Worried about passive investing if we have a recession?

[LeonardoCandoza]

I'm not an experienced investor but I went to school for finance and economics. I try to read the Financial Times and Bloomberg every day to get more knowledgeable and learn more about what is happening in the financial markets. All signs point to a high risk of a recession in the next year or two. No matter what your investment strategy a recession will hurt returns, but there are more risks with passive investing (http://incometowealth.com/risks-of-passive-investing/). I don't want to risk my retirement savings because of bad corporations of government decisions.

I know passive investing is the most simple strategy and it's had great success over the last few years, but is anyone worried about passive investing and not diversifying? What are you doing to diversify your investments?

[Rogar]

I'm not too worried. I suppose I fall into the category of passive investing as most of my equities are in index funds with low management fees. However I've never had more than half of my saving in equities. My strategy is basically a hundred minus age as a percent in equities and rebalance every year or so. Stay the course. I got through the financial meltdown with less damage than most or any knee jerk reactions juggling funds. At the time, declining interest rates added to the asset value of my bond funds but that has leveled out. Now it's pretty much biting the bullet of low returns on fixed income type investments, which is better than losing money if there is a market slow down. Right now I'm looking into building a bond or CD ladder, which Fidelity makes pretty easy, but mostly bond index funds, CD's and common bank savings.

[SteveinMN]

Unless one's last name is Walton or Rockefeller (or, now, Bezos) I don't think you can look at the next few years without concern about a big dip in equities or a large recession-ish drop back. Since DW is looking at retiring in the next year or two, we're especially concerned about this.

I've become a convert to the concept that retirees should have three income streams: a solid one which covers which necessary expenses (like housing costs, (known) medical insurance, etc.); one which serves as a hedge against inflation, because of its pernicious effect on savings; and one which funds discretionary expenses (like travel, hobbies, etc).

The solid stream should be savings, CDs, pensions, SS, and/or annuities, depending on their terms. The hedge stream likely will be equities though real estate or some other hard goods (like gold) might work into it depending on the investor; if there is a recession, there still is some time to recover. The last stream can be whatever one has a tolerance for, including, perhaps, more volatile equities than the other two streams (if stocks tank, you take a shorter vacation or skip it this year). That way the very basic expenses of life are covered with a high degree of certainty, there is some protection against the value of money lost to time, and there is money for the fun stuff.

DW and I have some cash/CDs, we will receive SS, and we have annuitized some of the 401(k)s I rolled over from previous employers. DW will receive a pension from work in addition to the deferred-comp plan she contributed to; I have a couple of small pensions which will come to about $1,000 a month. We will maintain some rollover IRAs as the hedges. We're not well set up for the discretionary stream as they've been part of the other streams, but we are working with a financial planner now to identify when to start pulling from the various streams, especially as we are years away from Full Retirement Age. We'll likely realign our equity holdings to better meet the criteria of the two streams because the investment goals are different. We can reduce expenses more than we have and we can consider working part-time to increase income.

I think that's pretty diversified. Certainly something could get in the way of some of it (for example, a disability that effectively eliminates the idea of going back to work). But I think it minimizes our exposure to the very worst.

[LDAHL]

Even in bad times, few investors can consistently beat the averages with market timing and stock picking strategies. The history seems pretty clear on that.

Are you the author of the newsletter article you link to? I notice the name is the same.

[LDAHL]

Unless one's last name is Walton or Rockefeller (or, now, Bezos) I don't think you can look at the next few years without concern about a big dip in equities or a large recession-ish drop back. Since DW is looking at retiring in the next year or two, we're especially concerned about this.

I've become a convert to the concept that retirees should have three income streams: a solid one which covers which necessary expenses (like housing costs, (known) medical insurance, etc.); one which serves as a hedge against inflation, because of its pernicious effect on savings; and one which funds discretionary expenses (like travel, hobbies, etc).

The solid stream should be savings, CDs, pensions, SS, and/or annuities, depending on their terms. The hedge stream likely will be equities though real estate or some other hard goods (like gold) might work into it depending on the investor; if there is a recession, there still is some time to recover. The last stream can be whatever one has a tolerance for, including, perhaps, more volatile equities than the other two streams (if stocks tank, you take a shorter vacation or skip it this year). That way the very basic expenses of life are covered with a high degree of certainty, there is some protection against the value of money lost to time, and there is money for the fun stuff.

