I've never seen so many retirees make the same portfolio mistake at the same time.

And the frustrating part is this usually happens because people are trying to do the right thing.

It's not because they're trying to chase returns.

It's not because they're reckless with their investing.

It's because they're taking a very cookie cutter approach without actually knowing it.

So what I see is two very different paths that lead to the same place.

And those two very different paths depend upon whether you're someone who's done this to yourself your entire life and what I typically see there, the mistake that happens, versus someone who's working with an advisor and some of the traditional cookie-cutter advice they get with their portfolio.

Regardless of what path you've taken, ultimately there's one singular problem that exists with each of these approaches.

And it's a major problem that costs many people dearly in their retirement years.

So today we're going to talk about what those two problems are and what you should do instead so that you don't become like the many people who make the same mistake at the same time and jeopardize their retirement years.

So I'm going to give you two very clear, very specific examples that illustrate the impact, the negative impact of both of these portfolio mistakes.

But here's why this matters people are living longer today than they ever have before, which means your portfolio needs to last longer.

At the same time, people are retiring earlier than they ever have before, which just magnifies the point I just made.

And then number three, there's ever-present volatility.

And that volatility is never going to go away.

So how do you as a retiree address these issues, address these challenges?

And I see two mistakes that people make.

Number one is people that typically have done this themselves.

They've saved, they've invested, they're preparing for retirement, and now they're taking a much deeper look at their retirement strategy.

Typically, these people fall into the mistake of saying, I'm just going to do what's worked until now.

You know, the last 10 years or the last 15 years, the SP, the NASDAQ, the US stock markets performed tremendously well.

Why change now?

That's one mistake.

The second mistake is that individual who's working with an advisor.

And typically, those individuals are being placed into a pretty cookie-cutter portfolio.

Typically, it's a fairly generic 60-40 portfolio.

And maybe there's a good story around it, maybe there's a good uh explanation for it.

But the reality of it is you're in that portfolio because it's what you're supposed to be doing, according to your advisor.

Both of these approaches are wrong.

And I'm going to show you why so that you don't make these same mistakes.

Let's start by understanding the mistakes made with path number one.

So you're going into retirement, you're in your early 60s, and you have a portfolio.

And if you look at your portfolio, it's almost entirely made up of US stocks.

More specifically, probably large tech stocks.

Now you might not have the individual securities themselves.

You might own Nvidia and Apple and Tesla and Microsoft and Google directly, or you might just own a US stock fund or a NASDAQ stock fund.

You might be looking at this and saying, why on earth would I change this?

Let's assume you have an SP 500 fund.

Well, since the beginning of 2010, the SP 500 is compounded at about 14% per year.

Why change that?

Now, if you own a NASDAQ, the NASDAQ 100 type fund, specifically owning large US tech stocks, that's compounded at close to 17% since 2010.

So why the heck would you change that going into retirement when it's worked so well here?

It's gotten you to where you are.

Why on earth would you consider changing that?

Well, let's look at a case study.

John is that individual.

John is 62 years old with$2 million in his portfolio, and he has all of his money in NASDAQ positions and growth stock positions.

It's worked tremendously well and it's built his assets to where they are today.

And in fact, it's what's enabled him to even be able to retire in the first place.

So John goes into retirement saying, if I'm compounding at these rates of return, why change this?

If I want to pull, let's say, 5% or so out of my portfolio, I can very easily pull 5% if I'm compounding a double digit return year over year.

Well, that happens and John retires and he has$2 million in his portfolio.

And then 2022 comes around.

Well, in 2022, the NASDAQ is down about 33%.

So you have a$2 million portfolio.

If you're down 33%, that's$660,000.

Now here's the thing.

You might hear that and say, yeah, James, of course it's down, but it's going to recover.

Well, let's look at the math.

Let's look at how things actually play out.

Things do recover, and in fact, they have recovered since then, but how does that change for someone who's retired and is now pulling money out of their portfolio?

So John had$2 million going into 2022 and the market was down.

His funds were down 33%.

