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Welcome to How to Retire on Time, a show that answers your retirement questions. Say goodbye to the oversimplified advice you've heard hundreds of times. This show is about getting into the nitty-gritty so you can make better decisions as you prepare for retirement. Text your questions to 913-363-1234 and we'll feature them on the show. Don't forget to grab a copy of the book, How to Retire on Time, or check out our resources by going to www.retireontime.com.
Welcome to How to Retire On Time, a show that answers your retirement questions. We're here to move past that oversimplified advice that you've heard hundreds of times. Instead, we're gonna get into the nitty gritty. As always, text your questions to (913) 363-1234. And remember, this is just a show, not investment advice.
Mike:Do your research. David, what do we got today?
David:Hey, Mike. Is it true that the first five years of retirement are the most risky for your portfolio?
Mike:In the conventional sense, I would agree with that, and here's why. So the cliche term is called sequence of returns risk. And let me just pull it back for a second. That's a really jumbled way to say, look, the sequence of the return or your annual returns are gonna matter. You don't wanna average it out.
Mike:Well, this year it was this much, and then this year it was that much, and this year it was that much, and that's not a clear picture of your actual return. And the reason is if you have, let's say, a 20% return, well, 20% return of what?
David:Okay.
Mike:See, the year before, that return mattered. So if you had a 30% crash, and then you got a 20% return, well, you got a return on less money.
David:Okay.
Mike:You see how people get caught up in percentages, and they forget about the compounding nature of the actual dollars in your account. Well, that's what you actually spend is your dollars, not your percentages.
David:Yeah. They don't they won't take my percentages at the car dealership or anything? No. They don't care. Alright.
Mike:So when you understand that side of things, then you understand that if the markets were to go down, let's say 30%, and then let's say you took out 4% as income, you're now down 34%.
David:Makes sense.
Mike:That's less money, which makes it more difficult to return, to break even, to recover, to x y z. And so those first five years are critical because if the markets were to crash, and no one knows when the next market crash is gonna be. But if the markets were to crash and you took income out of that account, you're accentuating losses, you're making it more difficult to recover, that divergence is a lifelong consequence. Lifelong. Oh.
Mike:You're not gonna outgrow that. It's like, you know, you get hit in the leg and it hurts for a while, you eventually recover. Yes. Well, imagine just like cutting a muscle and then trying to recover something. That seems really graphic.
David:Take longer.
Mike:Yeah. What's a better analogy here? I don't know. You break a bone and it heals incorrectly. You kinda are dealing with it for the rest of your life.
Mike:So if the markets were to go down, and the growth part of your portfolio goes down 30, that would need a 43% return to break even. Okay? You with me so far?
David:Yes. It's down that much, and then it needs to go up by 4343%.
Mike:Okay.
David:Just to get back to where
Mike:you were. Just to get to zero dollars. Ugh. Zero gain. Don't pass go Collect $200.
Mike:Just try to get to go. Just pass boardwalk.
David:Yeah.
Mike:So if your account, your growth assets are down 30%, which isn't that big of a market crash, all things considered. Remember 2008, 50% crash. 02/2001 and o 50% over three years. Okay. And there are other situations like that throughout history.
Mike:I'm not cherry picking a couple of bad moments. No. They're actually quite common when you consider the grand scheme of things.
David:Okay.
Mike:But if you're down 30, and then you take out 4%, that's not a 43 or 44 or 45% return. Say 50% return to break even. Now let's say you had to take some income out, and then you need new roof or something else happened, and now you're down, let's say, 50%. Or maybe you just oversimplified your portfolio, and instead of the market's 30% loss, you're now down 50%. Because, you know, that could happen.
Mike:Yeah. The Nasdaq was down like 80%, 80%, something like that.
David:When was this?
Mike:From 02/2001 and o two, because it was mostly tech stocks. So let's say you just you're like, oh, well, Nvidia can only get go up. Palantir to the moon or whatever. Yeah. And now you're down 50%, that's a 100% return to break even.
Mike:So your bills are the same price point. You need a certain amount of calories every day to live. There are certain humanistic baseline needs that you have. Yeah. Maybe you're still paying your mortgage in retirement.
Mike:Maybe you're still paying off I know people that are still paying off their student loans Woah. As they enter retirement. Whatever your situation is Yeah. Your basic needs, it's a finite fixed baseline dollar amount that does not care about your portfolio performance. So this is where you look at the first five years and say they're more risky, because if you get it wrong, you could be limping along for the rest of your life.
