It’s about time again for another post in my Ultimate Retirement Guide Series. As a refresher, the goal of this series will be to provide an in-depth answer to this question: “what do I need to do to retire?” As well as any questions that could stem from that initial question. The goal is to have this cover all of the information I’ve looked at since I started really becoming interested in retirement saving, both early or traditional. I hope to mostly focus on items that have been relevant to me in my own experience and where I am in my journey at the time of writing. Throughout, I will try to present as unbiased a position as possible, but I’m sure that I will not be perfect.
So far, we’ve laid out the following five large steps needed to retire:
- Determine when to retire.
- Determine the amount needed to retire.
- Save that amount.
- Prepare to transition from working to retirement.
Currently we’ve been working through step 2 by breaking it into the following subsections.
- The 4% rule of thumb
- Other withdrawal rates
- Other withdrawal strategies
- Length of retirement (and sequence of return risk)
- Asset Allocation
- Different types of investment strategies (rentals, stocks, ect.)
- Other expenses
- Visualizing retirement
Last time we talked about asset allocation. Mostly in the stock market. This time I thought we would take a look at a few different strategies someone could take.
As with most things on this site, I am not a financial advisor nor another form of expert. Everything below should be taken as opinion. Always consult with your financial advisor before making changes.
What will we cover
While you can throw a rock and hit a new investing strategy, we should probably refine our scope somewhat. For the purposes of this post we’ll discuss at a fairly high level the following strategies I’ve found to be the most common: stocks, index funds, dividend stocks/funds, and real estate. I’d consider some of the more out there stuff such as options to be sub groupings under these larger strategies. I find crypto, and other exotic assets, to not be something that I could write about at a high enough level to include either.
All about stocks
Let’s start with all of the stock strategies. These are, I believe, the most common way people save through retirement. Usually via vehicles such as their 401(k), Roth IRA, and taxable investment accounts.
The easiest one to talk about is stock picking. At its core, stock picking is trying to outperform the index by picking individual stocks. While the easiest to talk about, I think this is the hardest to successfully pull off. While you can buy individual stocks and do all of the necessary research, it’s difficult to pick a basket of stocks. To do this successfully you have to research and keep up to date with all the stocks that you own. Furthermore, this strategy may require a large amount of capital since depending on your brokerage firm you may not be able to buy partial shares.
The easiest way to be successful with stock picking is to have a huge number of stocks, because what if you’re wrong with one of them. Say stock XYZ is cut in half (or in the worst case, goes to $0), we’ll then have stock YXZ that may not have lost any value or even increased in price. Conventional wisdom is to not have more than 20% in any one stock position. However, if you spread that net wide enough and you’ll have our next strategy.
The darling of the FIRE community (and many other DIY investment communities). Index funds are an easy way to cast a wide net. At their core, an index fund tracks an index, say the S&P 500. While every index is different they all track some basket of stocks like the S&P 500 tracks the 500 largest US stocks. The Dow Jones uses a committee to select and then biases it based on market cap. Other indexes use different their own rules to decide what makes the cut.
An index fund simply tracks one of these indexes. For instance, buying an S&P 500 fund lets you buy shares of every stock in the Index without much effort. These index funds also tend to be cheaper than buying the individual stocks as you’re only buying a portion of the underlying shares.
Index funds also handle the concentration risk problem. If 100% of my portfolio is in the S&P 500 that means that about 0.2% of my net worth is wrapped up in any individual stock.
Finally you have less work to do. An index fund automatically gets rid of your losers. To use the S&P 500 example again, if a stock leaves the S&P 500 the index fund sells that stock and buys whatever replaces it. Something you’d have to do yourself if you owned the individual stocks.
The downside of index funds is that in theory you have lower returns than other strategies (assuming those strategies are successful). As there is a lower risk to casting such a wide net, you also get less benefit from the winners as the amount they make up in your portfolio is diluted. Plus everyone else knows it’s a fairly safe strategy.
Finally, at least as far as this post’s discussion of stocks is concerned, is dividend stocks. Dividends are paid out by companies to shareholders and make for cash in hand. Usually this is done with extra cash the company has. Some companies have become renowned for offering or increasing their dividends every year.
The idea is definitely appealing. If you set it up right you can receive regular payments at a fixed amount that cover your expenses. Even better, you don’t have to ever sell principle. So what’s the catch?
There are two catches. One is that companies can cease paying these amounts or adjust them down slightly any time they want to. Past payments are no guarantee of future ones, essentially. These changes may also accompany a downturn in stock price as well. Any increases in payment amount may not match inflation.
The other catch is the amount needed. The S&P 500 has had an average yield of about 2.91% (source). As we’ve covered earlier in this series (and here), your safe withdrawal rate may be much higher than this 2.91%. So you may have to save more money than needed to meet this. Not that having a lower withdrawal rate is a bad thing. While higher yields can be sought, higher returns tend to have higher risk.
All about real estate
With stocks out of the way, let’s move on to another popular venue, real estate.
Rentals are probably the most commonly thought about way of doing real estate. It’s fairly simple. You buy a house, find a tenant, and collect the checks. Obtain enough buildings and the income can cover your expenses.
Of course there are overhead fees like maintenance, bad tenants, property management (if so chosen), and the like.
If you decide not to go with a property manager you have to handle everything yourself, from finding tenants to fixing burst pipes at 3AM. I have no experience with these myself, but I’ve heard it essentially becomes a second job.
While you can take advantage of things like leverage to further increase your returns, you also have a higher concentration risk. Compared to something like an index fund, one house is expensive. Even several houses, assuming they’re in the same area, still suffer from a high concentration risk. What if the main employer in the area closes their doors? There’s not a lot that can be done in that situation. Spreading out rentals will probably require at least one property manager.
REITs are another option that could work. At their core, Real Estate Investment Trusts are just a different way to offset concentration risk. There’s a bunch of different kinds, but at their core they buy a bundle of buildings, sometimes spread out and run them on behalf of shareholders. They then have to pass a certain percentage of the income on to the shareholders. In theory you could build the same as the rental portfolio using REITs and offset some of the downside.
Research has shown a correlation between stocks and real estate (source). So it’s not a good way to offset stocks in your portfolio but it may be a good counter to bonds and other fixed income assets.
There are several other alternative assets or strategies outside the scope of this post. A lot of them would be active investing strategies, which is essentially just a method to the stock picking madness, or deal with alternative assets. These tend to require a lot more effort to implement and I don’t have a lot of experience with things like options or crypto to really talk about them in any intelligent manner.
Obviously each of these strategies has an expected rate of return. This would change the assumptions in your When to Retire calculus.
That’s about it for investment strategies. The big thing of note is that no strategy is perfect. Part of it comes down to the personality of an individual, part of it to goals, part of it to safe withdrawal rate. In the end no strategy is perfect but a combination might work for any one individual, like say Index stocks and rentals if that’s what floats their boat.