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Dear Retirement Investor, What If You’re Wrong?

Over the last several weeks, it has been a whirlwind of headlines from the financial media. Despite some very encouraging fundamentals in the economy—GDP growth, corporate earnings strength, positive corporate response to tax reform—we have recently rediscovered market volatility. In February, we saw a 10% drop in some of the indices in only 9 trading days!  Luckily, this swift downward slide was short-lived, and the markets rebounded. Until… they began to slide again. Now, we are hearing rumors of a potential trade war with China, and some of our social media platforms could be targets for increased regulation.

This is the nature of investing. Despite the beautiful oasis that was 2017, where volatility was at or near zero for the entire year, I must remind you that those results are not the norm.

For the last year or two, we are increasingly hearing more people who believe that we are due for another “Big One.” The question I probably should ask, but often fail to do so, is “How do you define a ‘Big One’?” After all, the traditional definition of a Bear Market is a 20% decline, which historically can be fairly common, with one happening on average once out of every 5 years. This type of market cycle is normal—so, if it happened now, would it be too much to handle for you as an investor?

Or, would a “Big One” be more like what investors experienced in 2008—where asset prices dropped between 35% and 50%?

I tend to think that investors are anchored to their 2008 experience, and sadly, the financial media continues to re-open that wound any time we experience volatility. This doesn’t serve investors, but it definitely draws eyeballs, which directly result in ad sales for the media machine. (Hint: this is one reason why I so often encourage clients to not even watch or read financial journalism)

Now…the title of this article I ask “What If You’re Wrong?” because whether you realize it or not, there’s a story you tell yourself about your financial future and the impact of equity markets on that future.

Some people believe that in the long-run, market returns are positive, and you simply have to hang in there when the seas get rough. Other investors believe that the next major financial downturn is all but inevitable, and it’s only a matter of time before the house of cards comes tumbling down. Worse, there are some folks who believe that it’s actually possible to predict the coming of this potential bear market and subsequent recovery.

Let’s look at each of these scenarios, and how they could impact your retirement plan if you are wrong. Note: most of the following information is going to be more relevant for investors who are either retired or very close to their retirement date.

In the Long Run, You Win— unless you don’t. There are many maxims about investing that are consistently thrown out to investors to encourage them to not panic out of the market. While, yes, we do want to encourage good investor behavior, we financial professionals should also make sure that clients have the financial ability to actually do what we are telling them to do. Some investors have the risk tolerance to be invested in growth markets, but they do not have the risk capacity to invest the way they are being coached to invest. For instance, some clients want a lifestyle in retirement that would be considered “constrained” under some retirement income metrics. These investors can be the most vulnerable to a market shock derailing their income plan, and in some cases, this derailment could be a permanent setback. I spoke with someone recently who told me that he “didn’t want to have to go back to work.”  Why leave something that critical to market probability and chance?

Mr. Market, My Hero. Another scenario, which is perhaps a more chronic condition for some investors, is when the market is being relied upon to produce a minimum level of return to make their plan work. I use “plan” lightly here because really this is more of a Hope and Change strategy— one where you hope the market probabilities don’t change in the future! Of course, we all hope to gain meaningful returns by being investors—we wouldn’t risk our hard-earned money otherwise. Yet, it still fascinates me that the old Wall Street retirement advice hasn’t changed with the times. You know the phase: “Past performance is no guarantee of future results.” This is more than just a meaningless disclosure—it’s a real statement that should be heeded by investors headed into retirement. Retirement strategies that are built on a rate of return requirement—either to preserve capital or sustain lifestyle— could be in for a rocky ride.

Are you ready to have an allowance?  Trust me, the institutional firms that still market the systematic withdrawal approach to retirement will be telling you when / how much / how little / go / stop…..and everything in between… in order to keep you invested. I tell attendees at our workshops that I know they aren’t going broke in retirement (barring some unforeseen medical or life event that depletes savings).  No, what will happen is that folks who finally tire of the market uncertainty or feeling like they have no control will simply cash in their chips and put their money in the bank. We think there is a better way to do things.

Did You Miss The Bus? A final consideration—one that flies in the face of conventional thinking—is that some investors are going to mess up their retirement future because they invest too conservatively, not too aggressively.

