Why Most People Pick The Wrong Asset Allocation For An Early Retirement

Client came to me with $3 million and they were 100% equities and they said Ari , isn't this crazy ? Like , how did my initial advisor even recommend this ? And I said it depends . How much do you want to spend in your retirement ? They said $8,000 a month . I said that's $96,000 a year . They go yeah , that's right .

I said it's about $100,000 a year and you've got a $3 million portfolio and 100% equities . Do I have that right ? They go yep , you've got that right . This is a rocket science . I go how much does your pension cover ? And they go well , about $6,000 a month . I go okay , so your pension covers about $6,000 a month . You want to spend $8,000 a month .

$2,000 a month needs to come from your portfolio . Do I have that right ? They go yep , you've got that right . I say great . Here's what I need you to think about that $3 million can fluctuate a whole lot more than someone who doesn't have a pension .

But it doesn't need to be 100% in cash , because the reality is you have the pension that's helping out , which means you can be able to take on a little bit more risk than your traditional retiree . Does that make sense ? They said yes , but once again , does 100% equities just sound really aggressive .

And what we ended up having a long conversation on is the fact that most people are getting older and think they need to be more conservative , and so I like to break it down like this . I'll say what does conservative mean to you ?

And someone said conservative means to me that my money's not going to go up and down a whole bunch because , as I'm getting into retirement , I don't have the ability to recover in the same way I did when I was younger . I said that's true . They said then , what do you recommend ?

I go well , why don't you hear this other definition from my client , who I asked about what does conservative mean to you ?

And they said conservative means they don't want to unnecessarily leave any money on the table , but at the same time , they recognize , if their plan shows , that they're in a position to spend and do everything they want to do that , they're okay with it . And so I said which definition resonates more with you ?

They said , well , I just want to make sure I don't run out of money . And so the reason I'm telling you this quick story is because the truth is , most of you have a cookie cutter portfolio . Maybe you're getting older and you're going , yeah , maybe I need to have a little bit more in bonds and cash .

Maybe some of you are going , no , I really like how much I have in equities . It's done really well for me , but I know I should start tapering that down . But I'm interested in early retirement . So I don't really know the timing of this because I'm not retiring at 65 . I'm retiring in my early 50s or late 50s or early 60s .

So I don't really know what that means in terms of a timing perspective for shifting the allocation . So what I want all of you to know is that I don't believe in cookie cutter planning . So I don't say hey , what's your age and your risk tolerance ? On a scale of one to 10 , you might be a two today and a 10 tomorrow .

That does not give you the confidence to retire early with confidence , the first thing you need to do when it's coming up with your asset allocation is understanding how much do you want to spend in retirement ? And some of you are like , listen , I'm five , 10 years out from retirement . I don't even know what I'm going to get to that .

And I say we have to start with your expenses , because it makes a really big difference . Doesn't need to be perfect , but if you want to spend $100,000 a month or $10,000 a month , it's going to really change the plan . Now , 100,000 a month is an extreme example , but some of you know I'm from Malibu , california .

There's some characters in Malibu Okay , that's me putting it nicely and a lot of you know this and my clients that are characters that are listening right now . They know who they are and there's nothing wrong with spending 40 , 50 , 60 , 1000 a month , but you better have a portfolio that's able to support that .

Now some of you are going hey , I don't want to spend anything like that . Like that doesn't even remotely . I mean it would be interesting , but I don't need that to live Four or 5,000 , 6,000 a month . I've got all my essentials met . Yeah , I want a little bit more for travel and I'd be good . I say great .

What I need for you is to have a portfolio that actually is dictated based on what you want your life to look like . This is why I don't love target date funds in your 401K . This is because they don't know how much you want to spend . They don't know that you might not have any children that you want to leave money to . They don't know your situation .

So today , a little bit of a longer intro , is me going through a full analysis and sample of how I create an asset allocation for someone that's trying to retire early , before age 65 , and how should that change throughout retirement . So , with that being said , my name is Ari Talbleeb .

I'm a certified financial planner , host of the early retirement podcast and vice president here at Root . Now let's hop right in . A large majority of you are not simply going to retire at 60 and go great , I've got an IRA time to turn on my income .

The reality is , maybe you're doing part-time income , maybe there's rental income , maybe you're debating turning on Social Security in a few years , maybe your spouse already has turned on Social Security . You're going to have various income sources , and so your asset allocation should absolutely change based on that .

So I tell everyone hope you marry your partner forever unless it's not a healthy relationship . But don't marry your asset allocation . No , simple dopey jokes . But I do this in a way to hopefully resonate with all of you . So what I always like to do is break down what is an asset allocation .

