Saving for Retirement vs College Funding

A trend of high student debt has developed in recent years and decades that has left many soon to be retired Americans with a choice: do I fund my child’s college education, to help them fulfill their dream or do I continue to fund my retirement, in order to live a comfortable life later on?  For many, this pulls at the heart string, because everyone wants to do as much for their child as possible.  But experts agree, that there can be a major down side to neglecting your retirement in order to fund your child’s college education.

We, as parents, want the best for our children.  We raise them with the best experiences we can give them, from extracurricular activities to family vacations.  This continues, for many, even after their children leave the home to go study at college.  With college tuitions rising drastically, many parents are left with the decision of letting their children take out loans, which may put them into exponential debt after college, derailing them from being able to choose a job, but instead accepting a job to simply pay their student debt.  Or, the parents borrow or stop investing in their retirement in order to save their children from huge student debt.  Although there are programs and loans through the government, that help students to pay lower interest rates, it is tough for many parents to teach their children that they can be whatever they want to be, when in reality, their children may not be able to fund a career because of oppressing student debt.

If the parents choose to fund their child’s college education, there are, for some, the hope that their child will take care of them in their retirement years.  The idea is that their children are an investment, and that the investment will pay off for them during their retirement years, when their child is a world renowned doctor or successful business person.  The downside to this thinking is the stress that this may put on the child AND the relationship between the child and parent.  There are many cultures where children are expected to take care of their parents, from Europe to Asia, the Middle East to Africa.  Unfortunately, this is not a trend that has translated into many family cultures in America.  Instead, sociological studies show that we tend to value the individual over the benefit of the group as a whole.  Obviously, this varies from family to family, but as a whole society, many children move away and want to live their lives.  This is not meant to be a negative observation, but rather one that looks at the reality of what our society values.

With this mentality intact, isn’t it fair to translate this need to take care of oneself into parenthood?  There is a trend in Mommy circles imploring mothers to take time for themselves.  This may be in reaction to the idea that the mother (and father as well) are to be sacrificial for the family.  But the analogy that gets used over and over again is, that if your glass is not full how can you give to your family?  And it’s fair to translate this into retirement savings.  If we do not invest wisely in our own retirement, then how can we be independent later on in life?

Are you worried about outliving your retirement?

What is the number one fear of retirees?  According to a recent Allianz study, 60% of individuals’ feared that they would outlive their income or their portfolios’ ability to create an income for the remainder of their life.  According to research conducted by Transamerican Center for Retirement Studies, only 11% of people have even thought about how much they should invest in their retirement.  But of those who have already begun to plan on how much they’ll need for retirement, half admit that they are merely guessing as to how much they’ll actually need.  To continue with this study, 61% cited that they have a retirement strategy, but only 14% have it written down somewhere.  And less than a quarter have a Plan B in case their retirement plan doesn’t pan out.

To look at the current soon-to-be retirees, there are 76 million individuals who are part of the “Baby Boom” generation (those who were born shortly after the end of World War II). Yet these Baby Boomers are facing unprecedented hurdles when it comes to planning for their retirement:

  1. Previously dependable retirement income is disappearing or becoming less dependable (i.e. Social Security). 55% of those categorized as moderate wealthy consumers, felt they were more likely to be struck by lightning than to receive what they were promised from Social Security).
  2. With less dependable retirement income, such as Social Security, more Baby Boomers are forced to privately and personally finance their retirement.
  3. Increased life expectancy from previous retirees.

According to the Allianz study, Americans fear that a retirement crisis is developing (92% among all applicants and 97% of those in their late 40s), 61% were more scared of outliving their retirement income than facing death.  Among those aged in their late 40s, this number rose to 77%.

With all this uncertainty about traditional retirement planning being sufficient for the future, it is no wonder that many soon to be retirees are apprehensive about what the future will bring.  The good news is that there are financial experts to help guide those who are beginning or have been planning their retirement financing.  In order to quell the worry, make sure that your retirement affairs are in order and are working the hardest they can to keep you safe and secure during your most enjoyable years.

What’s the deal with Phased Retirement?

The day is finally here, RETIREMENT!  You wake up (when you please, although your body is probably still used to your rigid work schedule wake up), roll out of bed, brew a cup of coffee, sit down and…now what?  It seems the goal has been reached, the golden years are being redeemed, but yet, what’s the next part?  The list of things to accomplish and enjoy may be long: travel, hobbies that may have been neglected and new adventures to begin.  But what to do with the day to day?  This is where many retirees end up, not knowing how to transition from a regular 9-5 or other regular work schedule to being the boss of their own time.

The freedom and flexibility of retired life, for some, may seem scary and the confusing feeling of wanting to go back to work may creep in.  Many retirees cite that their day to day life deteriorates in some way from the lack of structure.  As human beings, we are very routine.  We get used to the safety of knowing what comes next in our day.  A lack of structure can be frightening and something that many do not expect to be a worry or fear in retirement, after all, as teenagers, don’t we yearn for the freedom away from our parents?