So$2 million is now worth$1,340,000.

But not just that.

Keep in mind, John also pulled out 5% per year, which was another$100,000 from his portfolio.

So he wasn't down 33% in aggregate.

He was down 38%.

His$2 million is now$1,240,000.

Now some people might look at this and say that's no big deal.

He was down 38% one year.

The NASDAQ's done really well.

It could probably very easily jump 38% the following year.

Well, here's how the math on this works.

If you're down 38%, it doesn't take another 38% for you to break even.

Let's actually use a much more simple example.

If you have$100 and you lose 50% of your account value, that$100 drops to$50.

Pretty simple math.

Now let's assume the next year you're up 50%.

So down 50% year one, up 50% year two.

What does that do for you?

Does that get you back to break even?

No, it doesn't.

Instead, after year one, you're down to$50.

After year two, so let's assume a 50% increase, you're only back to$75.

So you're still down 25% total over that because a 50% drawdown, it's not a 50% upswing that gets you back to break-even.

You will need a 100% rate of return to get back to break-even.

So that's how the math on this works.

For every drawdown you have, you have an even greater upswing that's required to get you back to where you are.

Let's go back to John.

John was down 38% when you account for portfolio decline and pulling 5% out of his portfolio in 2022.

Now, based on the math we just looked at, it's not another 38% upswing to get back to$2 million.

It's actually a 61% upswing for John to get back to$2 million.

But even that's not the entire story.

Because if after year one, John's portfolio balance is down to$1,240,000.

And if John still wants to take$100,000 from his portfolio this year, which he does, you don't want to have to take a pay cut when the market drops.

What that really means is John's no longer drawing 5% of his portfolio.

He's actually drawing 8% of his portfolio because$100,000 represents 8% of his new starting portfolio value, which is the$1.24 million.

And keep in mind, this isn't made up numbers.

This is real performance, real returns using 2022 as a baseline for understanding this.

So now what we see for John is John needs a 61% rate of return to break even based upon where he is to get back to$2 million, but it's even greater than that because he's going to be taking 8% from his portfolio this year.

So it's actually closer to a 70% rate of return that he would need in that single year to break even.

Now, of course, you don't need to get it all back in one year, but keep in mind, every year longer it takes to get back there, you're taking greater than 5% out of your portfolio.

John's taking more than that initial 5%, especially if he's adjusting his withdrawals for inflation.

So that's the challenge.

That's mistake number one I see as people, and typically people who have been more in the do it-yourself route.

Nothing wrong with that, but keep in mind what got you here won't get you there.

What's worked to get you to retirement will not work throughout retirement.

And what we're hitting on right now is the concept of sequence of return risk.

It doesn't matter what your average return is over the course of your retirement, it matters the order in which you achieve those returns.

If you have a big down year, like we just illustrated, and by the way, the more concentrated you are, the more aggressive you are, the bigger your down years are going to be.

If you have a big down year early in retirement, you might never be able to dig yourself fully out of that.

And that could lead to running out of money way sooner than you otherwise would have.

Doesn't matter what the average return is on your investments, if you're pulling too much of your capital out early on and combining that with a really poor market environment for your specific concentrated investments, it's going to be a bad experience.

So that's problem number one.

Now the other problem, number two, is typically for that person that has worked with an advisor.

And problem number two isn't overly concentrated and overly aggressive.

In many ways, it's the opposite.

It's a cookie cutter portfolio.

And usually your advisor isn't going to come to you and say, hey John, hey Mary, here's a cookie cutter portfolio I recommend for you.

No.

Instead, they're going to say, This is a 6040 and give you some cool information and tell you a cool story around it, and then they're going to deliver it to you.

But why 6040?

Why on earth is that the default portfolio that's recommended to all people?

Now it can be a good portfolio if you're backing into it for the right reasons.

But if that's the starting point, simply because you took a risk tolerance questionnaire, because you're a certain age, because you're now retired, it's probably not the right portfolio for you.

Let me explain what I mean by that.

We just looked at John.

John was more of a do-it-yourself approach.