It's essentially saying what's the right amount should you have of things that are growing for you versus things that are there to preserve your capital . It's pretty simple and what you want to make sure is your asset allocation is talking to what I call your asset location , and I don't just call this .

Lots of advisors call it this , so I did not coin the term by any means . But asset allocation is what's the right amount ? Should I have an equities , fixed income and cash versus asset location is saying where should I own those assets ?

So , for example , let's assume someone comes to me and we determine that , after determining their goals and their travel and their healthcare expenses and all these things that they want to spend , let's say , say , I don't even know , I'm picking a number 5000 a month , that's $60,000 a year . Now let's assume they have a million dollars .

To keep it really simple , they want to spend $60,000 a year . Now , it's not going to be every single year , because a lot of you know this . But there's something called the retirement smile , which is the reality is , you're going to retire early .

You're going to have your energy and health , you're going to want to spend more and I'm going to want you to spend more . Then what's going to happen is , naturally , you're going to spend less and then maybe in your late 80s , early 90s , you're going to spend a whole lot more when you go .

Well , I don't want to pass away with five or $10 million , so don't feel like you're marrying your expense strategy in retirement . I want it to be dynamic , but it's important as it relates to your asset allocation . So let's go back to my example .

Let's assume you'll spend 5000 a month or 60,000 a year , every single year , just for example purposes , and you have a million dollars . Well , what that tells me right off the bat is I need to have enough income on the side so that if markets are going wild , you don't have to worry . You're not going . Oh my gosh , market changed . Does my income change ?

What I like to do is have a minimum of X number of years of expenses , and I'll explain that in just a second . So let's assume that you want to spend $60,000 a year . I'll ask someone . I'll say what's the average ? Market downturn until it just fully recovers , just just back where you make your money and they go .

I don't know , a few years ago it's actually you're pretty close , two to two and a half years , but that's the average . What if a 2008 occurs ? What if there are so many variables out there that actually freak you out , which , to a lot of you , you are going to go ?

Yeah , it is going to freak me out if markets don't do well and all of a sudden I need income . I don't want that to impact the next 40 , 50 plus years of my life , and I'd say reasonably so . What I want you to do is have enough on the side to have to sell something at a loss .

So , for example , let's assume you want to spend 60,000 a year and there's no other income sources and double that , that's 120,000 .

So I want at a minimum 120,000 out of the million in some super safe asset , not just cash , because I want it getting interest for you Could be CDs , could be an inflation protected security fund , could be any fixed income alternative asset that I deem is most fit for that particular client . Now , that's the average . I don't like the average .

I want to double that , so let's double it . So , instead of two years of living expenses , let's have four years . So that's $240,000 that we're going to have on the side essentially four years of living expenses .

So , no matter what happens , markets are doing well , markets not doing well , you are okay , you're not going to have to go tap those accounts , sell something at a loss to create your income . So why am I giving you this super basic example ? Well , $240,000 out of a million dollars that's nearly . That's technically a 76% equity , 24% fixed income portfolio .

So , right off the bat , I'm looking at 76% equities and 24% fixed income or cash . Most people go , yeah , that makes sense , it's pretty straightforward . And they'll go what if I have $2 million ? Well , once again now imagine you have $2 million , but the same exact example you wanna spend $5,000 a month or $60,000 a year , but you have $2 million .

Well , now you don't need a 76 , 24% asset allocation . The truth is , you now still need $240,000 , but you have $2 million . So now we have a whole lot more flexibility . And that's kind of the premise of why I'm doing this , and I'm just using my calculator right here to give you the exact number .

That's essentially saying that you need 12% of your portfolio in fixed income , cash type of alternative assets so that you have your income to whether there's four years of a market downturn , and then you've got 88% of your assets growing for you and you're in a great spot .

Some people go , hey , I just feel better with five years or six years of living expenses . I say , great , let's show you those alternatives . Other people go you know what ? No , already . The truth is , this makes sense . I get the analysis , but I've got rental income and I'm still working today and my spouse is still gonna bring in some income .

So how does that change the asset allocation ? I go okay , let's assume you have $2 million and you wanna spend $5,000 a month and you've got $3,000 a month that's already coming in from a spouse who's working some part-time income . Well , that now tells me 2,000 a month needs to come from somewhere . $2,000 a month , $24,000 a year .

We wanna add a minimum if we want four years of living expenses , have about $100,000 , just about in some super safe asset . So if you have a million dollars , that tells me that if you have some part-time income , there's no reason you couldn't have 90% equities and 10% fixed income and cash . Now some of you are like , oh my gosh , this is just .