But alas, there is a solution.  Many retirees find that they don’t have to leave the workforce completely, but rather, they phase out their retirement.  They scale down their 40 hour work week to a few days and few hours a week.  The above situation may be one reason, but there are multiple reasons why recent retirees remain at their jobs, ranging from the need for a supplemental income to needing a purpose and routine to daily life.

Phased retirement is a program that many employers are implementing because it is also beneficial to the employer.  The benefits that the recent retiree possesses can help the transition process proceed smoothly.  In many cases, the recent retiree may serve as a mentor to the employee being trained to take over their position.  Or, they may stay on and act as an expert or advisor to the business, loaning their many years of knowledge.  For the retiree, they are able to continue to exercise their vast knowledge of their field and keep the wheels turning, both for their own mental faculty and the company.

Another added benefit to staying active during retirement (either through a hobby, volunteer work or phased retirement) is that the brain remains active.  Science has shown, that keeping mentally active helps to ward off dementia.  For example, studies have shown that those who speak multiple languages (therefore engaging various aspects of their brain) have a lower risk of Alzheimer than those who speak only one language.

Regardless, if your passion for your career continues past retirement or if you choose a new hobby to undertake, the main suggestion that studies seem to stress is to stay mentally active, to keep the wheels turning and to continue to have purpose and satisfaction in daily life.  Because as humans, we all seek self-fulfillment and purpose, which can often be lost in the free flowing world of retirement.


When Is 6% Versus 7% a Better Rate of Return???

When utilizing proper Gamma retirement planning strategies an investor can experience significant positive effect when taking income from their retirement portfolio.  Most advisors today don’t employ a Gamma-Optimized strategy

“When it comes to generating retirement income, investors arguably spend most time and effort on selecting ‘good’ investment fund/managers – the so called Alpha decision – as well as the asset allocation, or Beta decision. However, Alpha and Beta are just two elements of a myriad of important financial planning decisions for the average investor, many of which can have a far more significant impact on retirement income.”  -David Blanchette, CFA, CFP , Head of Retirement Research at Morningstar Investment Management and Paul Kaplan , Ph.D., CFA, director of research for Morningstar Canada

A research report written by David Blanchette, CFA, CFP, head of retirement research at Morningstar Investment Management and Paul Kaplan , Ph.D., CFA, director of research for Morningstar Canada entitled;  Alpha, Beta, and Now …Gamma, explains that most retirees and their advisors are still focused on Alpha and Beta planning strategies which focus solely on investment management decisions when developing a retirement income plan. Both Alpha and Beta are statistical portfolio measurements. Alpha (negative or positive) measures manager effect within the portfolio, while Beta measures the risk or volatility of an investment portfolio versus a representative benchmark. Their research and paper concluded that utilizing a new statistical measurement they call Gamma (the effect that different retirement planning variables have on a retirement income plan) can now be confidently utilized for retirement income planning. As they explain, “We estimate a retiree can expect to generate 22.6% more in certainty equivalent income utilizing a Gamma-Efficient retirement income strategy when compared to our base scenario (traditional investment strategy only: Alpha/Beta planning). This addition in certainty-equivalent income has the same impact on expected utility as an annual arithmetic return increase of 1.59%”.

This is certainly an eye opening conclusion to an extremely thorough and riveting research report on Retirement Income Planning that absolutely validates why Her Retirement’s pragmatic and research based approach to retirement income planning works so well. The difference is that Her Retirement has looked at the  research of Blanchette, Kaplan, Finke, Phau, and Milevsky, as well as many others over the years, and developed a pragmatic approach that incorporates many of the same principles and strategies for maximizing a retirees’ retirement outcome.

Volatility and Sequence of Return Risk Must Be Part of the Equation

As a quick reference, recent research has indicated that when a retiree begins to take income from their portfolio it’s imperative to reduce volatility in the portfolio in order to increase the portfolio’s survival rate. The evidence concludes that for any stated rate of return, the portfolio with the lowest volatility will survive the longest when taking income from the portfolio. On the converse, the portfolio with the highest volatility will suffer portfolio failure the quickest.  With this knowledge, we constructed a portfolio to statistically reduce risk, to the greatest extent possible, while offering the highest return for that risk. Our recommendation was to utilize a moderate portfolio consisting of 50% diversified stocks and a 50% position in Equity Index Annuities (EIAs) linked to various globally diversified indexes.

In addition, a major risk that must be calculated to assess its effect on a retirement projection is Sequence of Return Risk. This is the risk that a portfolio will suffer major losses in the early years of retirement. This event would be known as “negative” Sequence of Return Risk and would have a negative effect on the survival rate of the portfolio (i.e. the portfolio would have a much shorter lifespan and a retiree would run out of money far sooner). On the converse, there is “positive” Sequence of Return Risk where the portfolio has tremendous upside growth in the early years or retirement. In a positive sequence of return environment a retirement portfolio would experience much greater potential portfolio survival (i.e. the portfolio would last much longer while taking income from the portfolio).

