Do You Have a Written Investment Plan?

Investing without specific goals in mind and a written plan designed to achieve those goals is like sailing on a ship without a rudder, wandering aimlessly whichever direction the wind blows.

So where to begin?  First, think about your goals. Let's assume you're 50 years old, and would like to retire by age 62, and have accumulated $250,000. Ask yourself the following question:  If I were to retire not at age 62, but next month, about how much would I need in monthly income from my portfolio above and beyond what I'll receive from estimated social security and pension benefits to maintain my standard of living?

Let's assume the answer to this question is $3,000/month, in today's dollars. This is $36,000 per year. Using historical trend line inflation assumptions of 3% annually, $36,000 today would be about $51,000 at age 62 ($4,250/month). 

Next, divide $51,000 by 4.5% (a reasonable portfolio withdrawal rate for a 3 decade retirement), which equals $1,133,333.

Congratulations! You've now began the process of creating a date specific, dollar specific, retirement accumulation plan. If at age 62, you began to withdraw $4,250/month, increased by 3% per year for inflation, from a $1.1 million nest egg, the odds are in your favor that your portfolio will outlast you if invested wisely and followed faithfully (something I will only briefly touch on in this post). 

The next question should be obvious: How are we going to grow our portfolio from $250,000 to $1.1 million over the next 12 years? This becomes a question of required rate of return. Without any further contributions, this would require about 13.4% CAGR (compound annual growth rate) over the next 12 years. Possible, but just as we assume trend line inflation, I wouldn't suggest building a plan that assumes anything much different than trend line asset class performance. Many will also factor in current valuations for global stocks and bonds, but we're intentionally keeping it simple here for illustrative purposes.

Since 1926, cash (US T-bills) has returned about 3.4% per year. The US stock market has returned about 10.6% per year. This is an equity risk premium (equity return in excess of cash) of about 7%. With cash currently yielding about 2%, that would imply an equity return assumption of about 9% before fees and expenses and any other portfolio assumptions such as global diversification, tilts towards known factors such as size, value, and momentum...valuation considerations, etc. Asset allocation assumptions such as how much (if any) to keep in cash, bonds, and alternative strategies should also be accounted for depending on your personal risk tolerance for both portfolio volatility and tracking error (performance variation) from standard benchmarks like the S&P 500. And let's not forget about portfolio management decisions, such as when and how often to rebalance as your portfolio allocations drift over time. The more specific you can make your plan, the less decisions you'll be forced to make during the heat of battle when human emotion and behavioral bias get involved.

Assuming you have the historical perspective, patience, and temperament to earn the equity risk premium with disciplined behavior, a diversified equity portfolio returning 9% would require annual contributions of just under $20,000 for the next 12 years. A portfolio that includes lower expected return asset classes, or is impacted by human intervention that results in less than market returns, will require more. Potentially much more.

The next consideration is what type of account(s)? Regular taxable brokerage? IRA? 401(k)? Maybe even a triple tax free HSA, if eligible? Tax implications have a substantial impact on your plan over the long run, and can often lead to higher net returns than selecting "better" investments, whatever that means. 

Fast forward 12 years, and let's assume you've made it to the finish line. But then you realize what you thought was the finish line is really just the beginning! Now what? Accumulation now seems like it was the easy part, and now you need an income plan from your portfolio for the next 3 decades...Do you switch from equities that got you here to bonds because they provide "income?" Using the same assumptions as before, with cash yielding 2%, and bonds about 3%...ask yourself this common sense question: Would you rather face a 3 decade long retirement taking 4.5% per year from bonds producing income of 3% or from equities with a history of producing 9-10% total returns? At this point, the conventional wisdom that bonds are "safe" and equities are "risky" is probably beginning to sound a bit backwards.

An equity focused portfolio may be as necessary post retirement as it was pre retirement. Managing sequence risk with concepts such as "guardrails" where you will keep your withdrawals within a floor of 3% and ceiling of 6% should also be considered as portfolio values fluctuate. A pre-retirement emergency fund of 3-6 months of expenses could be increased to 2 years of expenses in retirement as well, meant to be accessed during bear markets when equity values are depressed.

I'll stop here for now, as I've given you plenty to think about and work on in building out the first draft of your long term investing plan. A small percentage of individuals will be interested and able to do this on their own, and maintain discipline at market extremes.  The rest may find that a relationship with an investment advisor who offers comprehensive financial planning, perspective, and behavioral coaching provides value and peace of mind far in excess of the fee they are asked to pay. Vanguard Research believes this value to be about 3% per year, many multiples of what good advisors charge in annual fees.

Jesse Blom is a licensed investment advisor and Vice President of Lorintine Capital, LP. He provides investment advice to clients all over the United States and around the world. Jesse has been in financial services since 2008 and is a CERTIFIED FINANCIAL PLANNER™. Working with a CFP® professional represents the highest standard of financial planning advice. Jesse has a Bachelor of Science in Finance from Oral Roberts University. Jesse is managing the LC Diversified portfolio and forum, the LC Diversified Fund, as well as contributes to the Steady Condors newsletter.