I never even thought that I could have this amount in aggressive funds because I thought it was more risky . And that's when it's all about redefining risk . Some people go , hey , I just couldn't sleep at night Seeing my funds go up 30 , 40% and down 30 , 40% . Say great , you don't have to . Maybe it means you're working two , three , four , five more years .

But if you're gonna sleep better doing that , then I'd rather you do that Once again . I'm like the meanest early retirement planner . I don't want anyone to ever retire too early , but I also wanna make sure that you're not unnecessarily leaving money on the table .

So a good job of as an advisor is someone who's gonna actually quantify the trade-off so you can understand the magnitude of each decision and then from there help you determine what makes most sense . I'll give you a fun example .

Client came to me and they wanted to pay off their mortgage and I could tell if they wanted to pay off their mortgage based on the way they were talking about it and they were gonna feel a whole lot better paying off the mortgage .

I mean , they were gonna sleep better and I could tell they were gonna sleep better , even though it was clear that they should invest instead of paying off their mortgage . I mean , what they should do financially is pay the minimum to the mortgage , invest the rest and get a whole lot more growth . And that's the financial spreadsheet answer .

But I don't work with robots , I work with people , and so what's actually happening is that they're gonna sleep a whole lot better when they pay off their mortgage . They already weren't in great health . They don't need to add more stress unnecessarily , since they were in a good spot anyway . So could they have invested and done a whole lot better ?

Yes , but they understood the trade-offs and went hey , I'm gonna sleep better paying off the mortgage . So they did that and we understood that there's gonna be money left on the table and they were still okay . Most people go well , I've got a mortgage at four , five , six , seven , eight percent in crazy cases , but shouldn't I invest instead ?

Like , couldn't I get 10 , 11 , 12% ? I go , yes , but you're guaranteeing that return when you pay off the mortgage . So you're guaranteeing a 6% return versus trying to get eight , nine , 10 , 11 , 12 plus percent , which is certainly doable , but as an average over time and averages don't exactly size up to a traditional retirement .

Because let's assume that , very simply , you have a million dollars and it goes down to 50% . Well , now you have $500,000 . A 50% gain on $500,000 does not get you near that million dollars . So you actually have to do a whole lot better than 50% just to get back to even .

And that's where I tell clients hey , the way you win in retirement , in an early retirement specifically , is by not losing . I'm okay with you trying to hit home runs Up until retirement . I'd like to start to smooth it out with doubles and triples of a baseball analogy along the way . But once you're in retirement , it's all about consistent singles and doubles .

You don't need a home run to be okay . Now , some people do . Some people are like , hey , I want to spend 10 , 15 , 20,000 a month in retirement , and if I can't do that , it's not even worth being in retirement . I say that's fine . What you need to do is have a plan that tells you you're in a great spot to be able to support that income .

The last thing I want to leave you with and this will be a shorter episode than most Now I say that now , but I might keep going . But the reason I want to bring this to your attention is most people go well . Once I get older , I'm like 70s and 80s , shouldn't ? I have so much in conservative assets that I never run out . I go well , absolutely .

If you're not able to stomach the downturns due to education or due to the fact that you just don't feel comfortable investing in retirement , not only is that okay , it's really not a bad thing at all . Some people are like , no , no , I know , I need to invest . They go . Investing can be helpful .

But I have a client that has north of $8 million and they just cannot stomach investing in the stock market , and so , whether it's using a real estate fund or using any other alternative asset , that's just gonna let them sleep better at night . Now that particular client has a pension that covers the majority of their needs .

But the premise here is simple you should have an investment portfolio that lets you sleep at night , and if you don't understand the strategy , then don't invest in it , because you're gonna kind of trust an advisor is doing the right thing . Whether they're doing the thing or not . You need to understand why they're doing what they're doing .

So let me give you another example . This is specifically with Social Security , and I could use any example , but I find this one works with people . So what I'll tell someone is I'll say hey , what's your Social Security strategy ? Like , when are you gonna collect ?

And they're like , well , thinking about collecting earlier , because if I collect earlier , even though it's a smaller amount , I'm gonna get it for more years . I don't know how long I'm gonna live . I go , that's fair . Another person comes and says hey , I'm thinking about collecting later .

Yes , I know I'm not getting it as early , but it's gonna be a larger amount , and so it might be for fewer years , but that's what I wanna do . And if something happens , those dollars go to my spouse , meaning they would get the larger benefit for the rest of her life . I go once again , sounds fair .

And then I'll say how is your asset allocation gonna change based on your decision ? And they're like , well , and I can tell they don't really have an answer prepared for it , which , how could they ? But they go yeah , I'll just get more conservative . And I go , I would consider doing something the opposite . They're like what do you mean ?