Mike:I mean, if you have the first five years, seven years, ten years of your retirement, and it just grows like crazy, you're in a good spot.
David:And so people who have retired in the last few years, are they kind of in that spot?
Mike:Oh, yeah. Well, if you retired in, let's say, 2012 or later, you only know a growth market. Uh-huh. Oh, well, Mike, you know, the markets crashed in 2020. Yeah.
Mike:Yeah. But they recovered that year. Yeah. That's not a real crash. That's a blip in the radar.
Mike:And then they printed money. Eventually, things opened up, and it recovered very quickly. Yeah. It was a scary time. It was a very scary time.
Mike:I get that. But you really didn't have to endure the magnitude of fear that we felt at the beginning because it recovered so quickly. So when you're going down a roller coaster, you're like, oh, it's gonna be scary. How long is it gonna drop? And then once you you get the bottom and you're like, oh, that wasn't that bad.
Mike:Yes. That was 2020.
David:Okay.
Mike:Or 2022, 2023. It was kind of a slow burn. Your bond funds weren't doing well. Those aren't real market crashes. They were federally manipulated recoveries.
Mike:So it was faster and was easier.
David:Okay.
Mike:So if you retired from 2012, in my opinion on, you only know a growth market. You really don't know what a financially difficult market is. Your experiences or your history is shaping notice notice the pattern here. Your history is shaping your habits. Your habits, it's behavior based patterns on your actions.
Mike:In other words, how you're investing. And right now, regardless of whatever system you have, you probably feel like you can do no wrong.
David:Yeah. No matter how you have your portfolio aligned, it's been pretty good.
Mike:It's been really good. The DIY investor did not need a financial adviser over the last twelve years. A monkey didn't need it. And I'm not criticizing DIY investors True. At all.
Mike:Love the DIY. But notice how if everything's going up, it's really easy to look good. Yeah. And then you want to sustain those results, and you think you've got it figured out. And you're like, well, bond funds are stupid, so I'm just not gonna have those.
Mike:And you start de risking yourself. You start getting more reckless, and you have no idea what you're doing. So that's the premise of this is, yeah, the first five years of retirement are the most important, because if you accentuate a loss, you're limping along for the rest of your life. Also today for the next five years, is the market gonna crash? No one knows.
Mike:But if it does, and you were to retire soon, that's a tough situation to be in.
David:And are there some signs out there right now that maybe point to a potential market crash or overvaluation or fill in the blank?
Mike:Yeah. They call that a bias. So I've known advisers since 2015 that were saying next year, the markets will probably crash, and they create an argument as to why.
David:Okay.
Mike:That's the problem. There's always an argument for and against any economic outcome. So which is it? No one knows. And that's why I don't believe that anyone should really be focusing on a set it and forget it strategy, because everything works until it doesn't.
Mike:So a lot of people will buy an annuity and turn on lifetime income and say, well, it works, and it's guaranteed for life. Well, it might work by avoiding market risk, but you've got inflation risk. So everyone that bought an annuity turned on lifetime income before twenty twenty. In 2020, they're going, oh, I'm really smart because I'm still getting my paycheck during these turbulent times.
David:Mhmm.
Mike:And then 2021 happened, and inflation eroded, 2022, and eventually got under control. But you lost what? 30% of your buying power for life? Because those payments, in all likelihood, weren't going up. They were probably flat.
David:But yet the costs of everything were were high.
Mike:Horrible. Yeah. So you can get rid of one risk, but you're taking on another. That's how this works. There's no such thing as a riskless retirement.
Mike:Now can I get a little controversial for a second?
David:I mean, you've never been afraid to in the past.
Mike:Yeah. Why not? So in my opinion, a significant market crash in the first five years of retirement is one of the best things that could happen to a retiree. Okay. If they prepare correctly.
Mike:Most are not. This is not conventional portfolio structure. This is not conventional plan design. This is thinking outside of the box and saying, well, what if? And then fill in the blank.
Mike:Mhmm. So first off, let's solve the income problem. What if for the first five years or a five year period of time, you did not have income need concerns? So instead of lifetime income, what if you did buy something like and I'm not telling you to go out and do this, But what if you did buy an annuity, a fixed index annuity with a five year period certain so that when the next market crashed, instead of you trying to figure out how to make this work with your bond funds, you just had something else that you could turn on income, and it turned into basically a CD ladder for five years, gave you monthly payments for the next five years, that gives your other accounts more than enough time based on historical averages to recover. You don't accentuate losses.