He exhibited the challenges, the problems I usually see with the portfolios for people who do this themselves.

Now let's look at Lisa.

Lisa's working with an advisor.

Lisa also has$2 million in her portfolio.

And Lisa was recommended a 60-40 portfolio.

So 60% stocks, diversified stocks, 40% diversified bonds.

That's her portfolio.

Now on the surface, you can say, okay, well, she's diversified.

Okay, she's spread out.

Okay, she's taken risk off the table now that she's retired.

That sounds good at the surface level, but let's go a little bit deeper on this.

And the first question is what does going deeper look like?

Is it trying to say what are stock market valuations versus what are bond market valuations and what's uh the Federal Reserve going to do with interest rates?

No, it has nothing to do with that.

It has everything to do with going deeper on Lisa's specific situation.

What are her cash flow needs?

What are her expenses?

How much does she actually need from her portfolio?

Well, if we take a deeper look at Lisa's situation, we might see that she has strong pension income.

We might see that she has a strong social security benefit.

We might see that she has relatively modest expenses.

She has a paid-off home.

She doesn't need a tremendous amount of money to live a very comfortable life.

In fact, when we go deeper, let's assume that we can see that Lisa only needs$40,000 from her$2 million portfolio.

So we can see that by diving into Lisa's situation, we actually understand how her portfolio plays into her overall income picture.

What's coming in from pension, what's coming in from Social Security, what then needs to come from her portfolio to meet the lifestyle needs that she has.

We also might find out during this process that Lisa doesn't actually mind the ups and downs of the stock market.

She knows they come and go.

She knows it's a part of investing.

She wants to be responsible, but she doesn't mind having a more growth-oriented portfolio as long as she knows she's protected against downturns.

So what's wrong with a 60-40 portfolio in this situation?

At the surface, nothing.

But we have to go deeper.

Let's go deeper on why have bonds in your portfolio at all.

Now, to be clear, there are many cases, many very good cases when you should have bonds, but you have to start by challenging everything.

Why have bonds at all?

Well, I like to think about bonds and having bonds in your portfolio for a very strategic purpose.

And there's a couple strategic purposes.

But first and foremost is to protect against that sequence of return risk that we referenced in example number one.

That individual had all of his money in the NASDAQ or in the stock market.

With bonds, what you're going to get is you're going to get more consistency.

There's different types of bonds, short-term, long-term, medium-term, high quality, low quality, et cetera.

I'm talking specifically about shorter-term, high quality bonds here.

You're not going to get the same rate of return long term, but you're going to get a lot of consistency.

You're going to get more consistent outcomes.

You're likely not going to be down 30, 40% in a position like that, like you will be in your stock market investments.

So why accept a lower return here?

Well, you accept a lower return here because the stock market historically, if I'm using SP 500 as a benchmark here, the stock market historically has averaged about 10% per year.

So if we knew that we're just going to get 10% every single year forever, there's no reason to own bonds.

Just get 10% return and take 4%, 5%, 6% out of that each year.

That's how you'd think about it.

Well, that doesn't work because you don't get 10% every year.

In many years, you get a much greater return, but in many years, you get a much lower return.

And if you start taking too much out of your portfolio in years where your portfolio is down 20, 30, 40%, we saw in our first example how disastrous that can be for your retirement.

So what do we have bonds for?

We have bonds.

Think that's like a moat that you're building around your portfolio.

It's the moat that enables you to invest more aggressively with the core portion of your portfolio.

Because the average bear market in the US lasts about two and a half years.

Much longer bear markets might last somewhere around five years.

So if you have enough money in bonds, not just to fit an arbitrary allocation, not just to say 40% bonds sounds good and 60% stocks sounds good, but how do you tailor the amount that you have in bonds?

At root financial, we call this our root reserves.

How do we construct very intentional portfolios with enough in root reserves to protect against sequence of return risk?

Enough in root reserves to say even if the stock market falls and it lasts for five years, do you have enough in short-term, high-quality bond positions that will have a more consistent outcome that we can draw from given time for the stock market to recover?

