In December, I received an email from a client who was concerned about the stock market. He said, "I have a feeling the stock market is overvalued, and I don't want to increase my investment in bonds now, so I was thinking about taking X amount out of stocks and putting it into an annuity." We'll call him Mr. Risk-Off.
Around the same time, I received an email from another client who was upset that my recent recommendations had her at only a 65 percent equity allocation. She was insistent it was the right time to increase it to 70 percent. We'll call her Ms. Risk-On.
Mr. Risk-Off is in his late 50s and still working at a high-paying job. He won't retire for two or three years and will have a large company-provided retirement benefit for his first 10 years of retirement.
Ms. Risk-On is in her late 60s and retired. She has no guaranteed income sources other than Social Security.
They come from very different socioeconomic backgrounds, have a vast difference in their portfolio sizes and both have sufficient funds to meet their stated retirement income goals for life, even if their investments earn only low single-digit returns. Each of them has assigned an entirely different meaning to the recent market highs. Which investing style is right?
One of them came to the right answer, but both took these new market highs and jumped to a conclusion while skipping the most important step - the analysis.
The question they, and you, ought to be asking is, "Based on the current value of my accounts, what rate of return do I need to earn to achieve my lifestyle throughout retirement? And what kind of risk does an attempt to earn that return entail?"
The action the market highs should trigger is the action of re-evaluating your goals and seeing if you are in position to achieve them. The answer to that question should drive your portfolio decisions.
In their cases, I already knew the answer. Neither investor needs to earn anything much higher than a 3 percent average return to remain comfortable in retirement. What kind of risk does it take to achieve that return? It's certainly not the kind of risk that comes with a high allocation to equities.
That leads me to agree with Mr. Risk-Off's conclusion and disagree with Ms. Risk-On. But my conclusion is not based on an assessment of market valuation and has nothing to do with my feelings about the market. It has to do with an analysis of how well each investor is positioned to achieve their goals.
By revisiting his goals, I came to the conclusion that I agree with Mr. Risk-Off that reducing his equity exposure is prudent. However, I don't entirely agree with his proposed alternative. In his case, we are talking millions of dollars. Are annuities the right answer? Perhaps, for a piece of his portfolio. A portion of his equity allocation could be shifted to a variable annuity that allows him to continue to participate in an equity allocation, but which wraps the allocation with a minimum guaranteed income amount that he could receive later on. Such a product would insure his income outcome on a piece of his portfolio.
Contrary to Mr. Risk-Off's thoughts, I also think he ought to consider bonds for part of his repositioned portfolio - but not bond funds. He ought to consider building a bond ladder. With a bond ladder, we use individual agency bonds, municipal bonds and certificates of deposit, each purchased to mature in a specific year to match his retirement income needs. This would add a nice layer of security to his portfolio.
Ms. Risk-On is a more difficult case. She is a relatively new client who came to us from a previous relationship with a broker. She is used to telling someone what she wants to do with her portfolio, and having them make the transaction. She does not yet seem to grasp the extent of my fiduciary obligation to her. She can tell me what she wants all day long, but if I don't think it is right for her, I will not do it. If she wants to fire me, that's fine.
She does not need to take on risk, but she wants to, and not for rational reasons. She is fearful she will miss out on returns if she doesn't continue being aggressive. I am fearful she will jeopardize the longevity of her portfolio by taking on too much risk. I understand that a 5 percent shift may not seem large, but it concerns me.
By many measures, the stock market is overvalued, and yet, as we know from the '90s, it may keep right on chugging along for many years. Or we could find the market down 30 percent next year. I keep a crystal ball in our conference room to assist with these situations. It hasn't been much help.
Without a working crystal ball, I must revert back to the appropriate measure - her goals. In her case, a higher equity allocation offers her no substantive change to her lifestyle, even if equities do extraordinarily well from here. But it does increase the potential that she could have many sleepless nights and a revised budget when the next bear market comes along. At her age, I'd prefer to see her reduce risk rather than increase it.
My job is to keep portfolio decisions focused on a client's goals. Whether the market is high or low, that's the only way to invest.
Dana Anspach, certified financial planner, Risk Managememt Association, Kolbe Certified Consultant, is the founder of Sensible Money, LLC, a registered investment advisor with a focus on retirement income planning based in Arizona. She is the author of "Control Your Retirement Destiny," writes for About.com as their Expert on MoneyOver55 and contributes to MarketWatch as a RetireMentor.
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