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The Best Way to Invest for Retirement

How this author says you can lower your risks and boost returns


Turn on CNBC for two minutes and it’s easy to believe you need to stop everything and invest in the hot stocks the “experts” are recommending and get out — NOW! — of the ones they’re bearish about.
 
Chris Minnucci, author of the ironically titled The Death of Buy and Hold: How Not to Outlive Your Money — Investing for, and in, Retirement, says do so at your own peril.
 
Minnucci, an early retiree and self-taught investor, says you’ll be far likelier to make your retirement money last if you take a more cautious, deliberate approach to investing. Minnucci preaches diversification using what he calls “the principle of correlation combined with the complementary principle of compromise.”

(MORE: When the Stock Market Crashes)

Combining Correlation and Compromise

Correlation means a portfolio mix that includes: some high-volatility investments; some investments that tend to rise and fall along with stocks of large companies (known as large-cap stocks) and some “low-correlation” investments that tend to do the opposite of what large-cap stocks are doing. Compromise simply means using bonds to reduce your portfolio’s volatility.

I spoke with Minnucci to get his views and advice. Highlights from our conversation:

 

Next Avenue: What do you mean by ‘The Death of Buy and Hold?’

 
Minnucci: It’s a reference to the ongoing debate where some pundits say, ‘Buy and hold is dead’ and some say, ‘No, it’s very much alive.’ The title is an attempt to be ironic. Actually, the book recommends a buy and hold approach. What you want to do is die with some money.
 
But some analysts said during the financial crisis of 2008-09 that if you had just held the stocks in the S&P 500 for 10 years, your portfolio would have been flat.
 
If you’re 100 percent invested in the S&P, you’re not really diversified. The book points out that during those 10 years, a number of asset classes were going up — bond funds were up 5 percent, emerging market stocks were up 9 percent and some precious metals equities (stocks of gold, silver and platinum mining companies) were up 18 percent. The idea that the S&P hadn’t been going up doesn’t imply buy and hold is dead.
 
If you had been holding some of portfolios I describe in book, you would’ve done fine during the so-called ‘Lost Decade’ of the 2000s.
 
Buy and hold is the best investment strategy for amateur investors.

(MORE: Diversify Into Alternative Investments)
 
So you’re saying there are other stocks to hold beyond just the big ones in the S&P 500? Smaller stocks and international stocks?
 
Right. Owning just large-cap stocks in the U.S. doesn’t take advantage of some of the hedges in the book, like precious metals equities bought mostly through mutual funds and ETFs.
 
Most people think reducing risk means reducing your exposure to stock market volatility and buying bonds to do it. What do you think?
 
Risk and stock volatility are not the same thing at all. To me, the key risk is running out of money. Volatility is one way that can happen, especially if you retire and get hit by a bear market immediately. But it’s not the only way you can run out of money.

There’s the risk from stock volatility and the risk posed by not earning enough to keep up with inflation. That inflation risk is just as dangerous.

(MORE: 15-Minute Portfolio Checkup)
 
So you think people need to avoid holding too much in bonds because most bonds don’t keep up with inflation?
 
Right. If you rely too much on bonds, you could potentially increase your risk of not keeping up with inflation and then running out of money.
 
You say people need to understand how to diversify based on the principle of correlation combined with the principle of compromise. What do you mean?
 
The principle of compromise is basically adding bonds to your stock portfolio with the idea that bonds are a lot less volatile than stocks. So you can reduce the overall volatility of your portfolio by adding bonds. But they also return less than stocks; so when you add bonds, you reduce your return.
 
Most investors need to include bonds in their portfolio to a moderate allocation level.
 
The principle of correlation is the idea of adding highly volatile investments to your portfolio that tend to be not correlated with stocks. This approach allows you to potentially reduce the volatility of your portfolio and the risk of losses without giving up returns.
 
Precious metals equities is the one I really like, but it is extremely volatile compared to the stock market.
 
Why do you like precious metals equities so much?

They are a very strange asset class. If you look at them in isolation, they are lousy investments because they’re extremely volatile and have had lower returns than most other categories of stocks. But when you add them to a well-diversified portfolio of stocks and bonds, they don’t behave the way they do in isolation.
 
They reduce a portfolio’s volatility and they have done this in every bear market since 1973, save for one. They tend to zig when the stock market zags. They can also raise returns.

What asset allocation would you recommend for someone a few years from retirement and what would you recommend for someone in retirement?
 
For those who are not close to retirement and are in their early 50s, I recommend putting as much of money in stocks as you can emotionally handle without bailing out and selling during a market crash. Volatility will do you no harm if you’re not withdrawing money.
 
My advice is the same for people who are within five years of retiring and for retirees. For these people, it really depends on what your portfolio withdrawal rate is.
 
The lower your withdrawal rate is — the amount you take out each year —  the more flexibility you should have in picking stocks versus bonds. But as your withdrawal rate rises, especially if it goes above 4 percent and into 5 or 6 percent where you don’t want to be, you really need to put more and more money in stocks to get a return commensurate with your withdrawal rate.
 
I don’t recommend a withdrawal rate that high. You should try to keep your withdrawal rate to 3 or 3 ½ percent. The higher your withdrawal rate, the greater your risk of running out of money. A lower rate gives you more flexibility to invest a larger percentage of your money in bonds.
 
You recommend keeping 20 to 40 percent of the stock portion of a retirement portfolio in foreign stocks. Why?
 
Foreign stock markets are becoming a larger and larger portion of the total global stock market and emerging markets in particular are growing their share of total global capitalization relative to the U.S. You want to reflect that in your asset allocation, plus it gives you diversification benefits. Emerging markets did quite well from 2000 to 2009 when S&P was doing poorly.
 
You also recommend emerging market bond funds. Why?
 
Emerging market bond funds are invested in government and corporate bonds in emerging market companies in places like Brazil, Turkey and Mexico. They’re more volatile than most bonds, except junk bonds. I like them because of that volatility and because, like precious metals equities, they tend to be less correlated with U.S. stocks.  
 
What about other bonds?
 
I very much like Treasuries and TIPs [Treasury Inflation-Protected Securities]. Every bond portfolio ought to have a good helping of TIPS because bond portfolios are heavily exposed to the risk of inflation and TIPS are a great way to hedge that.
 
I don’t favor long-term Treasuries. I prefer intermediate-term and some short-term as well as corporate bonds.
 
Why not long-term Treauries?
 
There have been extended periods of time where their returns have run under the rate of inflation. That’s the last thing you want to encounter.
 
And how do you feel about junk bonds, which tend to yield more than other bonds but are also riskier?
 
I don’t like them because they are highly correlated with stocks and, relative to most bonds, they’re highly volatile, too. When the stock market has gone down, junk bonds have consistently gone down right with it and gone down significantly.
 
Finally, you prefer index funds to actively-managed funds. Why?
 
Costs are always a key consideration for investing. If you can find a low-cost, actively-managed fund that’s comparable to the cost of an index fund, that’s fine, but it’s really, really hard to do that. You’ll probably wind up picking a manager who just got lucky.

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