How to Assess Risk and Investment Strategies for a Million-Dollar Retirement Plan?

Hey, I'm Casey Weade, CEO and founder here at Howard Bailey Financial and also a certified financial planner practitioner. I'm here to walk you through how to invest a million dollars in retirement, but we have to make a few pit stops along the way. We're going to be answering the question, can you take the risk in retirement? Then we're going to be talking about how much risk you can take in retirement.

We're going to talk about how to allocate those dollars and how to build a bucket income strategy. But as I said, the first question that we have to ask is, can you take the risk? We like to ask this question using an acronym, that is, do you have the capacity for the risk? Do you have the attitude for the risk and do you have the need to take the risk in the first place? What do we mean by each one of these things? Well, capacity and need are really technical terms at the end of the day that come out of your specific financial situation. Do you have the ability to take the risk and do you need to take the risk? The attitude piece is all about your attitude towards taking risk.

When the market takes a nosedive, is it going to give you anxiety? If you're down 10, 20%, is that going to give you anxiety or are you going to say, hey, the market always comes back? So we have to get into some behavioral finance talks along the way, but let's talk about these individually as it pertains to some specific examples. So we take a look at someone that has $10 million in assets saved for retirement and they want to generate $25,000 a year from that $10 million. Well, we know they could bury it in the backyard and have enough to last the rest of their life, right? Even if we experience inflation, they're going to be okay.

So someone in this situation where they're spending way less than they could in retirement, they have plenty of capacity to take risk in retirement, but they don't have the need to take that risk in retirement. So it really becomes about the attitude. We want to see that you have at least two out of three of these different attributes in order to start taking risk at all in retirement.

Then we take a look at someone that has $250,000 saved for retirement spending $25,000 a year. Does this person have the capacity to take market risk? Really no. They can't afford losses in retirement because if that 250 goes to 125, they're going to be running out of money pretty quickly in retirement.

This is someone that doesn't have the capacity, but there's a dichotomy here because they have the need to take the risk. They're not going to be able to generate enough income off of fixed income instruments or guaranteed or safe instruments to generate enough income to last the rest of their life in all likelihood. So they need to take the risk, but do they have the attitude to take the risk? And someone in that situation, if you're finding yourself in that position, you're probably going to say, well, I need to make some adjustments.

We're probably going to encourage you to reduce that spending need, reduce some of your expenses or continue to work for a longer period of time. Those are going to be the most responsible things to do. And then we have the scenario that we're talking about today.

Someone that has about a million dollars saved for retirement and they want to spend $25,000 a year. Well, that's 2.5% of their million dollars. Do they need to take risk? They probably don't need to take risk, especially in this current interest rate environment we find ourselves in.

Now, if we're in a 0% interest rate environment, maybe they need to take a little bit of risk, but someone that's spending 2.5% of their nest egg probably doesn't need to take any risk. Do they have the capacity to take some risk? They absolutely have some capacity to take some risk in retirement. So again, it's coming down to the attitude, especially for this couple.

What is their attitude towards risk? Now, this couple we're talking about here today, we know they have the capacity. They don't have the need, but this is a couple that said, you know what, we're okay taking some risk in retirement. We don't want to risk our entire nest egg.

We want some safe money. We want some protected money. We want some downside protection, but we are willing to take on some risk.

So now that leads us to the next part of this discussion, which is, well, just how much risk should we be taking with our million dollars, wanting to generate $25,000 a year in income from that bucket? And I also want to mention that this is their supplemental income, supplementing their social security income. So this is a couple, we're going to be taking a deeper dive into our planning software, and you're going to see that they're getting about $4,000 a month in social security income. So this is getting them to around $6,000 a month net after tax income in retirement, and that's their overall spending goal.

So they don't need to meet that entire spending goal from their nest egg. This is just supplemental income. So let's go ahead and ask that question.

How much risk should this couple be taking? So you've probably heard of the rule of 100. The rule of 100 is something that's been around for a long time that really shows you how much risk should you be taking in retirement. And this is kind of a rule of thumb that lasts your entire life.

So if you're 20 years old, you put a percentage behind that number, you should have 20% of your assets safe, protected, you should have 80% at risk. If you're 65, as this couple is, they should have 65% of their assets protected, 35% at risk. However, it's just a rule of 100.

And this is my big problem with rules like this. The rules of thumb, they don't really come down to creating a personal financial plan for yourself. This is not personalized financial planning.

We have to be very cautious with using rules of thumb, as you can see from this example. So if they're 65, 65% being safe would mean they need to have $650,000 down here in that safe bucket, $350,000 in this at-risk bucket. And I also want to mention, we're not talking about a bunch of different tools right here, because at the end of the day, there's either risk money or safe money.

There's only two ways you can invest your money. It's either at risk or it's safe. And so we want to talk about it from a high level.

