Introduction

As a fee-only financial advisor, CPA, and CFP® professional, I often get asked about the best investment options for retirement planning, longevity planning, and long-term care planning. In recent times, market volatility has made some clients nervous, prompting them to explore alternatives such as certificates of deposit (CDs), money market accounts, or annuities. However, I believe a stock portfolio that is well diversified, primarily through low-cost mutual funds and Exchange Traded Funds (ETFs), remains the optimal choice for funding your retirement.

Recovering from Stock Market Declines in Retirement

We have all seen the statistics that over the long term, stocks perform better than bonds and fixed-income investments. Most people understand that (even though past performance does not predict future results); it’s the up and down swings (known as “volatility”) along the way that concern retirees. What if your portfolio falls in value when you are withdrawing from it? While this concern is valid, it is crucial to remember that you do not need your entire portfolio every month to pay your bills — you need a small portion of it. Also, there are ways to mitigate this concern, including:

a. Maintaining a well-diversified portfolio

By investing in a variety of sectors, industries, and countries, you can spread out the risk and reduce the impact of any single stock or market decline on your overall portfolio. This approach helps ensure that your investments are not solely reliant on the performance of a single stock or sector, which can be more vulnerable to fluctuations. ETFs and mutual funds can accomplish this goal.

b. Adopting a dynamic withdrawal strategy

Instead of relying on a fixed withdrawal rate, such as the often-cited 4% rule , consider following a “guardrails” approach. This means determining in advance that you will reduce your spending by 10% the following year if your portfolio falls below a certain level. This effectively adjusts your withdrawals based on market conditions and your portfolio performance. In years with strong market performance, you may be able to withdraw a bit more, while in years when your portfolio falls below a certain level, you can adjust your spending to increase the likelihood that your portfolio will last a lifetime.

Here is an example of how that would work in practice:

Portfolio balance $1,000,000, withdrawals $50,000/year. If your portfolio falls below $715,000, then $50,000/year of withdrawals will equal > 7% of the portfolio. Therefore, set your target at $715,000. If your portfolio falls below that level and stays there for the rest of the year, then reduce your distributions (and spending) to $45,000 the following year. By implementing this guardrail, you decrease the likelihood that you will outlive your money.

c. Rebalancing your portfolio regularly

Rebalancing your portfolio periodically helps maintain your target asset allocation, which is crucial for managing risk in retirement. By selling assets that have performed well and buying assets that have underperformed, you can maintain your desired risk level and ensure your portfolio remains aligned with your long-term goals. This practice can also help you avoid the temptation to sell stocks during market downturns.

It is also important to note that you cannot take your portfolio with you when you go, and the date of your demise is undeterminable. Your time horizon is usually long term if you do not want to outlive your money.

The Illusion of Safety: CDs and Money Market Accounts

Now that we have established the benefits of investing in stocks (through ETFs and mutual funds) for retirement planning, let’s briefly discuss why other options like CDs, money market accounts, and annuities may not be the best choice for long-term financial growth.

CDs and money market accounts are often considered “safe” investments because they carry little to no risk of capital loss. However, this perceived safety can be deceptive, as these investments often provide returns that barely keep pace with inflation, if at all. Over time, the purchasing power of your investment can erode, leaving you with less real wealth than you initially saved.

The interest rates offered by CDs and money market accounts may create a false sense of security. While your principal investment is protected, returns that are lower than the rising cost of living can leave you exposed to the more insidious risk of inflation. As the cost-of-living rises, the value of your investment may fall behind, leaving you with insufficient funds to maintain your desired lifestyle during retirement. Annual returns of 5% sound amazing until you compare that with an annual inflation rate of 7%.

