Why Simply Saving for Retirement Isn’t Enough? Part 1

by Income DistributionIncome PlanningInvestment PortfolioRetirement IncomeRetirement Income PlanningRetirement Savings

The other day I was having lunch with a friend and we were talking about retirement and the services that Her Retirement provides. She mentioned that she’s been very good about saving money in her 401(k) and said, “I’m all set for retirement.”

This comment made me realize that the average person might also believe the same thing. Many people think they’ve worked hard for 20, 30, 40 years and they’ve saved quite a little nest egg. Retirement plan done. No need to do anything further, but keep working until you feel ready to retire and give your boss or your business the boot.

Well folks, sorry to break it to you, but this is NOT a retirement plan. It’s certainly a great start and if you have more than 4x your salary saved and your 50 let’s say, you’re in pretty good shape, savings wise. However, when you move from the accumulation phase of life (pre-retirement) and into the de-accumulation phase (retirement), you need a comprehensive plan that includes sophisticated strategies to protect you from all the inherent risks you’ll face in retirement. There’s so many things that can go wrong in retirement. You MUST be prepared. And the best way to be prepared is to be pro-active…either learning about the risks and methods to minimize them, or work with a retirement specialist like Her Retirement to understand the blind spots and then put fortification around your savings so that it lasts throughout retirement.

With the right plan and strategies, you can not only mitigate risks, but you can actually make your savings last even longer in retirement (up to 10 years or more). In our full Retirement Income Projection Analysis, we show you the impact (and importance) of:

  • Re-allocating your portfolio (to include less risk/safe money options, improve your investment return and significantly reduce fees)
  • Reducing your taxes as close to 0 as possible
  • Maximizing your Social Security filing strategy to get the most money from this critical benefit
  • Determining your most tax efficient withdrawal or draw-down strategy

 

In our next few series of posts, we’ll dig a little deeper into what can go wrong in retirement and more reasons why simply saving for retirement is not good enough. Stay tuned.

In the meantime, we welcome you to learn more and take one of our new e-classes; try our QuickStart Income Calculator/Report, request a complimentary “Am I Ready” assessment or any of our other free or fee-based assessments.

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

by Income DistributionIncome PlanningRetirement IncomeRetirement Income Planning

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

Part 3: Americans fear outliving their income more than they fear death… Have You Been Putting Off a Retirement Evaluation? The Truth will Empower You.

by Blog

Part 3 of a 3 part series of articles on the value of retirement evaluations

The Value of a Retirement Portfolio Review…uncovering a portfolio’s true value

As stated in part 2 of this series of articles, it’s amazing that most individuals spend more time planning their summer vacation than planning their retirement.

When meeting with potential clients, the primary focus of our first introduction meeting (or complimentary consultation) is to discuss the client’s current retirement situation, including their investments, their retirement goals and aspirations, and risk tolerance. The primary focus of this initial consultation is to find out if the client and/or their advisor has run a recent portfolio evaluation, at least on an annual basis. This is extremely important in the retirement planning process because without an annual review of the current portfolio, one cannot ascertain whether the asset allocation is correct or not.  For instance, proper asset allocation looks at how much stock, bonds, international stock, small cap or large cap stock are in the portfolio and at what percentage. Without this review, an individual could be too heavily weighted in one particular area or another, while also assuming too much risk or not enough risk to get the return they need.

It’s also imperative to look at each individual stock, bond or mutual fund position on a micro analysis level to assure each component or each manager or stock or bond is performing to its maximum ability. For instance, we frequently explain to clients that there’s two types of returns: absolute return and relative return. Absolute return simply tells you that you earned a 5% return over the past five years, but there is no context nor any ability with an absolute return to determine if this 5% was good, bad or ugly. An absolute return tells us nothing.

The more important factor to look at is relative return which tells you how well your portfolio is doing, or how well each individual component within the portfolio performed against the appropriate benchmark. This is the more important factor when reviewing a portfolio on a regular basis. This tells the true story. When looking at relative returns, for instance, that same five year period we discussed in the absolute return section above the results look a little different.  If over the past five years you got the same 5% return, but the appropriate benchmark did 4%, that means you out performed that benchmark on a relative basis by 1% a year over a five year period. That would be a positive relative return performance. However, if you did that same 5% return and you weighted it against the appropriate benchmark, and the appropriate benchmark did 6.25% return over that same period of time, you would have a negative relative return over that five year period of minus 1.25%.

So as you can see, it’s imperative when working with an advisor or doing your own investing, that you perform an overview of your portfolio on a regular basis to assure your asset allocation is appropriate for whatever stage of life you’re in. It’s also absolutely essential that you do both a micro and macro component review against the appropriate benchmarks on a regular basis to maintain the positive relative performance on the portfolio over time.

This is the next factor that is extremely important to understand. When working with your own investments, or with a financial professional or advisor, make sure that you prepare (or have he/she prepare) these relative performance reports and portfolio overviews at least annually. And if you’re not getting this done, our advisors can offer a comprehensive current portfolio analysis to show you how has your portfolio performed based upon the exact make-up of your portfolio over the past year or years.  A 1% positive relative return versus a minus 1% negative relative return means a tremendous amount of additional monies in your pocket while in retirement, and it’s essential to the overall longevity and survival rate of your portfolio.

The second piece to the equation in the complementary consultation is running a sophisticated retirement projection.  The retirement projection takes all factors into consideration such as inflation, estimated rates of return, volatility of the portfolio, Social Security income, pension income, and any and all other factors entered into the system. We then project out your retirement income needs to assure that your portfolio and your overall retirement income scenario will continue and your income will continue for your entire lifetime.  Not all retirement projections are created equally.  Let us repeat, not all retirement projections are created equally. There is a definite advantage to using a more sophisticated retirement projection analysis system, especially when it comes to tracking the volatility of a portfolio within the projection and looking at what is known as Monte Carlo simulations, or viewing your portfolio and testing it in retirement against sequence of return risks.  If your retirement projection has a straight line percentage and does not factor in volatility, either through Monte Carlo simulation or sequence of return risk environment simulations, then the projection is really not giving you what you need.

It’s extremely perplexing when a perspective client nearing retirement does not take this complimentary consultation offer into consideration. Especially after we discover that they or their advisor have never done a retirement income projection, looking at absolute and relative return results. This is the most important and crucial step in determining where an individual is with regards to their retirement planning. Once again, it’s imperative to understand where you are with your portfolio, to maximize the returns within that portfolio, as well as understanding where you are currently in your retirement planning process. Will your portfolio last to age 100? Will your portfolio last until age 80? These are crucial questions that must be answered in advance of retirement. Our advisors provide a complementary consultation to assess each individual’s current portfolio and retirement projection values and needs. Don’t you owe it to yourself to make this happen? If you or a friend of family member could benefit from this complimentary consultation, let us know.