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6 Retirement Portfolio Red Flags


Investors that are in or nearing retirement have to think differently than those in the growth phase of their life cycle. If you have been fortunate enough to amass a sizeable nest egg, rule number one is to not lose it. Rule number two is to not let anyone else lose it for you.

Topics such as income needs, risk tolerance, asset allocation, security selection, and choosing the right advisor to implement a coherent strategy are crucial decisions. This will likely be driven by a mix of your personal investment philosophy, market outlook, and other exogenous factors.

Remember that every household is unique and should be treated accordingly. You may think that you want the exact same solution as your neighbor. However, they may have completely different factors that influence their investment strategy and may not be appropriate to meet your goals.

No matter what your situation is, these red flags come up repeatedly when I am doing portfolio reviews for prospective clients. I urge you to be cognizant of avoiding these pitfalls as you are implementing a realistic retirement portfolio that will go the distance.

Commitment to high fee mutual funds

High fee mutual funds are still one of the worst ways you can invest your money in the stock market. Here are the two main problems with these legacy products: (1) they create a phantom drag on performance by the nature of their exorbitant expenses and (2) they are susceptible to underperforming a passive benchmark with little marginal alpha in the rare event they outperform.

I’m not here to tell you that you need to be 100% passively indexed to a basket of exchange-traded funds. However, you should be consistently monitoring the progress of any mutual funds versus their peers to determine if they are adding value. There are still a handful of funds that do offer unique strategies or consistent enough performance to warrant your money, but they are few and far between.

Often these are kept in your portfolio because you or your advisor are just too lazy to change them out. There may also be barriers to exit such as redemptions fees or other hidden incentives for your manager that you aren’t aware of.

Shotgun approach to security selection

When in doubt, just own 3 or 4 of everything. This is the motto of many portfolio managers who are trying to seem smart by loading you up with 20, 30, or 40 funds. I mean do you really need 3 large-cap value mutual funds? Trust me, they aren’t going to be that different at the end of the day.

I call this approach the “shotgun” method because these portfolios are just predicated on the notion of a high volume of holdings to spread your wealth around and create maximum confusion.

A more targeted or “sniper-like” approach is to hone in on the core areas of your portfolio that you can own in just 3-5 low-cost index funds. This will still result in a well-diversified retirement portfolio that is easier to track and understand on a long-term basis. Then you can add in some additional tactical positions to gain exposure to specific themes or other sectors of the market that you believe will outperform.

High allocation to money market or low duration bond funds

I reviewed a portfolio from a local advisor the other day that was 25% cash and 25% low-duration bond funds. Let’s face it, that’s 50% of your portfolio that won’t earn more than 1% in the current market environment. The investor who shared this information with me stated that his account had been in that state for the last two years and the advisor is just being cautious.

You can spend years of your life and waste precious opportunity by waiting for the next bear market to appear. Meanwhile, with 50% of your portfolio virtually in cash, you are now asking the remaining 50% to pull the entire load in generating your returns. This means that to achieve a 6% total return, the 50% that is invested will have to rise by 10%. That’ just not a feasible approach to generate the type of consistent and steady gains you need to reach your long-term goals.

In addition, there is no guarantee that this advisor will end up putting that money to work in the market when there is a significant dip. If they haven’t been disciplined enough to invest this capital for two years, why is there any reason to believe they will change their tune near the market bottom?

Don’t let fear keep you from implementing a balanced and steadfast retirement income portfolio.

Over dependence on high yield

One of the problems that the 2015 market flushed out was the overdependence on high yield securities. Junk bonds, master limited partnerships, bank loans, and other credit sensitive areas took a big hit in their prices as income investors moved to a risk averse stance. If you were unfortunate enough to feel significant pain from this recent down cycle, then it highlights a fundamental flaw in your strategy.

There is no free lunch when it comes to high yield. The promise of greater income also comes with it an associated cost in higher volatility and potential loss. I have always advocated taking a conservative stance by pairing high quality and high yield securities together in order to mitigate the effects of this volatility. That way you are still able to maintain a reasonable yield without taking too much risk.

Having to prod your investment advisor

An open dialogue with your advisor is a crucial component of a successful relationship. My favorite clients are the ones who challenge me with fresh ideas or ask questions to better understand their opportunities and risks. However, if you find yourself constantly prodding your advisor to move to low-cost ETFs or develop a clear strategy, then are you likely in a toxic relationship.

Many advisors are better salesmen than portfolio managers. Putting together a sensible portfolio isn’t on the securities exam to be licensed in this business. They may also be financially motivated by other hidden factors to keep you in certain investments or to remain as passive as possible with your portfolio.

Your advisor should be compensated in a fair arrangement that places your interests and theirs on the same side of the table. They should also be motivated to place you in the lowest cost investments to achieve the best returns. Lastly, they should be implementing a cohesive strategy that resonates with the current market environment and makes sense with respect to your personal investment philosophy.

The grass isn’t always greener in an annuity

The lack of forward progress last year is a frustrating facet of investing in stocks and bonds. Returns aren’t linear. Rather they come in unpredictable cycles that are often difficult to capture if you aren’t disciplined with your investment decisions.

This frustration may lead to some investors shopping for a “guaranteed” alternative that usually takes the form of an annuity. Many investors simply give up on the investing game and turn their retirement portfolio over to an insurance company to provide a lifetime income stream. This is what’s known as an immediate annuity.

While the allure of a guaranteed income stream can be attractive, it also comes with risks as well. Namely giving up all your liquidity and the lack of flexibility. What if you needed a lump sum of money all at one time for an emergency? What legacy will you leave your children or other heirs? Do you fully understand all of the costs and fine print in these products?

These are just some of the important questions that will need to be answered in order to determine if an annuity is right for you. The grass isn’t always greener when it comes to analyzing the pros and cons of these income alternatives.

The Bottom Line

The beginning of the year is a perfect time to do some in-depth analysis of your retirement portfolio to determine if it’s performing to your expectations. If you find that you are fighting one or more of the issues outlined above, it may be time for a change in your strategy.

Start by writing down a list of your goals by order of importance – i.e. capital preservation, income, growth, leaving a legacy to heirs, etc. Once you have completed this exercise, you can move on to interviewing new advisors or searching for an investment philosophy that aligns with your needs. Make sure that any changes are implemented after suitable due diligence and with patience to ensure you don’t experience any further setbacks.

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