The Downside of Annuities

Annuities are another investment option frequently considered by retirees for their perceived safety and guaranteed income. However, there are several reasons why annuities may not be the best choice for funding your retirement:

1. High fees. Annuities often come with high fees, which can eat into your investment returns. These fees may include sales commissions, annual charges, and surrender charges if you decide to withdraw your funds early. Over time, these fees can significantly impact your overall investment performance. (As an aside, if the product is so great, why is it so expensive to get out of one?)
2. Limited growth potential. Annuities typically offer fixed or variable returns, but neither option may provide the same long-term growth potential as a well-diversified stock portfolio. Fixed annuities may offer guaranteed returns, but these returns are often modest and may not keep up with inflation. Also, once they start paying out, the payment usually does not change over time. Variable annuities may offer the potential for higher returns linked to market performance, but they often come with higher fees and less flexibility than investing directly in stocks or mutual funds.
3. Lack of liquidity. Annuities are designed to provide income over an extended period, and accessing your funds early can be costly. Surrender charges and penalties for early withdrawal can significantly reduce the value of your investment if you need access to your money before the end of the annuity contract.
4. Complexity. Annuities can be complex financial products with numerous variations and options. Understanding the features, fees, and potential risks associated with a particular annuity can be challenging for investors, making it difficult to determine whether an annuity is the best choice for their retirement planning needs. Complexity is just not necessary for most people.

Options for Funding Long-Term Care

The big elephant in the room in retirement is long-term care needs and how to pay for them.

One of the best options for funding future long-term care is long-term care insurance. However, that is not an option for everyone, considering that the insurance industry has tightened its underwriting standards so fewer people qualify.

Instead of buying a complicated and expensive annuity on the off chance you need care, consider setting aside a portion of your IRA to cover these costs. Keeping your IRA invested in mostly stocks allows it to grow more over time, so you will have a pool of money when you are 85+ and need care. While you may have converted some of your accounts to a Roth IRA over your lifetime to reduce future taxes, you may want to keep $300,000-$500,000 or more to pay for your long-term care.

Many long-term care costs such as room, board, and medical care are tax deductible to the extent the expenses exceed 7.5% of your income. This means your IRA can be used to fund your long-term care expenses almost entirely tax-free. (You may need to pay higher Medicare premiums in future years as a result.) This is a good reason not to convert the entire balance to your Roth during your earlier retirement years!

Another option for funding a portion of long-term care costs is a qualified longevity annuity contract (QLAC). You can use up to $200,000 of your IRA or 401(k), 403(b), or 457 plan to purchase a deferred, fixed annuity that doesn’t start payout until age 80-85. While that same $200,000 left alone in your retirement plan may grow to generate the same payout amount at that age, that is not guaranteed. Another benefit of the QLAC is that the amount used to purchase it is not considered part of your IRA balances when calculating your required minimum distribution (RMD) each year. While all the above caveats to annuities also apply to QLACs, for someone with a large IRA balance, expected to live late into their 90s or beyond, a QLAC may make sense.

In Summary

A stock and bond portfolio that is well diversified, primarily through low-cost mutual funds and ETFs, remains the optimal choice for funding your retirement. The stock portion of the portfolio offers the potential for higher returns over time, which can help you build and maintain your wealth, even in the face of inflation and market volatility. Combining a smaller amount of high-quality, short- and medium-term bonds in your portfolio increases your diversification and reduces your overall risk.

While CDs, money market accounts, and annuities may seem like safer alternatives, their low returns and other limitations can leave you with less real wealth and financial security in the long run. By maintaining a well-diversified portfolio, adopting a dynamic withdrawal strategy, and regularly rebalancing your investments, you can mitigate the risks associated with stock market declines and enjoy a more secure and prosperous retirement.

Securing your retirement requires a thoughtful and informed approach to investing. At Milestone, our advisors (all CFP® professionals) are goal-focused and plan-driven. Reacting to current events can result in sabotaging your retirement. We can help you focus on the big picture and the things you can control, such as financial planning and tax optimization, including but not limited to:

• Planning to reduce lifetime taxes
• Funding your retirement
• Long-term care planning
• Medicare premium planning
• Social Security claiming strategies
• Legacy planning

Of course, you should not make any financial decisions without talking over your specific situation with a fee-only financial advisor. If you need advice on where to put your savings, how to fund your future long-term care, or financial planning in general, please reach out to our team . You can also learn about our team here .