Saving for Retirement and How to Handle Luck

By Laetitia Peterson*

One of my favourite nonfiction holiday reads was Everything You Need To Know About Saving for Retirement by Ben Carlson, a fellow financial adviser at Ritholtz Wealth Management in the US. Ben is the co-host of the Animal Spirits podcast and author of the popular blog, A Wealth of Common Sense.

As a financial adviser to many members of the legal profession and an investor myself, I identify with Ben’s confession.

“I’m never going to make millions of dollars on a single investment."

"I’m never going to create a startup that changes the world and becomes a unicorn."

"I’m never going to get rich overnight."

"It’s simply not in my DNA."

Do I get a touch of jealously when I see stuff like this? Sure. You wouldn’t be human if you didn’t dream about huge or seemingly easy riches. But I’m OK with the fact that easy riches aren’t in the cards for me. Instead, I’ve chosen the slower path to building wealth.

There are some downsides to this path. I don’t get to brag on social media about how much money I made on a high-flying stock or business venture. I don’t get to become rich overnight. I don’t get to become a guru who preaches the easy steps you can follow to become wealthy. I don’t get to create a world-changing company.

I don’t get to write a medium post about how transcendental meditation changed my life once I became a billionaire.

And I don’t get to know what it’s like to deal with a life-changing amount of money. It can be difficult to stick with your own investment plan when you see others hitting the jackpot during a raging bull market.

But there are some upsides to being comfortable in your own skin as an investor.

For me, building wealth slowly over time suits my personality better than the alternatives. "And the best part about building wealth slowly is…it actually works.”

At The Private Office, we advise people with a money personality like Ben’s and mine who choose to build their wealth slowly and don’t want to take on boatloads of risk. Some people prefer daytrading or concentrated deep value investing or venture capital or investing in private businesses or rental property or start their own businesses to build their wealth for retirement. That’s fine. There is no one size fits all.

Talking about not being comfortable with taking risk, an objection that keeps coming up with clients is market timing risk. The fear of bad luck is often holding clients back from getting started on an investment portfolio.

You could have been lucky by retiring in 2010 right before the onset of a decade-long bull market and enjoyed higher than expected returns. Or you could have been unlucky by retiring in 2000 just before a lost decade of global share market returns which included two enormous market crashes (the tech wreck and Global Financial Crisis).

It’s also important to remember it’s not so much the overall market return that matters with market timing risk but also the order in which you receive the returns.

For example, from 2000-2020, the NZX 50 Index returned 10.6% annually.

Let’s say you retired with $1 million in the NZX 50 Index in 2000 and let’s further assume you decided to withdraw $40,000 in year one with an annual 2% inflation adjustment each year thereafter.

By 2020, you would have withdrawn more than $1 million from that portfolio over a 21-year period, while the remaining balance would still be a remarkable $4 million. With a withdrawal rate of 4% and annual returns in the order of 10%, it is no surprise the remaining balance would be significantly higher than the starting amount. That is the magic of compounding.

To show how market timing risk manifests itself, let’s assume our hypothetical retiree with a $1 million portfolio experienced these same exact returns but they occurred in reverse order. So, the first year would be +13.92%, then +30.42% and so on. The same $1 million would have been taken out as distributions but now there would be well over $5 million remaining.

The annual returns for the New Zealand share market would be the exact same in both examples — 10.6% per year, but the ending balances show a difference of close to $1 million. This is purely down to luck.

So how should you handle “luck” when planning for a successful retirement?

The answer is threefold: Diversification, Asset Allocation and having a Sound Financial Plan in place.

Diversification

My example here was fairly crude. Few retirees have their portfolio entirely invested the New Zealand share market which represents less than 1% of the world share market. It is prudent to add other share markets in proportion to their size as well as bonds to the mix to see how diversification in the portfolio would have changed the situation.

Asset Allocation

Using the same assumptions as above, but this time instituting a "Socially Responsible" 60/40 globally diversified portfolio consisting of 60% growth assets (shares and property) and 40% income assets (bonds and cash), would have left this retiree with $2.3 million by 2020 as opposed to the $4 million under the all-share New Zealand portfolio.

However, instead of losses of -0.35% and -32.80% in 2007 and 2008 respectively in an all-NZ share portfolio, the SRI 60/40 portfolio was up +5.72% in 2007 and only down -15.99% in 2008.

By spreading your bets, you can reduce the risk of one asset causing severe damage as, when this happens, most investors have difficulty sticking to their plan and tend to bail out just at the wrong time and not capturing the long-term returns available to them if they remained invested.

So while the NZX 50 Index returned 10.6% per year from 2000-2020, a globally diversified SRI 60/40 portfolio, rebalanced annually, would have resulted in a return of 8.04% per year, still very respectable and without the huge swings in a bear market. It is also worth noting that the NZX 50 Index had a ‘top league’ performance in the last 20 years but when you look further back this has not always been the case. We advise against relying on past performance to predict future performance.

Having a Sound Financial Plan in place

The perfect portfolio only exists in hindsight and every retiree is going to face unique market, spending, tax and withdrawal circumstances.

Therefore, the best and simplest way to protect against timing risk is to have a flexible financial plan that allows for the occasional course correction.

Having a comprehensive financial plan is important no matter your stage in life. You must be able to adjust your plan to the reality of what the markets or your life throw at you. That could mean holding enough cash or bonds to see you through a prolonged bear market or recession, so you don’t become a forced seller in a down stock market. Or it could mean setting aside reserves when the markets are rocking to see you through the tough times on the other side.

However you decide to invest your money, a financial plan that takes into account the element of luck, both good and bad, is a necessity. At the Private Office, we are used to building this risk into our financial planning work to show all types of scenarios. About the author Laetitia Peterson is a personal wealth adviser and is married to competition barrister, Andrew Peterson. She has worked with companies such as Goldman Sachs and boutique funds management firm Liontamer, which she co-founded with Janine Starks. She is now the CEO and founder of The Private Office, helping successful lawyers achieve the financial goals important to them and their families.

About the author Laetitia Peterson is a personal wealth adviser and is married to competition barrister, Andrew Peterson. She has worked with companies such as Goldman Sachs and boutique funds management firm Liontamer, which she co-founded with Janine Starks. She is now the CEO and founder of The Private Office, helping successful lawyers achieve the financial goals important to them and their families.

A disclosure statement is available on request and free of charge.