“How can this be?”  you ask.

It’s often discussed in our industry about the changes that need to be considered when one retires. One of those changes is that people should invest more conservatively in retirement because they cannot afford to lose funds to market volatility…. or should I say have large losses due to market volatility? The idea of “not losing” is a myth when it comes to investing. There’s no free lunch. Retirees need to understand that asset allocation—and constructing a thoughtful retirement income plan—can significantly improve their outcomes. This doesn’t mean that we divorce ourselves from growth assets…actually the opposite. We create a plan that will allow for us to embrace a growth-oriented allocation for part of our portfolio. 

With increasing longevity driving retirement seasons that can last 30-plus years, investors cannot afford to shy away from growth completely. We need to have assets that can give us real returns—net of inflation—so we can maintain purchasing power. A major concern for some retirees should be what their portfolios could look like 10, 15, 20 years from now if they don’t allow for some growth.

Take this example:  Investor Jones, age 62, takes a conservative route with $250,000 in assets that aren’t needed for his current retirement income needs. He invests in a portfolio that gives him a 4.5% return over a 15 year period. His account now stands at $483,820. However, if inflation averaged 2.5% during that same period, his real rate of return would be 1.95%. What this means is that, while his account has a balance of $483,820, the purchasing power of those funds is equal to only $334,000 in today’s dollars. This is a significant shift, as Mr Jones is moving into a phase of life where he may need these assets to supplement his lifestyle and where medical expenses tend to increase.

Note: The example given is hypothetical in nature, for illustrative purposes only and results are not guaranteed.

So, what can YOU do?

The truth is we must plan…and continue to plan as the years go by. Market volatility will make the news media headlines all day…because that is what helps the media drive their profits from advertising. Do you think the media is going to front page stories like Mr. Jones?  Or, will they give primetime interviews to retirees who got cooked in another major downturn?  Sure, they might…but by then it will be too late for those people who were harmed by not having an effective plan.

The challenging part of the retirement equation is that most people have little or no experience with withdrawing money from a portfolio. Thus, when they approach retirement or interview financial professionals, they tend to continue using their experience as accumulators as a guide. The game changes completely—and so many folks don’t realize it. If you want to be successful with your retirement dollars, I cannot stress enough the importance of these 3 action items:

1) You work with someone who is a credentialed financial professional that has a fiduciary responsibility to you as a client. Professionals that carry the CFP®marks are a good litmus test for this requirement. I would also encourage you to go a step further and look for someone who is both independent of any major institutional firm and who specializes in retirement planning. Much like the world of investing, retirement planning is its own specialty, and folks preparing for their retirement years should seek professionals with retirement planning expertise.

2) Have a written plan. This is where a good many financial professionals can fall short. When I say written plan, I’m referring to a document that you—the client— can read and understand. Do you have one of these?  Sure, many people get printouts of charts and graphs w/ monte carlo simulation results. Can you actually read and understand that?  What you should require is that you get a document that you can read and understand. If you can’t, how will you know if your plan is working or on track?

3) Participate in the process.  A good financial professional will make sure that you are engaged in the planning process. The more involved you are in the planning process, the more you should be able to identify and align with your finalized action items. Your plan should reflect your needs / wants / desires on paper— and give you a roadmap on how to make it all happen. If you don’t actively participate—or worse, the planning team doesn’t ask you to be an active participant— you should look for a group that will be proactive in planning with you. Retirement is too important to simply let (insert big firm name here) take the wheel.

Retirement planning doesn’t have to be tedious or stressful. Let our team guide you through our planning process, where we can align your assets with your values. Reach out to us to schedule your free 1-hour consultation!

 

Investment advisory and financial planning services offered through Planners Alliance, LLC, a SEC Registered Investment Advisor. Subadvisory services are provided by Advisory Alpha, LLC, a SEC Registered Investment Advisor. Insurance, Consulting and Education services offered through Vertex Capital Advisors. Vertex Capital Advisors is a separate and unaffiliated entity from Planners Alliance, LLC and Advisory Alpha, LLC.