At this point, we're going to take a deeper dive into different risk levels here in just a moment. But this isn't really how they should be allocating, because we should be allocating based on their unique need, not some rule of thumb. Their need is something that we use this risk triangle because there's three points on the triangle.

And there's three points to allocating dollars to safe money or at-risk money. That is, these bottom two points is you're going to need some money for emergencies in retirement. That has to be protected.

We don't have the ability in our retirement years to just slap something on a credit card and do a little bit of overtime to pay it down. We need to make sure we always have those emergency dollars available. They want to have 12 months of their expenses covered.

And this is what's different in retirement versus during your working years. During your working years, all of that income is variable, right? You lose your job, you lose all of your income. In retirement, they have Social Security benefits.

So we're really only concerned with that income that's being generated from their investments. And we want to set aside about $25,000 for that emergency need that can be there safe and secure in some savings account or bank account. And for you, maybe that's $12,000.

Maybe that's $100,000. This is where we get into deeper planning discussions around your specific attitude towards risk and your money in general. Then we have this other point over here.

So we talked about emergency savings, wanting that safe. Then we have another point over here, which is the dollars that we can't live without. This is our non-discretionary income need.

And we're setting aside $250,000 to cover that. Why? Well, we want to generate $25,000 a year every year. We're setting aside 10 years of income needs to ensure that they're always going to be there and be able to be covered.

Now, for you, you might say, I want five years covered. I want three years covered. I want 15 years covered.

You have to make it personalized for yourself, of course. But we're coming down to this 10-year number here. And there's a lot of market research that backs up that 10 years is about the right number when we look at some of the lost decades we've had in the past, the bad times we've had in the markets.

We could have had a period of time, just like we did from 2000 to 2010, where the market went through two major market downturns and took about 10 years to recover. Then with that, I want to take this another step. I want to talk about dollar-cost averaging.

So when we talk about dollar-cost averaging, on the way to retirement, that's what you do is you're putting money into that 401k. So for those of you watching this video, you're saving for retirement. You're not timing the market.

You are just making a specific allocation out of every paycheck into your 401k. Or if you're putting money into an IRA or a non-qualified account, for that matter, you should be systematically allocating dollars to the market. Why? Because when the market's high, you're buying less of the market.

Think about it like buying less shares. When the market's low, it's less expensive. You end up buying more of the market.

So you essentially end up timing the market without having to know anything about the market just due to the natural price fluctuations that happen. And we know that the market goes through some pretty serious price fluctuations as we've seen through the financial crisis, through the tech bubble, et cetera. Now in retirement, that dollar-cost averaging becomes reverse dollar-cost averaging or RDCA.

Now instead of putting money into the market at these different intervals, you're starting to take withdrawals. And what's the number one rule of investments? You want to buy low and sell high. If you're indiscriminately taking income from a portfolio that's doing this, you're going to end up violating that number one rule of investments systematically.

Now you're running the risk of running out of money in retirement. This is also known as systematic return risk. So that return risk that you could have a bad period of time as soon as you step into retirement.

So you want to be careful of that and you want to plan for that. And that's why we want some safe money set aside. They end up with about $275,000 in that safe bucket.

And then everything else they can take risk with, about $725,000 allocated to that at-risk world. But let's take it a step further and start building out an allocation, start building out what I like to refer to as your fiscal house. So your fiscal house, it looks like this, and it's a great metaphor because of this.

When you think of a major hurricane or a major storm or a tornado running through the Midwest, you see all of that devastating destruction. But what's remaining? The foundation is always remaining, right? And if we go through a major storm, or if you go through a major storm, maybe you lose some ceiling tiles, maybe you lose some roofing tiles on your roof and you have to repair it, but the roof is still there. And so we want to have some foundational dollars, our foundational dollars that we can't live without.

That is $25,000 for our emergency and $250,000 allocated to our fixed income, giving us $275,000 in that foundation. Then we're starting to take some risk. So we get to that other $725,000 that we said we were going to take some risk with.

We have a half a million of that that's going into the walls. And if you think about a house, the walls, that half a million dollars, it's not just made up of drywall, right? There's a lot of different things in there. So we want a diversified approach, and that's really the metaphor.

We're taking a diversified approach to generating yield or generating income, which creates a little bit more stability in that piece of our portfolio. For this couple, they wanted to generate some additional income just in case they wanted to take the grandkids on a trip to Disney, or if they wanted to go on a trip around the world, they need to put in a new water heater, et cetera, right? They wanted some flexibility in that plan so they could go jump over and grab some additional income should they need it. So this is our dividend income strategy with those remaining dollars being allocated for long-term growth.

Long-term growth is going to be our best inflation hedge. So these are the dollars that we might go to if we experience high rates of inflation in the future and they need to make some income adjustments. If you'd like to get a free personalized income analysis as well as a personal financial review, all you have to do is call the number on your screen to meet with one of our fiduciary financial planners that meet with people across the entire country.