DW and I have some cash/CDs, we will receive SS, and we have annuitized some of the 401(k)s I rolled over from previous employers. DW will receive a pension from work in addition to the deferred-comp plan she contributed to; I have a couple of small pensions which will come to about $1,000 a month. We will maintain some rollover IRAs as the hedges. We're not well set up for the discretionary stream as they've been part of the other streams, but we are working with a financial planner now to identify when to start pulling from the various streams, especially as we are years away from Full Retirement Age. We'll likely realign our equity holdings to better meet the criteria of the two streams because the investment goals are different. We can reduce expenses more than we have and we can consider working part-time to increase income.

I think that's pretty diversified. Certainly something could get in the way of some of it (for example, a disability that effectively eliminates the idea of going back to work). But I think it minimizes our exposure to the very worst.

Steve Vernon has written a few good books outlining a very similar strategy. I think it has a lot to recommend it.

[Teacher Terry]

Our pensions do have a COL increase yearly which also helps. I think 3 streams of income is important.

[dado potato]

@SteveinMN

For your "solid" stream, Social Security benefits have the advantage of being indexed to the CPI, and for MN residents there has been a tax cut on Social Security income (since 2017).

The Social Security website (or perhaps your financial planner) can help you decide when would be the optimal time for DW and yourself to begin receiving Social Security benefits. For example, if you were born in 1958, full retirement age is 66 years and 8 months. Every month the recipient delays Social Security benefits (perhaps as long as the working spouse continues earning an income) the monthly benefit would increase, as follows:
If you wait until age 67, the benefit increases by 2.7%
If 68, increase by 10.7%
If 69, increase by 18.7%
If 70 or older, increase by 26.7%

Your "three streams" retirement income planning look good to me, speaking as an old croc. You might be interested in Wade Pfau, an academic expert on annuities who has written and given talks (available on YouTube) on the allocation of assets for retirement income.

What you called "solid" stream, I believe Pfau would say is income for one category of spending goals: your minimum needs threshold.
I gather that you also are planning for some discretionary spending (I would guess cultural events, travel, hobbies, personal services, wine, gifts, chocolate, yes?). I believe Pfau would say these items require additional income for another category of spending goals: your lifestyle goals.

A long life, and/or inflation, and/or ill-timed losses on investments, and/or an inadequate total income during retirement can result in a portfolio "failure". The consequences of partial (or even total) failure to meet lifestyle goals may be endurable by substituting other lifestyle goals which cost less. The consequences of a failure to meet the minimum needs threshold are much scarier. If pensions and Social Security will not be sufficient to meet the projected total spending goals, Pfau suggests SPIAs (Single Premium Immediate Annuities). In effect an SPIA transfers the longevity risk from the individual retiree to an insurance company. Assets are liquidated from the estate to buy the SPIA. The retiree is "relieved of" a minimum of $10,000 … along with the associated investment risks, and management responsibility. The insurance company contracts with the annuitant to pay the annuity for life (single or joint as the contract specifies), and will do so, regardless of any cognitive impairment or difficulty with the activities of daily living.

I agree with Pfau on that point. Mortality credits increase as a function of how old the annuitant is when he purchases the SPIA (within limits set by the insurance companies, such as age 85 or 90 for a single life annuity). Personally, I would not buy an SPIA before age 75. Until then I plan a portfolio of highly rated bonds (not bond funds) and CDs, maturing then. Most of my bonds are municipals that pay interest in January and July. (I like matching interest income with property tax payments which I need to make in January and July). I have also nibbled on zero coupon bonds of a California School District. Incidentally, Steve, my portfolio contains a AAA-rated revenue bond of the MN Public Facilities Authority, so I hope the Twin Cities keep on flushing and paying their water bills. <wink> Most of the bonds in my portfolio are General Obligation municipals, and I select locations where little public corruption has been reported in the newspapers.

Pfau used Monte Carlo simulation (with certain historically-based assumptions about total return on assets) and concluded that "the Efficient Frontier for Retirement Income" consisted of SPIAs and equities. SPIAs provide for spending needs, and equities are a hedge against inflation and a reserve that can absorb financial shocks during retirement, such as divorce, long-term care expenses. etc. The portion of the Equity Reserve that is not drawn down to absorb financial shocks would remain in the estate of the second to die. If there is no legacy motive, perhaps the second to die would liquidate the Equity Reserve at age 84 and buy another SPIA (the cherry on top!).

