When you review your portfolio, what do you look at first? Our guess is performance -- whether your account is up or down, and by how much.
To be extra thorough, you might even compare that with some broad measure of market returns, like the S&P 500 (or a broad bond index if you hold fixed income). This is all well and good, but we humbly suggest going a step further and paying attention to risk factors as well.
With that in mind, here are a couple of things to consider and discuss with your retirement-planning strategist with regard to the amount of risk you're taking with your nest egg. In our next installment, we'll detail a few more.
Have all of your stocks gone up a lot?
Many folks would think this is an ideal scenario, but it is actually a warning sign -- all your stocks moving in the same direction is a potential sign you aren't sufficiently diversified.
Diversification is not just about having more than one stock -- it is about having multiple stocks, across multiple sectors and industries and, ideally, even multiple countries. If all your stocks rise simultaneously, this movement suggests they are all responding to the same key factors and drivers. A properly diversified portfolio will spread out investments across categories that respond uniquely to different factors and drivers.
Many investors think owning more than one stock is diversification and, to some extent, that's true. But this scenario diversifies only one type of uncertainty: company-specific risk. While it could help protect you from the risk of having all your money concentrated in an Enron-like house of cards, it won't protect you from higher-level concerns and considerations.
If, for example, you own a slew of energy-firm stocks, you've diversified company-specific risk. But you are still exposed to the risk when the sector falls prey to sinking oil prices -- as it has since June 2014. If you own all U.S.-based firms, you could obtain significant diversification on a company- or industry-specific level. But you likely haven't mitigated the risk of the U.S. government passing laws detrimental to domestic firms.
How much do you withdraw annually, and could you cut it if you had to?
This might seem like an off-topic question, because few folks think of withdrawals as a risk. However, they are a crucial consideration in retirement planning -- particularly for investors early in retirement. The primary point of a retirement portfolio is to fund the years when you aren't working. The very biggest risk you face during that time is depleting your assets while you still need them. And, annual withdrawals typically put the greatest strain on your portfolio during retirement.
You can calculate your annual withdrawal rate by using your account's online-access tools. It usually isn't too hard to sort the transactions page to view your withdrawals for the year (if you can't figure it out, your grandkids can probably help). Total the past year's withdrawals, and then divide that sum by the value of your portfolio at the beginning of the year. The resulting number is your withdrawal rate for the year.
How high is it? If it is lofty -- 8%, 9%, 10% -- you could very well have a major, acute and immediate problem in need of rectifying. Even if it is a more manageable level -- 4%, 5%, 6% -- you should consider the worst-case scenario and assess how you would live if you had to slash this amount by a quarter or half. Write down your plan.
Having flexibility in your withdrawal rate is a big depletion-risk mitigator. Even if you presume you will perfectly foresee every market downturn from here until you leave this earth, it is wise to humbly prepare as though you won't.
Fisher Investments is an independent, fee-only investment adviser serving investors globally. To learn more about Fisher Investments, please visit www.fisherinvestments.com.