The 1/3 Rule: How to Organize Your Estate For A Stress Free Retirement

Too much of a good thing can rapidly become a bad thing, and  I have noticed investors entering retirement with too many assets they like and not enough assets they need. This is why I created my “1/3 Rule” for helping clients identify a target allocation for their retirement assets.

Here is the 1/3 Rule:One third rule

1) No more than 1/3 of estate’s value in “user assets.”

2) No more than 1/3 of estate’s value in illiquid assets like rental properties and/or business holdings.

3) At least 1/3 of estate’s value in liquid investments like cash, stocks, bonds, mutual funds, retirement plans, annuities, etc..

For many Americans, their most valuable retirement assets  are their “user assets,” which include primary homes, vacation homes, automobiles, campers, boats, etc.. User assets are things we own and use, they have values and can be sold, but they generally don’t create income for us in retirement. In fact, I usually treat user assets as liabilities because they cost money to own and operate them.   There are several reasons why people tend to accumulate too many user assets in retirement, and here are just a few: 1) it is preferable to eventually own our homes than be lifelong renters; 2) the tax code provides several  incentives for owning a home but none for renting; 3) HOMEhome prices have appreciated over the last several decades as interest rates have been falling; and 4) we have more time and money on our hands when the kids grow up and leave the nest, and we can quickly accumulate campers, boats, snowmobiles, vacation properties to fill the void.  If we are not careful, we could end up in retirement with 80% or more of our net worth tied up in user assets. This can cause a real retirement pinch if we are living on a fixed income of social security and a possible pension but our property taxes, insurance, and maintenance costs continue to increase while the values of our toys decrease.   In order to enter retirement with minimal stress, I  recommend clients  aim for no more than 1/3 of their net worth allocated to their homes and toys.
Some of my clients have successfully owned small businesses and rental properties during their working years, and because they are familiar with both, they often end up having a large percentage of their net worth in these mollys_front_w_wraptypes of enterprises. This  can cause problems if the economy turns sour near a planned retirement date , especially if a business or a rental property must be sold in a hurry.  Additionally, businesses and rental properties can be a real hassle to pass on to heirs who must manage or sell them, especially if the investments and/or heirs are located outside your state of domicile.  Because these types of investments can be illiquid, (difficult to sell),  I often recommend retired clients  keep no more than 1/3 of their net worth in businesses or rentals.

Finally, I encourage clients to shoot for having no less than 1/3 of their assets in liquid (easy to sell) investments such as cash, stocks, bonds, mutual  funds, etc. by the time they retire.  I suspect the main reason why people retire with too little in liquid assets is they are too easy to convert into cash in a pinch. When people need money for a kitchen remodel or a daughter’s wedding, it is much easier to sell $30,000 of stock than it is to sell $30,000 of a rental property or a piece of your home.  If people are not careful, they can end up with too much money invested in their homes or savingsbusinesses and not enough in income producing liquid assets. Unfortunately, many people got caught up in the real estate bubble in the early 2000’s, and they found out in 2008 how dangerous it could be having most of their net worth invested in businesses and real estate and too little in liquid assets.  To avoid this danger, be sure to invest in your employer’s retirement plan,  your own IRA’s, or in self-directed investment accounts such as those offered at Coco Enterprises.

For young investors, it is not unusual to have most of their net worth in their homes or their businesses; however, I recommend they keep an eye on their net worth statements to ensure they  don’t become under-invested in liquid investments. Like steering an aircraft carrier into a harbor, it is easier to steer your retirement assets towards the 1/3 rule if you start making your adjustments well before you are at your destination.  If you are a business owner, start planning an exit strategy, and if you own rental properties, be sure you aren’t too heavily invested.   If you need guidance on how to use the 1/3 rule to reduce stress and uncertainty in retirement,  give us a call to schedule an appointment.  We can help you develop a plan to organize your assets to ensure your retirement will be as good as you imagine.

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