We build and consume retirement savings gradually. We gradually trade our human capital for pay. We gradually invest a portion of that pay. And, in the future, we gradually use what we accumulate to support ourselves as our human capital dwindles.
This is the life-cycle of the average retirement account, which is all intuitive when things are calm. But, introduce some market volatility, and it’s extremely easy to lose sight of.
Last week on the Mullooly Asset Management podcast, this is why I mentioned that it’s integral to remember that not every dollar in a retirement portfolio has the same time horizon. Some dollars may be needed next month, and they are different than dollars that may be needed next year, which are different from dollars that may be needed in ten years. And, while those dollars may all hold the same value today, treating them equally is a big mistake.
We tend to consider our investments as a homogeneous entity with one time horizon, when it’s probably more helpful to separate the dollars into vintages. The same retirement portfolio can hold 2021 and 2022 vintages alongside 2041 and 2042 vintages. Not every dollar has a 20 year time horizon, but not every dollar has a 12 month time horizon either, and we should allocate them accordingly. We have to balance these sort of polar opposite needs in order to be successful.
To be clear, this is a form of mental accounting. But, as I’ve written here before: while mental accounting may only be a mind trick, who says it doesn’t matter?
We’ve found that, especially for retirees, this sort of mental accounting can be very reassuring during times of market turmoil. It’s why our process begins with getting a grip on personal cash flow. This allows us to identify a retirement portfolio’s different vintages. When constructing a portfolio, considering, “what will be needed and when?“, is much more helpful than guessing, “where is the market going next week and why?”. Allocating capital becomes less of an enigma when it’s simplified to matching future needs with appropriate assets based on their time horizon.
The tendency to think of our investments as one uniform entity is understandable, but it’s far more useful to remember that different dollars have different time horizons.