Long-Term Investing Isn’t Just for the Young

Last week’s note explained how the stock market experienced average annualized returns greater than 10% over the previous 50 years despite having its value cut in half three times during that same period.  We also made the inference that, despite the high likelihood of having its value once again cut in half at some point in the future, the stock market may continue to generate attractive long-term returns for those that can stay the course.

But what if you don’t think you have a long-term investment horizon?
I often talk to retirees about equities for the long-term, and the most common response is something like, “The stock market may be great for the long-term, but I’m [70+] years old. I can’t afford to lose 50% and I don’t have a decade or more to recover.”

To that comment, I always ask the same two things:

First, how much cash do you need to cover your expenses for the next 5 – 10 years? And second, how are you going to grow your income to keep up with inflation if you don’t use equities?

Let’s start with the first one.

Say you need to pull $50k/year from your portfolio (money beyond what you are receiving from social security or pensions).  If you are an aggressive investor, you may be comfortable keeping just two years of spending money ($100k) in short-term Treasuries or cash equivalents.  If you are a moderate investor, that allocation to safer investments may be five years of spending money ($250k), and if you are a conservative investor, that number may be closer to 10 years of safe money ($500k).

In this context, your allocation between equities and safe assets is not a set percentage of your portfolio but instead a number tied to your spending goals. This is an important distinction because your optimal allocation will be highly dependent on your goals and the size of your portfolio.  In other words, all 75- year olds should not have the same mix of stocks, bonds, and cash.

Sticking with the example above, in a base case, a moderate investor with a $1 million portfolio, comfortable maintaining $250k of spending money in safe assets, would have 75% invested in equities.  The same investor with a $2 million dollar portfolio would have 87.5% investing in equities. 

If the stock market goes down and the investor is forced to pull from their safe money to avoid selling their equities at a loss, the equity allocation as a percentage may drift higher.  If the investor’s spending expectations increase, the percentage allocated to equities may decrease. Again, these allocations are not set in stone.  

Now for the second question, how are you going to grow your income to keep up with inflation if you don’t use equities?

As my favorite author, Nick Murray, often writes, “Capital, in its essence, resolves itself into two forms. One form is wealth. The other is money that runs out.”

At some point, I’ll be talking with a retiree that realizes they have enough to live on even if they stop investing.  “I’m 80 years old, I have $1,000,000, and if I pull $50k / year, I’ll have enough money to last 20 years without worrying about the ups and downs of the market.” 

That strategy works until it doesn’t.  What if inflation takes off?  What if expenses increase?  What if the life expectancy extends? What type of legacy remains for loved ones or charity?  If a retiree doesn’t care about any of these things, they don’t need my help. For those that do care, maintaining some exposure to equities, regardless of age, is part of an effective wealth management strategy for growing income, reducing longevity risk, and transitioning assets to the surviving generations of loved ones and charities.  

The secret, of course, is having a plan to stay invested and committing to follow that plan even when things get scary.