It's not an arbitrary percentage, it's an amount based upon your specific cash flows.

So if we look at this in Lisa's specific example, if her specific cash flows are$40,000 per year that she needs from her portfolio, we want to make sure there's five years of that set aside in bonds.

It comes out to$200,000.

Well, if we then work backwards and say, Lisa, you have a$2 million portfolio.

We're going to put$200,000 in a very intentional mix of high quality bonds, then the remaining$1.8 million can be diversified in different stock investments.

What that comes out to is a 90-10 portfolio.

And I'm not saying that every retiree should have a 90-10 portfolio.

What I am saying is your allocation should be a direct reflection of your needs, not simply this templated cookie-cutter portfolio allocation that unfortunately too many people are put into.

Why does that matter?

Well, if we go back to Lisa's situation, if she were to invest in a 90-10 portfolio and have a 30-year retirement versus invest in a 60-40 portfolio and have that same exact 30-year retirement, taking$40,000 out per year.

If we assume, this is a big assumption, not a guarantee, but just to illustrate a point, if we assume the 90-10 portfolio would have grown by 8% per year and the 60-40 portfolio would have grown by 6% per year, then the difference in the final value of her portfolio upon her passing would be over 85% different.

Meaning millions of more dollars that she would have had in a 9010 portfolio had she invested in a way that was more aligned with her needs, not simply a templated cookie-cutter portfolio.

Now you might say, who cares?

If you pass away, you're dead.

You don't get to enjoy that.

Well, I care.

And Lisa cares, and her beneficiaries care, and the things that she could have done in her retirement years.

What else could you do with a few million more dollars in your retirement years?

What other places could you travel to?

Who could you bring along with you?

Who could you gift money to?

What could you gift money to?

What could you do if all you had to do to get that extra money was simply have a portfolio tailored to your needs as opposed to tailored to a generic cookie-cutter 60-40 allocation?

Now, just one more point to be clear.

If you back into a personalized portfolio and it ends up being a 60-40 allocation, that's great.

That means that portfolio, that allocation is right for you.

But don't start there, is the point that I'm making.

So if I go back to John and if I go back to Lisa, they both had different portfolios, but they had the same problem.

Neither of those portfolios were tailored to their needs.

One was based upon what's worked up until now, and the other was based upon a templated cookie cutter solution that's worked historically.

Neither, though, were tailored to John or Lisa specifically.

So what should you do?

How do you avoid falling into the trap of having a very generic portfolio that either is too risky and blows up your retirement, or that's too templated and cookie cutter and leaves far too much money on the table?

Well, you have to ask yourself questions.

What happens if there's a major market decline in retirement?

What happens if inflation stays elevated?

What happens if my spending needs in retirement don't perfectly adjust in a linear fashion, but ebb and flow based upon different stages of life?

What happens if one spouse passes away before the other?

These are all the questions you need to ask.

This is a planning that needs to be done so that you can back into an understanding of what portfolio is right for you.

Now, if you're watching and you fall into one of those two buckets and you know, yes, this is something I need to fix, I need to correct, reach out to us here at Root.

You can either scan this QR code right now, which will take you to our website where you can set up a call, or you can just go to rootfinancial.com.

Link is in the show notes below.

Check out our advisors, check out our website, see the types of services that we implement for our clients to ensure that the portfolio isn't generic, nor is it too overly risky, but it's the right portfolio for your specific needs.

So retirement risk, when it comes to your portfolio, it's not volatility, it's a mismatched portfolio that doesn't reflect your unique risks and your unique needs in your unique overall plan.

At the end of the day, your portfolio shouldn't just reflect your age, it should reflect your life.

So step number one, build a financial plan.

Understand your cash flow needs throughout retirement.

Then step number two is design a portfolio that fits into that.

Plan first, allocation second.

If you're starting with a portfolio, you're likely to drift in the wrong direction.

But if you start with a plan, and that plan is a reflection of your life and only your life, your portfolio design is gonna be far more effective.