Retirement Focus: It’s About Cash Flow

I was recently having an in-depth conversation with one of my clients, and he said perhaps one of the truest statements I’ve ever heard when it comes to retirement planning. While we were discussing some potential ideas for him and his wife, he said:

“You know, you will probably create hundreds of these plans over the course of your lifetime. But, me, I only get to do this once…so I can’t afford to mess it up.”

Naturally, he was thinking about himself and his family when making this statement; however, his mindset reflects the thought process of plenty of workers today. The idea is that you only get one shot at having a successful retirement, so one had better make it count.

As more and more Boomers move into their retirement years, those of us in the financial industry are beginning to see changes in the retirement planning landscape. For one, people are living longer—-much longer—than they have in the past. In fact, I have a relative in my own family that worked for 34 years and is now entering his 31st year of retirement. How crazy is that?!

One might expect that with the Baby Boomer generation creating such demand for retirement planning services, there would be some definite benchmarks for how to measure retirement success. Unfortunately, the only thing our industry has agreed about is our disagreement on how to plan for retirement; and the continuous information dump provided by the internet only adds more layers of confusion and noise.

Some advisors will argue that retirement is all about “safe money” or “not losing” your nest egg, and others will stand for the exact opposite, saying “nothing beats the market over time.” The debate is endless, and in many ways, it can seem pointless, as proponents often care more about pushing their viewpoints than hearing those of their opposition. In the middle of this battleground stands the client, who just wants to enjoy a secure and safe retirement. In my opinion, this could quite possibly be the worst environment for someone who genuinely wants advice because they’re trapped in a world of debate about financial products.

So, how does someone go about trying to plan for their retirement? What should be the focus?

In my opinion, the most important facet of a retirement plan is having sources of guaranteed cash flow.

Now, for the sake of this discussion, let’s qualify what I consider to be guaranteed vs. non-guaranteed. In my view, guaranteed income sources would be: social security, pensions, or income from annuities (contractual guarantees only).

Income that I personally do not consider guaranteed is: bond interest, dividend payments, rental income, or any other type of distribution from a portfolio of securities.

Of course, this is the point where everyone’s biases begin to run wild, and they debate starts to rage. “How can you say that ______ is guaranteed?” or “Clearly, you must not understand the income reliability of __________.”

The goal here isn’t to get lost in the minutiae of social security reform proposals, pension funding, or the actuarial reliability of investment products. The point is this—- Cash Flow is what matters in retirement.

In the July 2014 Issue of the Harvard Business Review, Robert C. Merton writes:

“To begin with, putting relatively complex investment decisions in the hands of individuals with little or no financial expertise is problematic…More dangerous yet is the shift in focus away from retirement income to return on investment that has come with saver-managed DC plans: Investment decisions are now focused on the value of the funds, the returns on investment they deliver, and how volatile those returns are. Yet the primary concern of the saver remains what it always has been: Will I have sufficient income in retirement to live comfortably.”

Sadly, I believe that Merton is 100% correct in his beliefs. Financial discussions that focus on retirement planning are too often dominated by conversations about portfolio returns—-recent returns or projected returns—take your pick. Instead, we should be helping clients understand how the income pieces of their plans can fit together to establish an overall cash flow strategy.

From there, we can allow the clients to help determine what level of fluctuation they desire in their income streams. Naturally, some clients will not want to have any fluctuation; therefore, they will gravitate towards more of their assets being dedicated for income. Yet, some clients, will find themselves more open to some fluctuation, as long as they have a nice baseline of guaranteed income. These clients may be more inclined to place more assets in a growth-oriented strategy that allows for market fluctuation.

Our role as retirement income planners is to help clients navigate the multiple decisions they will face as they transition into the retirement season of their lives. But, I can honestly say that I have yet to meet with a client who didn’t have the desire for knowing their retirement cash flow potential as a very high priority. Workers today spend much of their energy in focusing on returns—too much energy. Returns are important; however, I don’t believe they should be the dominating factor in a planning process. If we want to work with the massive numbers of Baby Boomers moving into their retirement years, the conversation needs to begin with cash flow—-that’s where these clients experience their money and their retirement.

Michael H. Baker, CFP®, RICP®