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Q&A: "We're Retired and Will be Selling our House this Year. How Should We Invest the Proceeds from the Sale?"

Economy Investment Tax

Question and background: 

We're retired and will be selling our house this year. How should we invest the proceeds from the sale? 

My wife and I will be 62 this year, we have been retired 7 years, our current portfolio is $1.3 million. 70% equities, 30% bonds, most have been owned 25 plus years. We don't buy/sell much and have been living off dividends and income. We have no debt and have sold our main residence and will be moving to our winter home. We will have $500,000 from the sale to invest this fall. I hesitate to buy equities at the top of the market and feel we are equity heavy for our age and status of retired. We would like to be able to take out a minimum of 3% and would like 5% annually of the additional investment. We have no plans of adjusting the original portfolio. What would you recommend?

Larry's answer: 

Smart move on your part, taking advantage of the principal residence capital gains exemption and moving into your winter home. I agree with my colleagues that you could benefit from some broad-based retirement planning and income projections, but will focus my comments here on the investment piece. 

I'd encourage you to consider doing two things:

  • Not "compartmentalize" the $500,000 drawing $15,000 (3%) to $25,000 (5%) annually only from it, but rather view your $1.8 million portfolio in total and think about the best ways to draw from the total portfolio.
  • Reduce your equity exposure or at least take steps to mitigate the risk of loss in the event of a healthy (much-needed) stock market correction. This could include liquidation of a portion of your equities, taking a small slice of your portfolio and buying long-dated Put options as protection ("portfolio insurance"), putting in place stop-loss sell orders, or some combination of those ideas.

You're right to be concerned about buying equities at market highs...but that same logic also applies to the equities you already hold. If your current portfolio is in a regular taxable account (non-retirement) and you're concerned about triggering large capital gains taxes, then you may wish to explore the purchase of long-dated Put options. One options contract controls 100 shares, so a comparatively small portion of your portfolio could provide a leveraged hedge against a market downturn without you necessarily having to sell your equities (and trigger capital gains if outside a retirement account).

With the sale of your home, your total portfolio asset allocation will be roughly: 50% equities, 22% bonds, and 28% cash. In the current environment of overpriced financial assets, I'd be inclined to further reduce equities, somewhat increase bonds (but be ready to possibly sell some if interest rates rise in earnest), and slightly raise more cash as "dry powder" to buy back into markets when investments can be had at better prices. 

Most financial pundits today focus on stock market valuation in light of the last 12 months of earnings or the next 12 months of projected earnings. The trouble with that is we're not in any kind of a normalized, sustainable environment. Global central banks have goosed asset prices through monetary policy on steroids. Corporate profits are around 70% above long-term averages. We're now five years into a cyclical bull market recovery that has had no significant pullback. While the economy is recovering vs. the 2008-2009 recession, it's been moving at a glacial pace and nothing like the typical historical recovery. Even now, it's as if it still has a "low-grade fever," not quite bad enough to land in the hospital, not quite good enough to get up and dance.

In this context, I pay more attention to those analysts who measure current stock levels in light of longer-term historical valuations. And history indicates that, when US stocks are this overpriced, the next 7 to 10 years generally result in abysmal average annual returns (1% to 3%, for example). 

Of course, that doesn't mean we're going to have an imminent crash, nor does it mean the markets can't (irrationally) march yet higher. It sure seems they want to push higher. However, it does imply that future returns have already been pulled into the present and there's significant risk in equities (and in bonds and other income investments) at current levels. So why accept the current level of risk when commensurate reward is unlikely to materialize?

Nobody can precisely or consistently time the markets, that's a given. But that's the answer to the wrong question. The question is not one of timing or trying to outperform the markets, but rather of paying attention to investment valuations -- avoiding those that are overpriced and owning those that are underpriced (and there aren't many of those today). This is a tactical approach to portfolio management and it's a minority perspective, but I believe it's the best approach in the current environment. 

Hope this useful. Feel free to contact me if you have any questions or I can be of help. All the best!