Designing A Retirement Portfolio That’s Just Right For You by Chuck Carnevale, F.A.S.T. Graphs

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No one knows your own personal financial situation better than you do.  Every individual possesses their own unique investment goals, objectives, needs and risk tolerances.  At first glance this may seem simple and straightforward to the point of stating the obvious.  However, I contend that the reality that individuals have different financial situations, goals and objectives is profoundly important as it relates to designing an appropriate retirement investment portfolio.  There is no such thing as one-size-fits-all when designing the appropriate retirement investment portfolio, or any type of portfolio for that matter.

I believe that a retirement portfolio should be designed to meet the unique needs and goals of the individual it is built for.  To me the first and perhaps most important step is to ascertain a realistic assessment of the investor’s tolerance for risk.  This will establish a foundation of what types of assets the investor would be capable of staying the course with. If the investor cannot tolerate the high risk necessary in order to achieve a high rate of return, the odds of a successful long-term outcome are greatly diminished.

Once risk assessment is established, the next logical step when designing a retirement portfolio is to determine the amount of income the investor needs to support them.  Just as it was with risk assessment, income goals also need to be realistic and consistent with risk tolerance.  After establishing risk tolerance and income needs, it then becomes reasonable to evaluate total return potential.  Once again, realism comes into play.  Investors need to understand and accept the reality that there is generally a trade-off between rate of return, income and risk.

In today’s market environment, I believe a realistic and reasonably conservative income goal falls somewhere between 2 ½% and 5%.  Of course, higher yield is also associated with higher risk.  Also, higher yield tends to be achieved at the expense of higher capital appreciation.  To clarify and summarize, in order to achieve a higher yield you must simultaneously be willing to accept less growth or capital appreciation potential.

However, that does not necessarily mean that you cannot achieve an acceptable long-term total return at reasonable levels of risk.  Instead, it simply means that a greater portion of your return will come from income rather than capital appreciation.  I will be illustrating these principles more fully later in the article.

Is Index Investing the Right Choice for Retired Investors?

There are many who argue in favor of investing in index funds or ETF’s over constructing a portfolio of carefully selected individual securities.  Their supporting evidence is usually predicated on statements such as the majority of actively-managed accounts do not outperform the S&P 500, or that your portfolio can only be successful if it beats the benchmark, again, usually the S&P 500.

Personally, I find these arguments irrelevant regarding designing a retirement portfolio that specifically meets the needs, goals, objectives and risk tolerances of a specific individual.  For starters, as I previously indicated, a properly constructed portfolio is not simply or only about generating the highest total return.  Investors are wise to recognize that total return is comprised of the two components income and capital appreciation.  The former, income, is usually the most predictable and reliable component.  In contrast, the capital appreciation component is harder to predict, and due to its more volatile nature, less reliable.

As to outperforming the index, wouldn’t it be a tragedy to have a portfolio that outperformed the index but did not meet your needs?  The corollary to this last point is the fact that an index such as the S&P 500 will not necessarily meet the specific investment needs of every investor.  For example, there are many retired investors that require more income than the S&P 500 is capable of generating.  Supporters will argue that it doesn’t matter, because you can also harvest profits to supplement your income.  But doesn’t that assume that profits will be there?  As indicated above, the capital appreciation component is less predictable than the income component.

To conclude this section, retired investors have numerous investment choices at their disposal. In broad terms, investors only have two options - equity or debt.  When investing in equities you are positioning yourself as an owner of the asset.  Equity ownership comes with no guarantees or assurances that your investments will be successful.

Debt instruments imply loaning your money at interest.  With positioning yourself as a loaner, you are assured of getting your money back at some point in the future, at least in nominal dollars, assuming of course the debtor is capable of paying the loan back.  Consequently, as a general rule, debt investments are considered safer.  On the other hand, debt instruments are typically associated with generating higher levels of income but earning lower total rates of return.

The point is that not all investment options are offered in order to achieve the highest total return.  Some are offered to provide a higher level of income and/or significantly lower levels of risk.  Therefore, investors are free to pick and choose among all the options that they feel best suit their own needs.  Investing is not just about high returns; it’s also about safety and predictability.

Furthermore, within those broad categories are numerous types of securities that can be utilized.  As an investor you can choose to selectively invest in individual securities, or you could invest in packaged investments such as ETF’s, mutual funds, partnerships, etc. Regardless of what type of instrument you choose or prefer, I believe they all require an appropriate level of research and due diligence.  Just as there are many thousands of individual stocks and/or bonds to choose from, there are also many thousands of packaged products to decide upon.  For example, many years ago it was reported that there were actually more stock mutual funds in existence than there were common stocks.

So what is the best option among all the many choices?  The only correct answer is that it depends on the preferences of each individual investor to decide what’s best for them.  Therefore, my advice is to follow your own hearts and minds and never let anyone talk you into investing in something you’re not personally comfortable with.  But most importantly, do your best to choose the options that are best capable of meeting your own needs and risk tolerances.  However, in order to accomplish that, you need to understand how the investments work and what they are actually capable of producing.

Performance is Two-Faced

Obviously, all of the available investor choices cannot be adequately covered in a single article.  However, I will readily admit that I have a preference for carefully selected individual securities over investing in packaged products.  Therefore, the vast majority of my work is oriented towards discussing individual stocks, primarily high-quality dividend growth stocks.

Moreover, consistent with the themes that I’ve already written about in the preceding sections of this article, I offer the following discussion about calculating performance.  In my opinion, there are important aspects regarding performance measurement that are often overlooked.  Many believe that performance measurement is simply adding up the numbers, I believe it is much more.  For example, consideration about how much risk was taken to achieve a

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