finance Conference suggest there is less risk of default with general obligation bonds than revenue bonds. Indeed, revenue bonds generally depend on the vitality of a project, which is more uncertain than the ability of the state or municipality to raise taxes to pay a general bond obligation. For this reason, I may tilt a portfolio more towards general-purpose municipal bonds than towards revenue bonds for retirees.
Municipal bonds are not without risk. There is no principal guarantee and the market value will fluctuate so an investment, if sold before maturity, may be worth more or less than its original cost. Like any bond, municipal bond prices can be negatively impacted by rising interest rates. Additionally, municipal bonds may be more sensitive to economic downturns – investors may fear that a struggling state’s economy may be unable to repay the bond.
For these reasons, I like to be as diverse as possible. I can use short-term municipal bonds for more capital stability and less interest rate risk. I could also incorporate medium-term municipal bonds for additional yield. If the portfolio is greater than KI$250, prefer to buy individual municipal bonds for greater customization and tax loss harvesting opportunities.
3. Beyond stocks and bonds
I like to sprinkle small amounts of other investments. I call them my “satellites”. Depending on the client’s financial situation and risk tolerance, I may add real estate or small amounts of commodities including coal, gold, corn, and natural gas. I generally use mutual funds or exchange traded funds for diversification and relatively low cost. I generally only buy small amounts, maybe 2-5% of a portfolio, to help diversify the portfolio and provide a hedge against inflation.
Inflation is a major real enemy for retirees. Rising prices erode the purchasing power of a portfolio. One good thing about owning real estate is that the landlord can often raise rents, which is a hedge against rising prices. I can buy real estate investment trusts (REITs) that combine various properties. I can also use private REITs, which are not publicly traded and therefore less liquid, for more sophisticated investors. Private REITs aren’t for everyone, as they tend to incur higher fees, don’t have daily published prices, but they often offer a higher return than publicly traded REITs.
For more on fighting inflation, check out my blog post Could inflation affect your retirement plans?
Investing in retirement is different from investing while working. In retirement, an investor’s time horizon shrinks – they need the money earlier to live on, and there’s no paycheck to replenish the account. A retiree’s portfolio also has less time to recover from a stock market correction. For this reason, I find that retirees fear losses more than they enjoy their gains.
Understanding these differences is important for successful retirement investing. Using these three approaches – moving a bit more into defensive consumer stocks, using municipal bonds to help prevent new taxable income, and adding small amounts of inflation-fighting investments like real estate and possibly commodities – in my opinion, can help sweeten the ride for retirees.
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Disclaimer: Summit Financial is not responsible for any hyperlinks and externally referenced information found in this article. Diversification does not guarantee a profit or protect against a loss. Investors cannot buy an index directly. Individual investors’ portfolios should be constructed based on the individual’s financial resources, investment objectives, risk tolerance, investment time horizon, tax situation and other relevant factors.
CFP®, Summit Financial, LLC
Michael Aloi is a CERTIFIED FINANCIAL PLANNER™ Practitioner and Certified Wealth Management Advisor℠ with Summit Financial, LLC. With 21 years of experience, Michael specializes in working with executives, professionals and retirees. Since joining Summit Financial, LLC, Michael has implemented a process that emphasizes integrating the various facets of financial planning. Supported by an in-house team of estate and tax specialists, Michael provides clients with coordinated solutions to disparate issues.
Investment advice and financial planning services are offered by Summit Financial LLC, an SEC-registered investment adviser, 4 Campus Drive, Parsippany, NJ 07054. Tel. 973-285-3600 Fax. 973-285-3666. This document is intended for your information and advice and is not intended to be used as legal or tax advice. Clients should make all decisions regarding the tax and legal implications of their investments and plans after consulting their independent tax or legal advisers. Individual investors’ portfolios should be constructed based on the individual’s financial resources, investment objectives, risk tolerance, investment time horizon, tax situation and other relevant factors. Past performance is not indicative of future results. The views and opinions expressed in this article are solely those of the author and should not be attributed to Summit Financial LLC. Links to third party websites are provided for your convenience and informational purposes only. Summit is not responsible for information contained on third party websites. Summit’s financial planning design team has admitted attorneys and/or CPAs, who act exclusively in a non-representative capacity with respect to Summit clients. Neither they nor Summit provide tax or legal advice to clients. All tax declarations contained in this document have been not intended or written to be used, and may not be used, for the purpose of avoiding US federal, state or local taxes.