Mike:You've structured out your income. It's not lifetime guaranteed income because you want flexibility, but you've now just basically gone on this journey and said, oh, there's a Grand Canyon in front of us. How do we get through it? Oh, we push this button, and then magically, this income stare for the next five years appears. It's not really magic.
Mike:It's just called good planning. Do you see how that works? Yeah. Now you're not dealing with sequence of returns risk. What you're dealing with is, okay, in a good situation, this is how I take my income.
Mike:In the next market crash Yeah. And you're able to change it along your journey, along retirement. That's the first part.
David:Okay.
Mike:Second part, taxes are a big issue for retirees. Are they not? Yeah. Of course they are. So most people seem to have all of their assets or majority of their assets in IRAs.
Mike:So when they turn 73 or whatever the RMD ages when you get there, you're gonna be forced to pay income taxes, right, distribution, whether you end up spending it or you reinvest it, you're gonna be forced to pull money out of your IRA. That's an income tax situation, ordinary income. So what if just hear me out.
David:Okay.
Mike:What if when the markets crashed, let's say your portfolio for easy math went down 50%, your growth portfolio, your IRA went down 50%.
David:K.
Mike:The tax bracket is still the same. The tax bracket didn't lower by 50%. Uh-huh. It's the same dollar amount. So in other words, if your account goes down hard, yeah, that stinks.
Mike:But now if you don't sell the assets, don't sell your positions, you can get twice as many of them from your IRA to your Roth and pay the same tax bill as long as you pay the taxes out of a protected account, whether it's CD or you can maybe take it from that fixed index annuity payments. You just you got your income plus a little bit extra for taxes. Maybe it's a buffered ETF. Maybe it's a bond, like a treasury. Whatever it is, you can structure however you want.
Mike:But if you know when the markets crash, you're gonna take your assets, let's say, $100 a share, now it's $50 a share, you can get twice as many IRA to Roth converted. That accelerates your amount of money you're moving from one account to the other, and you paid half the taxes or you paid the same amount, but you got twice however you wanna slice it. You've accelerated your tax planning without accentuating losses.
David:So that RMD, when you have to do it, that's when you can do a Roth conversion, basically? Because you're taking the money out, you pay the taxes, and then you're free to do whatever.
Mike:I mean, it's in your Roth. So it grows tax free, pays out tax free. Yeah. There's no RMDs on the Roth. So Okay.
Mike:Why wouldn't you wanna do that? Right. But if you do a conversion at the bottom of the market, and then you pay the taxes out of that conversion, that's the same as taking income. You're accentuating your losses. So let's say your accounts go down 50% for easy math, and you've gotta pay, I don't know, 20% of the conversion over.
Mike:Now your your accounts just got hit down even harder. You're punching down or whatever the expression would be. So that accentuates the losses, making your Roth have a more difficult time to recover. You don't wanna do that. You've gotta have some assets that are protected so that they can pay the taxes based on the conversions that you're trying to do.
Mike:That's step two in what we call the bear market protocol.
David:Okay. Alright.
Mike:Yeah. And it could be a CD ladder. You could do a bond ladder. There's many ways to slice it. The easiest one in my opinion is to buy a fixed indexed annuity to just turn that five year period certain.
Mike:Most people don't even know that exists. Right. Because everyone talks about this lifetime income stream, which Yeah. My book argues against that, but I acknowledge why people would want that, but whatever. Mhmm.
Mike:I believe you need to have flexibility with some growth, some protection, balance, and all things. But anyway, so if you can take income from a protected source, the other accounts have time to recover. Great. Mhmm. You're not creating an issue of sequence of returns risk, like when everyone talks about.
Mike:Then the taxes, so when your accounts go down, this is why it's really, really good. If your accounts go down Mhmm. And you're able to put twice as much through your IRA to your Roth, now your future tax burdens are less.
David:Oh, yeah. Yeah.
Mike:Yeah. You see how that worked? Yep. K. Pretty good.
Mike:Yeah. Now here's the third one. Are you ready for it? I'm ready. The third one is somewhat symbolic upon the holiday that's near
David:Okay.
Mike:And a moment in history. So let me decode that for a second.
David:Yeah, please.