An “average” Sequence of Return Risk is a market environment where there is average or lower overall volatility in the portfolio which would give the portfolio moderate survival ability while taking income from the portfolio.

In summary, depending on the market environment (negative, positive or average) what the retiree experiences early in their income phase will have a direct effect on the portfolio survival rate…even with identical portfolio returns over the long term.  A retirement income projection analysis must calculate the effect Sequence of Return Risk has on the long term survivability of a retirement portfolio. This will assure the highest probability of portfolio survival based upon the income strategy employed.

Based upon the below retirement projection, one can see how the practical application and effect  of a Gamma-Efficient retirement income strategy can have greater impact on income when compared to a traditional Alpha Beta strategy that is employed by most retirees and advisors today.  In this recently completed retirement projection for a new client we found the following:

After projecting the client’s traditional Alpha Beta retirement strategy (the “before” scenario), we reallocated the client’s current 80% diversified stock and 20% diversified bond portfolio to a more conservative allocation that would offer less return, but would dramatically reduce the portfolio’s volatility, while also offering reasonable growth potential.  The client’s retirement projection variable was reset to the “new” reallocated portfolio and the results of the “before and after” are quite compelling.

The Results Speak for Themselves

The retirement projection assumptions utilized for this analysis were as follows:

Rate of Return Estimates –
Global Stock Portfolio @ 8% net
Global Bond Portfolio @ 3% net
Equity Index Annuity @ 4% net

Current Portfolio at 80% global stocks and 20% bonds = 7% melded return estimate (net)
Proposed Portfolio at 50% global stocks and 50% EIAs = 6% melded return estimate (net)

Additional Assumptions –

The client is currently 53 years old and preparing to retire at age 62 with a net retirement income need of $5,000 per month. We inflated her income needs at a 3% adjustment per year beginning immediately in the projection.  Her current portfolio is valued at $450,107. She also has a small pension that will begin at age 65 paying her $11,124 annually. As well, the client will begin taking Social Security income at age 62 in the amount of $2,473 per month with a 2% cost of living pay increase per year. The client also has $25,000 per year rental income. We increased the rental property income at 1% cost of living adjustment. The analysis will also assume a marginal tax rate of 17%.

All these assumptions and variables were entered into our Retirement Income Projection Analysis (RIPA) system and here are the results:

The Results – Results presented on both a negative and average Sequence of Return environment

Negative Sequence:
Current Scenario – Age 90 Client Runs Out of Money
Proposed Scenario – Age 90 Client has $818,887

Average Sequence:
Current Scenario – Age 95 Client has $1,355,620
Proposed Scenario – Age 95 Client has $1,625,598

As we see by the above results, it’s imperative to develop a strategy that will utilize risk reducing investment vehicles to assure an income portfolio’s survival over the long term. Traditional stock and bond growth strategies employed by most are not enough. A Gamma-Efficient portfolio strategy must be utilized to assure the highest probability of portfolio survival.

Why 6% is better than 7%?

A new paradigm needs a new strategy:  growth vs. income planning; Alpha Beta planning vs. Alpha Beta and Gamma strategies to generate a better retirement outcome.

As Blanchette & Kaplan explain, “Alpha and Beta are at the heart of traditional performance analysis; however, as we demonstrate, they are just one of the many important financial planning decisions, such as savings and withdrawal strategies, that can have a substantial impact on the retirement outcome for an investor.”

The above “current vs. proposed” is a very real and very typical scenario with many retirees. In most, if not all cases, the results will be the same… math is math and there’s really not much debate in how numbers calculate. This is an important and valuable outcome scenario where a combined stock and equity index annuity portfolio (generating a 6% return) is clearly better than a stock and bond portfolio (with a 7% return).

We have witnessed clients that are “annuity phobic” due to all the media’s misinformation and hype, as well as the all stock proponents who wrongfully claim that all annuities are too expensive.  We’ve also witnessed clients that are “stock phobic” due to more rhetoric about how one can lose all their money in the stock market and stocks are no place for retirees to invest due to the risk. We purport that the best approach is a combination approach (based on research and factual numbers, not hearsay).

We also suggest several additional Gamma strategies/products to further increase the portfolio’s life expectancy:

Single Premium Immediate Annuities (SPIAs)
Dynamic Withdrawal vs. Traditional Static Withdrawal
Sound Social Security planning with sophisticated Social Security timing software

At Her Retirement we focus on the same five important financial planning decisions/techniques as suggested by Blanchette & Kaplan’s Alpha, Beta and now…Gamma research:

1) A total wealth framework to determine the optimal asset allocation
2) A dynamic withdrawal strategy
3) Guaranteed income products (i.e., annuities)
4) Tax efficient allocation decisions
5) Portfolio optimization that includes a proxy for the investor’s implicit and/or explicit liabilities

“We believe retirees deserve an investment and income planning experience that is founded on long-term, research and evidence-based results NOT rhetoric.  And we’re committed to providing this for them.” -Her Retirement