Dear Wealth Wise: My 72-year-old wife and I are retired with a net worth of around $10 million. About $3 million is in real estate, including a rental house that provides $1,500 a month in net income and has an $180,000 mortgage. We own a home and a vacation home outright. Our investment portfolio is aggressive. We have $3.8 million in IRAs, another $850,000 in Roths and $900,000 in a Generation-Skipping Trust that I am the trustee of. We get about $9,600 a month in Social Security, pension, and annuity payments. We have $800,000 in non-tax-deferred accounts, including $150,000 in cash accounts. My philosophy is that we have enough money to never have to worry, so I’m investing for my heirs. Therefore, we’re heavily invested in mutual funds and ETFs, some of which are fairly aggressive. Is this OK?
— Legacy Builder
Dear Legacy Builder: Retirees are often encouraged to reduce portfolio risk. The logic is that when you’re tapping your portfolio for income, you don’t want to be in a position where you have to take losses on stocks or other assets to pay the electric bill or put food on the table.
Here, we have a wealthy couple who are still investing aggressively, but for a good reason. Are they taking on too much risk? Here’s what our experts have to say.
"Risk" is all relative
A stock-heavy portfolio can be dangerous for retirees with limited income outside of it. That’s not the case here, which is why Phillip E. Battin, president and CEO of Ambassador Wealth Management, says he’s not particularly worried.
"With about $10 million in net worth and $9,600 a month in combined Social Security, pension, and annuity income, they indicate their income needs are met," he says.
"There is a risk that the current renters don’t renew their current lease, or that the couple will have trouble renting the home in the future," he continues. However, it doesn’t seem like our couple is particularly dependent on that income. And they could probably unload the rental home if needed and use the proceeds to generate income another way.
As such, Battin doesn’t think our couple’s stock holdings sound too risky. However, he cautions, investing 'aggressively' does not have to mean taking an overweight position in technology or speculative investments.
Robert Jeter, CFP and financial planner at Back Bay Financial Planning & Investments, agrees.
"I would be careful conflating 'aggressive' with asset allocation versus speculating," he says. "Higher-net-worth individuals tend to have extra confidence in deviating from simple investment strategies, costing themselves money. The best course can be to remain aggressive from an allocation standpoint, but simplify the investment strategy to reduce tracking error and tax drag."
Focus on tax efficiency
When you’re a couple with a roughly $10 million net worth who's focused on passing down a legacy, tax optimization becomes extremely important. That’s why Jeter says this couple needs to allocate assets properly.
"Your most aggressive investments should be in your taxable and Roth accounts, while any conservative investments [should] be in your deferred accounts," he says.
Battin agrees. "With the assets outside the retirement accounts, they may want to consider investing those aggressively to take advantage of the step-up in cost basis upon their passing," he says.
And speaking of inheritances, Brandon M. Cox, CFP and founder at Coastline Complete Wealth, says this couple should not overlook the benefits of a Roth conversion.
"The tax brackets today may be as friendly as they will ever be for you or your heirs," he says. "I would absolutely be looking at whether it makes sense to start converting some of that IRA money to Roth."
As he explains, if either our reader or his wife outlives the other by a substantial amount of time, that IRA eventually gets taxed at the much less favorable single tax brackets.
"Then," he says, "whatever is left could go to your children, who generally will have to empty inherited traditional IRAs within 10 years. They may be taking those distributions in their 50s or 60s, right in the middle of their peak earning years, and stacking that IRA income on top of everything else they already earn."
By doing a Roth conversion, Cox explains, "you may actually have an opportunity to pay less tax on some of that money today than you, your surviving spouse, or your children will pay on it in the future."
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Have a spending plan and make sure you can handle market dips
Given our couple's net worth, it's easy to see why they say they have "enough money to never have to worry." But to figure out an appropriate investment strategy, you first need to understand their spending and emotional needs, says Chris Berkel, president and founder of AXIS Financial and an investment adviser.
"Risk tolerance, practically speaking, is made up of two components — ability and willingness to accept risk," he says. "The most common way to assess ability is through a robust financial plan, and so to help this gentleman and his wife, we really need to understand his spending goals."
As Berkel explains, if our reader and his wife spend $150,000 a year, their situation is very different than if they’re spending $400,000 a year. If their guaranteed income can’t fully support their near-term spending without using their invested assets, their ability to handle a stock market downturn may be more limited.
Therefore, if our couple relies at all on their aggressive assets for near-term needs, they may want to rethink that part of their plan.
Berkel further explains that willingness to accept risk is typically "emotionally driven."
"Some people are the go-get-'em type and will gladly accept a 50% loss to maximize their longer-term gains," he says. "Other people like to be steady, and even a 10% drawdown can have them waking up in the middle of the night."
If our reader thinks he and/or his wife will struggle emotionally during market downturns, they may want to reduce at least some risk, even if they don’t need to spend the money anytime soon and want to leave it to their heirs.
Not all questions submitted will be published, and some may be condensed and/or combined with other similar questions and answers, as required editorially. The answers provided by our writers and experts in this advice column are for general informational purposes only. While we take reasonable precautions to ensure we provide accurate answers to your questions, this information does not and is not intended to constitute independent financial, legal, or tax advice. You should not act, or refrain from acting, based on any information provided in this feature. You should consult with a financial adviser regarding any questions you may have in relation to the matters discussed in this article.