Mike:Black Monday nineteen eighty seven was a very scary day. If you don't remember it, here's what happened. The markets dropped 20% in a day. Oh. Imagine you've worked forty years.
Mike:Uh-huh. You've got a million dollars, and then you lose 200,000 in a day.
David:That would be painful.
Mike:Yeah. That would hurt. That's how most portfolios seem to be set up is to just take it on the chin, and if the markets crash, you just kind of shore up, you spend less money, you just kinda get through it. And that's a crappy situation. Yeah.
Mike:So the next market crash can either be a Black Monday for you, where you just watch your money go away, and you're just panicked, concerned, losing sleep, fill in the blank. Mhmm. Or it can be a Black Friday. Everything's on sale.
David:Oh.
Mike:Now I'm not saying you put all of your assets into protected growth accounts, but what if you had some that were liquid enough that when the markets tanked next, you started buying things at 50% off? Let's say stock x y z is a $100 a share, and it loses 50%. Now you can buy it at $50 a share.
David:Okay.
Mike:That's the same as 50% off.
David:That's a good discount. Yeah. I'm usually excited if I see a 50% off.
Mike:Yeah. So everyone's concerned about the next market crash because, oh, well, the markets are gonna crash. I'm gonna lose money. I can't do IRA Roth conversions because I don't wanna accentuate the losses, and I can't take income because I don't wanna accentuate the losses. So I better lock everything up to an annuity and hope it all works out.
Mike:No. That's the wrong way to look at it. The next market crash, if you prepare your plan correctly, is you've got income from a protected source so you can sail through it no problem. You're able to accelerate your tax planning because you're doing conversions at a lower rate, and you're buying into the market with everything on sale, which leaps your assets forward whenever it recovers. And broadly speaking, the markets have always recovered.
Mike:Yeah. Individual stocks, not a guarantee. Well, there's really nothing guaranteed in the market, but you see my point. Historically, that's always recovered. Stocks have not always recovered.
Mike:Some stocks are no longer with us. May they rest in peace, Toys R Us. But you see my point. There are certain things we cannot control. So when you accept those and you build a plan to turn those pitfalls into opportunities, laying and waiting for you, then you're not scared about the next five years or the first five years of your retirement because you did some good planning.
David:Okay.
Mike:That's my opinion, and it's a very strong one that's very well researched because the reality is you need to have some You're going to have some money that's lost in the next market crash. But those are funds, if appropriately designed, are funds you don't need to touch for over ten years anyway. So you can let them recover. And your other assets that might be protected, we call it the bear market reserves, just spending spree at that point. Have at it.
Mike:Yeah. I I can't really do Black Friday sales, but I I just can imagine the people lining up at Walmart. Yeah. I worked at Target. That was my first job when I was 16.
David:Okay.
Mike:We'd line up carts. So when people would come in, they'd grab the cart and then run to the deal they wanted. It was madness.
David:I've never done that personally.
Mike:Yeah. I don't. But everything in the market just is. Does not care about your feelings. It's your preparation that's going to help you understand, is it opportunity or is it a disaster?
Mike:And right now is the time that you have to prepare so that when not if, but when it happens Mhmm. You've decided how you want to experience that situation.
David:And so did we answer the question here? Is it true that the first five years of retirement are the most risky?
Mike:Just depends on how you prepare. Yeah. If you wanna go hiking in Alaska in the summer, you might need a light jacket, that's it. Yeah. But if you wanna go in the winter, and you're still wearing that light jacket, yeah, you're you're at risk of hypothermia and all sorts of other issues.
Mike:So it just depends on how you're prepared. And this idea of one portfolio, set it, forget it, that's the dangerous part. It's the products being sold that I think are without context to understand how to prepare for what could happen. You want to be adjusting your portfolio. You want to be making adjustments along the way.
Mike:The problem is products are sold, not strategies. And I think you win retirement through strategy. That's all the time we've got for the show today. If you enjoyed the show, consider subscribing to it wherever you get your podcast. Just search for how to retire on time.
Mike:Discover if your portfolio is built to weather flat market cycles or if you're missing tax minimization opportunities that you may not even know exist. Explore strategies that may be able to help you lower your overall risk while potentially increasing your overall growth and lifestyle flexibility. This is not your ordinary financial analysis. Learn more about Your Wealth Analysis and what it could do for you regardless of your age, asset, or target retirement date, go to www.yourwealthanalysis.com today to learn more and get started.