I thought , getting older , more conservative . I go once again . Let's look at another example . Let's assume you have a million dollars and you wanna spend 5,000 a month in retirement , that's $60,000 a year . Now what if Social Security gets turned on and Social Security is providing four of the $5,000 ? Meaning , $4,000 a month come from Social Security .

5,000 a month is what you need . Now 1,000 a month is needed from your portfolio . Does that make sense ? And they go yep , that makes sense , I go . So are you gonna become more conservative ? And they go yes , and I go . Let me make sure I understood my point here , or I'll ask them , of course .

I'll say make sure you understood my point here , which is , as you get older and more guaranteed income gets turned on , less needs to come from your portfolio Doesn't mean you need to make it more aggressive , but it certainly means you could and still be in a good spot .

What I don't wanna have happen is that my clients get mad at me when they're in their 70s and 80s going hey , I see I was in a fine spot to invest well and do well , that even if markets went down 20 , 35 , 40% , I was still gonna be okay .

Why didn't you give me the confidence to spend more when the money would have been worth more when I was in my late 50s , early 60s , when I have my energy and health . So the premise here is I wanna make sure that , as more guaranteed income sources get turned on , your investment allocation is actually reflecting that .

Now , the really basic point here is as there's more income whether it be pension or rental income or social security less has to come from your portfolio , and so your portfolio should be reflective of that . Most people don't make that adjustment . Most people get into retirement and they've got 60% in equities , 40% in fixed income .

Maybe they're thinking about 65 , 35 . Maybe they're thinking 70 , 30 . I don't think it should be any of that . I think it should be based on how much you wanna spend in retirement . Do you have enough set on the side to be able to ride those waves ? So if something does happen , you are okay . And then this is all . Level .

One Like this is all asset allocation , early retirement planning . If you need this income for 40 , 50 plus years , the truth is you're tiring in your early to mid 50s or even early 60s . You might need this money for 30 , 40 years . So I don't want you to be so conservative that the first 15 years of retirement are smooth and the latter 15 aren't so smooth .

I want you to have consistent income the rest of your life . Now , this is all , like I said . Level one this is asset allocation . Asset location is essentially saying if you want to have an 80% equity and 20% fixed income portfolio , don't just put 80 , 20 in your brokerage account which I call the superhero your IRA , your Roth IRA , your 401k , your HSA .

That's what most people do , is they go yeah , I think I'm 80 , 20 or 70 , 30 , or I go , you're not any of those things , you're an individual person . I'm just kidding . I'll make that joke with clients . I'll say and I stole that from another advisor who uses that joke , let me say , but I thought it was funny . So you're your own person .

You're not an asset allocation , which is true , obviously , but stupid joke . Let's get back to my point . My point here is , with asset location , I want to make sure that if you are saying I want an 80 , 20 portfolio , you don't just put 80 , 20 in every account . That's not tax efficient .

Here's why what you want to do is say , okay , I've got a Roth IRA worth $200,000 and I've got a 401k worth $800,000 and it's all pre-tax . So I have a million put together , but 200,000 Roth , 800,000 is pre-tax . You want the 200,000 in Roth to be 100% equities because that's the best account for tax-free growth over time .

Then you want the $800,000 to be even more conservative so that you get to an overall allocation of 80 , 20 . So sometimes it's 100% Roth IRAs , with 50% in an IRA , depending on how much the IRA makes up of the whole portfolio .

Sometimes it's you have a brokerage account and it's got some really healthy gains in it and you don't want to just make a switch all at once because there's tax implications . So what we'll recommend is saying let's do a portion over time and let's identify each security to understand the potential drawdowns .

Last example here and then I promise this is the final one , for the episode today is a client came to me and they had about $1.4 million in Apple Stock . I said what's the worst case scenario ? Like just absolute worst case scenario . They said well , worst case scenario is it goes to zero . Technically , I go , that's right , I go .

What's the worst case scenario ? Tax wise ? They go , well , I'm in the 15% capital gains bracket . There's that net investment income tax of 3.8% . So 18.8% let's call it 20 to make it easy I go , that's right . 20% taxes is kind of the worst case scenario . If you sold today , they go . Are you trying to tell me to sell today ? I go .

No , I'm trying to help you understand what are the potential kind of drawdowns . Some people go hey , I've got this company , I've worked there many years , I'm comfortable with this level of an allocation , but when I retire , I want to know how to use .

You know , the tax gain harvesting you talk about to pay 0% taxes on the gains and I say , great , I've got another episode and if you guys haven't heard that , go ahead and check that out on YouTube or the podcast where I talk about tax gain harvesting to pay 0% in taxes in an early retirement .

