Read enough about investing and eventually you run into this entertaining hockey metaphor: “Skate to where the puck is going, not to where it is.”
This arrestingly simple piece of advice was supposedly uttered by hockey legend Wayne Gretzky (a claim thoroughly debunked). It lives on, on countless web sites, many dedicated to investing advice.
“Skate to where the puck is going” makes sense, at least for the type of investor interested in market timing, that is, in trying to guess in advance which way the markets will move.
For serious retirement investors, the far better sports metaphor lies in the story of Roger Bannister, the young English physician who, with surprising little training, was the first person to beat the 4-minute mile, in 1954.
Bannister set out to beat the mile after a personal failure: Insufficiently prepared, he did not medal in the 1952 Helsinki Olympics in the 1500 meters. So he set his sights on the mile.
Other runners in various countries were closing in on the 4-minute mile barrier, so Bannister had to train fast. He finally did it on a track at Oxford University, and he had company: Two runners helped Bannister set his pace along the way, a standard practice for the sport.
Bannister finished the first half of the mile behind his pace-setter, with the second pacer behind him. Then things flipped and he chased the second pacer to the last lap before passing him: Final time 3:59.4. A gathered crowd erupted in joy.
And that’s the key to long-term retirement investing: Setting a pace and sticking to it.
You can think of your portfolio as your pack of pace-setters. The finish line is whatever number you have set as your retirement goal.
Setting the goal is important. You cannot measure your progress without a final, achievable number. If you expect to live entirely on your savings and to avoid drawing it down, use this simple rule of thumb: $1 million generates $40,000 a year.
That’s 4%, the level you can reasonably expect from a well-managed retirement portfolio that holds dividend-paying stocks and bonds.
Like a pension fund manager, you must consider which tools will help you get to your target, whether that’s $1 million or $2 million or some other number. How much will you save over what period of time to build up your team? What rate of return should you strive to obtain?
In short, what’s the right pace? Consider that a balanced retirement portfolio generating 7% will double your savings every decade, thanks to compounding.
You might decide to reach for 9%, but can your portfolio sustain that pace? Importantly, reaching for that extra 2% implies a higher level of risk. Over one period you might outperform, only to give back even more later on.
This is where the pace-setters come into play. A market timer will tell you to put a lot of your money into a single stock or a single asset class. “This is the one that will beat all comers. Don’t worry,” they’ll say.
And that might turn out to be true for a while. But like an exhausted runner that single asset class will, in time, fall back into the pack.
If you run a risk-adjusted portfolio, however, there’s less dependency on a single asset to beat all comers. Like Bannister running at Oxford, you let a mix of asset classes — your asset allocation — keep the pace. Perhaps U.S. stocks take the lead for a period, bringing excess returns. Later, it might be commodities, or foreign stocks and bonds.
It won’t matter in the final stretch which asset class was best or when. What matters is selling off those excess gains and reinvesting in the laggards while they are comparatively cheap. That, in a nutshell, is rebalancing.
Beating your personal 4-minute mile in retirement investing is nothing more than rebalancing and letting compounding deliver the inevitable result: Achieving your retirement goal on time, reliably, while making the impossible look easy.