There are any number of visual cues offered about retirement. Some suggest buckets while others offer simple calculations. The reality of any plan is protection of some assets while risking others. So how do you build a retirement plan that does both for you and helps you avoid doing too much of the heavy lifting? Try the barbell approach.
This is not a new method by any means and although there are varying ways to apply this sort of analogy to your retirement plan, this might make some sense for most of us. Broken into two pieces, the bar represents the safest investments while the weights (the bells) are what is put at risk.
The safe investments include everything that is removed from the influences of Wall Street. If you are tied to a mortgage, you are tied to Wall Street, even if those ties seem removed. A house without a mortgage is considered the best bar to have. While the equity in it is tied up and illiquid, it does provide a measurable and risk-free haven. But most of us have a mortgage and far too many of us expect to carry that debt into retirement.
This short bar acts as an additional weight on the process. Now mortgage debt, even one that has been refinanced to below or near the current inflation rate, still offers no real return. You can extend that bar with the purchase of Treasuries. Or perhaps even create a safe haven with an investment of cash – as in that illusive-for-most-of-us emergency account. In other words, any investment that is not tied to the markets in any way.
The bells at the end of that bar is where you take your risks. But what risks are better than others? Some folks suggest playing one bell against the other. This strategy bets against the market on one side with investments that use tools such as short-selling and at the pother end of the bar, a bell that focuses on high income yielding securities such as dividend paying stocks, highly rated bonds or perhaps even preferred stocks.
But if balance is key to generating income and the bar represents the safety between the two, perhaps this might not be enough to generate the kind of income you need in quantities large enough to matter. The above method could offer about a 6% overall return.
But you could use the barbell analogy somewhat differently. Assuming that you do have a mortgage, and most of us do, the bar should instead represent your ability to pay down your loan, maintain upkeep, insurances and taxes. You might begin this process with a short bar but as time passes, the bar will lengthen allowing you to add more weight at either end. The amount of additional debt keeps the length of that bar shorter longer and keeps your ability to lift more. The need to protect against the potential for long-term unemployment, which according to a recent article in the New York Times, is now on par with our European neighbors.
While the bells at the end of the bar seem more important, without a means to lift those “investments”, you plan will not be able to do as much as you would like. So what sort of weight do we put on this bar once we have it stabilized?
There are basically two different type of weights: those that have value and those that have growth. One looks for bargains and the other looks for risks. Value investing, using mutual funds for an added layer of safety, looks for the bargains in companies that have fallen out of the news yet continue to exist and in many cases both profitably and often paying dividends. Growth investing is more risky and when pursued in a mutual fund situation, can alleviate some of the losses associated with buying individual shares.
Value investing should be done outside of a pre-tax account while growth investing should be done inside a tax-deferred account. Both could be funded equally but the key is to fund them regularly and evenly. Value and growth investors were rejoicing through most of 2009 and through the first quarter of 2010 when reality hit. The second quarter of this year offered no investor any real respite. That’s not to say the opportunities disappeared. They simply got a little cheaper.
Yes, retirement planning is a balancing act and adding anything to the bar must be done proportionately. The value side might see the addition of bond funds at some point. To counterbalance this added weight, your growth side could diversify globally or simply move into an index fund. Either way, the best balance is is achieved with the best bar, not the weights on either end.
This barbell analogy is just another way to reinforce the notion that your best option for the retirement you want will come from how well you handle your personal life’s finances; with your market participation feeding off those moves.
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