But the premise of what I'm talking about now is I want to make sure that you don't go . Well , I'm going to hope that my stock keeps going up and up and up and if it does , happy days . But if it doesn't , it's hey , now I can't retire on time . So why am I bringing this up ? The truth is , no one really loves their individual stock position .

What I find is people want to make sure they can retire if they want to , but they also don't want to leave money on the table unnecessarily .

So what we'll do is we'll identify the specific position and sometime it's tens , if not hundreds of positions and say here's exactly when we should sell each position , based on the potential drawdowns and how much you want to spend in the first years of retirement . So the premise is we want to connect all of this investments , taxes , state withdrawal strategy .

It's a holistic approach . That's the approach we take here at Root Financial . I don't find there's another approach that works , so that's why I do it this way . I need every single thing connected and I want to make sure that nothing's being left on the side unnecessarily . I don't want you leaving money on the table needlessly .

That's what I want to go through in today's episode an example of how to even think through an asset allocation . But to summarize , make sure you understand what you want to spend in retirement , but don't marry it . In the first few years . You might want to spend more on travel and you might want to do some fun stuff .

Great , I want you to do the fun stuff . I just want you to do it without that little thing in the back of your head going hey , mind a good spot to actually do this . Then I want you to go . Okay , based on my current investments , am I allocated appropriately Meaning ? Should I have more conservative investments to help weather the dancers ?

Am I overly conservative ? How is this going to change ? Based on my income strategy ? How am I making sure that if I do make changes , there's no tax implications that are going to create a big burden , whether it be today or down the line ? So just making sure you have a holistic approach with this is going to put you in an amazing spot to retire early .

So I love talking about this stuff because the truth is , if you're good with numbers , you can retire earlier . And good luck quantifying the impact with friends and family and your health . On a spreadsheet you just can't do it . So that's why I love doing what I do .

If you guys , of course , are interested in creating a custom strategy , it's what we love to do . We focus on retirement planning and specifically early retirement planning . So anyone retiring before 65 , there's more nuance involved health insurance , withdrawal rates , tax planning .

That's the real value , and I've said this on previous episodes I don't think it's worth paying an advisor for investment management . I think it's worth paying an advisor for holistic planning , and I have a video on YouTube where I go through the pros and cons and help you understand the difference .

If it even makes sense to hire an advisor and sometimes I say it doesn't make sense to and people are like shooting me emails that are other advisors and like , hey , don't say that , you know it's bad for my business I'm like I don't care . The truth is it just depends what stage of life you're in , what experience you're looking for .

Some people are reaching out like , hey , I think I could do all this on my own . I say , great , what's the ROD of that ? And they're like what do you mean I go ? Rod stands for return on desire Meaning . Is that what you want to do , not just can you do it ? How many years would it take to figure it out ?

And is that what you want to do the whole time ? And some people are like , yes , I say great , then don't pay me . Like watch my videos and podcasts and you're good to go . Other people are like , no , I want to make sure , in case something happens to my spouse , we're taken care of , or you know what ?

I just want an objective third party to run ideas by , say , okay , then there's reasons , but I only want someone hiring us if they're over the moon excited . Not , I think I should do this . I've been putting it off for some time . I know I need an advisor . We don't do that , we don't do . Your advisor is going to talk about boring numbers and graphs .

We say , hey , you know how much can you spend in retirement ? What's the most that you can spend without running the risk of running out of money , not what's the least , so really helping you get the most life out of your money . So hopefully this episode was helpful and I'll have a new episode for you all next week .

I just realized that I forgot to go over a review of the week at the beginning of the episode . I do that each week , so I'm going to go over one briefly , and this is going to come from KD 22522 . I'm just pulling up my phone here . Ari has a wonderful way of explaining complicated retirement financial planning topics . Thank you for your expertise .

You're very welcome . I love doing it . Kd 22522 . Guys , that's it for today's episode . Love you . Thank you for listening to another episode of the early retirement show . If you have a question that you want answered in a future episode , you can always go to my website , earlyretirementpodcastcom .

That's earlyretirementpodcastcom and you can go ahead and submit a question that I'll look to answer in a future episode . Thank you all for listening . Please do rate it , review it and share it with someone who you think would benefit from this information . If there's anyone out there that you know , I certainly appreciate it and I will see you all each week .

Hey guys , it's me again . Please be smart about this . Nothing in this podcast should be construed as financial , tax or legal advice . Consult with your tax preparer or financial advisor before taking any action . This podcast is for informational purposes only .