I would consider a dividend-growth-stock-index etf (such as VIG) and a global-stock-index fund (such as VTWAX) for my Equity Reserve.

Unlike Pfau's efficient frontier, I would buy $10K per year Treasury I Bonds (real return is low... principal increases with the CPI for 35 years or until redeemed), and I would include them with the Equity Reserve. I would allocate the annual maximum to I Bonds, because there could be occasions when a financial shock occurs, and equity funds like VIG and VTWAX could only be sold at a capital loss. At such a time, I think it would be preferable to cash in some Treasury I Bonds.

[Rogar]

I stocked up on I bonds back when you could buy 30k a year and the interest above the inflation rate was 1%. It’s been a very good investment for the fixed income category.

[SteveinMN]

I know annuities get their share of grief in the investment community (largely because so many are so expensive for what you get) but it is a way of diversifying risk and essentially guaranteeing a certain level of income out of that money. SPIAs probably are the most palatable to the Mr. Money Mustaches of the investing world (like the folks at the Bogleheads Web site) but I think the view looks very different from the vantage of early-60-something than it does from 30-35 years old so if an annuity makes sense for one's needs, one should buy one.

One other aspect of investing that I believe does not get enough attention is tax planning: which income streams to draw from first to manage the tax hit based on where you see tax rates headed and which instruments are available to you. This can include how much money one can earn from a paying job without losing benefits or seeing some benefits taxed above some threshold. There are some basic "rules everyone knows" (like Traditional IRAs versus Roth IRAs) but rarely do I see people manage their taxation systemically (capital-gains exclusions from selling a home after a specific age; using HSAs for non-medical expenses, gifts to family to reduce taxes; pushing income into or out of certain time periods, etc.).

dado, you are in no fear of Minnesota ever diminishing their use of water. We are, after all, the Land of 10,000 Lakes! We have done a lot in tax-protected investment instruments, so we haven't put money into municipal bonds, but who knows how that may change?

[ApatheticNoMore]

I tend put money in bonds in addition to stocks (basically a "balanced" fund type ratio). That's it, therefore I don't market time based on the news. And yes being more aggressive is tempting and might do me good, but would mean panicking on news reports and trying to market time.

Plus cash emergency funds that so I *probably* (but who can say with certainty) won't be raiding the 401k at the worst possible time. No I don't think I'm particularly clever in outsmarting the market, and yes I'm prone to worry about a bunch of "what ifs" so yea.

[bicyclist]

I am an especially great one to comment on this thread because I have been an investor with the Vanguard Group since 1981! Vanguard built its success on passive investing. There is no investing without risk but spreading assets between stock, bond, cash mutual funds and real estate has worked well for me and many other people. I haven't been drawn to annuities-you are going to pay a lot for what you get and there's evidence that gains in the markets will compensate more than sufficiently for periods of decline.

[SteveinMN]

I haven't been drawn to annuities-you are going to pay a lot for what you get and there's evidence that gains in the markets will compensate more than sufficiently for periods of decline.
Annuities are not good for many of the people who buy them. Depending on one's other sources of income, however, "pensionizing" a certain amount of retirement savings with a SPIA (if one doesn't know what it is, don't buy one ;)) is a reasonable choice. A person who retired in 2006 right when the economy cratered would have had to wait about ten years for the markets to return to where they were. If most of a person's retirement income was equity-based, they were scrambling.

Our annuities are designed to cover our must-haves: housing expenses; insurance; a certain level of groceries, clothing, etc.; and so on. Other more-variable income streams will supply the money for expenses we can readily control: travel, hobbies, and gifts. It works in our particular situation. Of course, as they say on the innertubes, YMMV.

[Molly]

Leonardo - I'm an amateur investor and have been investing for around 40 years. I'm a big believer in passive investing and dollar cost averaging. I have always had a diversified portfolio based on my age and had automatic withdrawals from my paycheck into my 401k every pay. I lived through many recessions and have always stayed the course. I actually made the most money during recessions because I bought the shares "on sale".

I did purchase an annuity when I retired. I know I probably would have been better off keeping the money in the 401k, but I just couldn't stomach any more downturns in the market. The returns may be lower, but the insurance company assumes the risk.