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I RECENTLY RETIRED and have a lump sum from my former employer to invest. For months now, I’ve presumed that I would just add it to our existing investments in the same proportions, easy-peasy. In practice, however, one consideration has led to another, so I’ve made no firm decisions.
Within our 70% stock-30% bond portfolio, I’ve long had a soft rule of keeping well over a third of our stocks in broad market index funds. I see now that this was a rule of convenience, made after I was forced into compliance. As my 401(k) offered only index funds, I invested in them, and then took credit for the wise decision to index.
With the new lump sum rolled into my IRA, I now have a universe of possibilities—for good or ill. Adding to the impasse: At some point, I’ll roll my index-hugging 401(k) assets into an IRA, as well. How should I invest this money?
At the end of December, I took advantage of earlier capital losses to sell down some winning positions in our taxable account, parting with some actively managed funds that I really like, but with the goal of making our portfolio more tax-efficient. Must I say goodbye to these funds completely, I wondered, or should I ease my “one-third index” rule and reacquire them in my now-larger IRA? We’d still have some money in index funds, just less.
Alternatively, I’ve considered investing the lump sum in an index-based balanced fund or target-date fund. Although my retirement year has arrived, I’d choose a target year in the future to gain a higher stock allocation.
An index-based target fund would keep up my index holdings. And while it adds a new fund to the mix, it might also add some simplicity. I’d give no more thought to my asset mix for that portion of the portfolio, plus a target-date fund would add exposure to assets that we don’t own as individual positions, such as Treasury Inflation-Protected Securities.
I notice that Fidelity Investments’ target-date funds, both the indexed and active versions, continue to hold more than 40% of their stock allocation in international shares even after their target dates. I like that, and I’m inclined to raise our allocation to foreign stocks and also to venture a bit beyond indexes. Research has shown that active management may have some advantages overseas, particularly among small-company stocks and emerging markets.
One argument has kept me from acting. Since a retiree like me will be spending U.S. dollars, perhaps we need higher U.S. stock holdings in retirement. Still, after a decade of foreign-stock underperformance relative to the U.S. market, I’m thinking about taking our allocation from somewhere around a third of our stocks now to 40%, closer to the market weight for foreign shares as a portion of global stock market value.
What about bonds? Part of the lump sum will be invested there. This is another area in which research indicates some benefits to active management. My default would be to add to our already significant position in Fidelity Total Bond, an actively managed fund. Another option would be to add a short-term bond fund, which would be less sensitive to interest rate hikes that the Fed has assured us are coming. As it is, much of our bond allocation is already in certificates of deposit and my 401(k) plan’s stable value fund, so we stand to benefit from a rate increase and avoid the volatility now afflicting the bond market.
A third bond option would be to add money to a U.S. total bond market index fund. This would offer the usual cost advantage of indexing, plus that index focuses on higher-quality bonds, which could provide better ballast in a stock market drop.
Decisions about bonds would be more important if we were to shift from our current 70% stock-30% bond allocation toward the traditional 60% stock-40% bond mix. Yet this is a move that I’m not as inclined to make. While it feels right to reduce stock risk at this stage, market risk isn’t the only danger. What we regard as “safe assets” now are threatened by inflation. A greater stock allocation could give us more protection there.
In thinking through all these considerations, I find that I’ve come full circle. A traditional allocation using index funds would be good should we suffer cognitive decline. Perhaps then we’d be less likely to go down ill-advised investing paths, failing to recognize the risks involved. This basic approach might also benefit a surviving spouse who is less interested in investing.
As William Bernstein says, if you’ve won the game, why keep playing? As in sports, our task is to do the best we can without hurting ourselves. My conclusion: A well-balanced allocation—with a significant share given to indexing—should give us a reasonable chance of accomplishing that.
Michael Perry is a former career Army officer and external affairs executive for a Fortune 100 company. In addition to personal finance and investing, his interests include reading, traveling, being outdoors, strength training and coaching, and cocktails. Check out his earlier articles.
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Two Words: Paul Merriman. Check out his website here: https://paulmerriman.com/best-in-class-etf-recommendations/
At least it will give you information you can use to monitor your investments.
It is important to be fully aware that the decision to reduce one’s bond allocation to protect against inflation increases the downside risk to one’s portfolio.
Now that’s a nice striper! Bet he put up a huge fight! When I retired and rolled my 401K into a self directed IRA I chose to move the money to cash first and then roll it into the market a quarter at a time. It was a seven figure account and I did not want the heartburn I would feel if the market dropped 40% the week after I put it all in index funds and bonds. So I did lose a little by spreading out the investments but peace of mind is pretty high priced so I thought it was a good blend of math and behavioral economics. We are 55% equities and 40% bonds, cash and 5% alternatives. The math would favor your 70-30 allocation I believe but we’ve won the game with much more invested than we need so I chose to be a little more conservative.
Thanks for the comment Steve. Had I been putting it all into the stock market, I would have averaged in as well, but decided that if investing the new money in accordance with my allocation into stocks and bonds rather than all in stocks, I could invest all at once.
The thinking on the allocation overall has continued to evolve. After writing the article, my thinking started to shift more toward 60/40, along the lines of your closing comment. Then I read a really nice piece from another writer on considering future income as part of one’s bond allocation. With this in mind, 70/30 feels fine. (Sorry I can’t find this to link to, as it’s a great piece.)
PS – yes that was a fun fish. Lake Ouachita, Arkansas. 🙂
Mike, thanks for the interesting article about the thought process many of us are going through as we transition into the decumulation phase of life. It sounds like you have been very successful in saving and investing and are well set for a successful retirement.
I had a similar thought to Richard’s. I also have a nice monthly pension. It is comforting to know that a significant portion of our expenses is covered.
Was the lump sum part of a pension pay the included a monthly paint option? If so, what was the reasoning beyond the decision?
Rick, thanks for reading and commenting. I think I just addressed your question in my reply to Dick Quinn below.
I assume that lump sum is the value of a pension. If I am right, what was your thinking on taking the lump sum – if you had the option?
I have a substantial pension and although I didn’t have the choice, I can’t imagine taking the lump sum. The peace of mind of a steady income for me and my survivor and not needing to make all the decisions you talk about for me out weighs the advantage of grabbing the cash or even a better chance of keeping up with inflation.
When I managed pension plans we did allow lump sum payouts for vested deferred benefits. I often heard from the union and a few retirees about those who blew their funds in a year or two.
Thanks for reading and commenting. The decision to take the lump sum was based mostly on two things. One, the interest rates for pension plans which were in effect for my benefit commencement date were at historic lows, making the lump sum more valuable than usual. Two, we intend to keep taxable income low and harvest capital gains at the 0% rate as I wrote about here, which would have been very difficult with the monthly pension added to other income we can’t control.
If one has the self-discipline to not blow a pension lump sum payout I’m thinking that a key consideration would have to be just how likely is that pension to really last for your retirement. Way too many of them end up being taken over by the PBGC with reduced benefits.
Yes, that can be a valid consideration. Always check the funded status of your plan. At least that there is enough to cover retirees already in pay status.