Viewing entries tagged
retirement distributions

Avoiding The Low Interest Rate Trap

For many pre-retirees and "in place" retirees, this extended period of low interest rates presents a financial conundrum; how to keep pace with rising costs, when your income specifically can't?

Feeble returns on safe investments such as bank deposits and bonds may hinder retirement income models for another decade according to a recent interview with Bill Gross, manager of the world's biggest bond fund. Currently the average yield on a five-year CD is about 0.8% compared with 2.26% back in 2009. 

But, for the record, the problem here lies not so much in the environment of low rates, as it does in the misguided approach that most American's take to retirement. 

It's long been said, that inflation, especially when it's lowest is at it's most insidious levels. With an average inflation rate of around 3%, retirees hardly notice year by year the rate at which their prices are rising.  When rates are low, inflation spends much less time as a topic addressed by the mainstream media, and the less that investors/retirees hear about it, the less that they factor it into their thinking in planning for their future. 

It's All In How You Look At It

America suffers from many ills as it relates to retirement. Many of those are self inflicted like the problem that low yields portend for keeping pace or actually enjoying retirement. But, many of those exact problems are caused by the perception of retirement. 

Striving to reach an artificial finish line such as "your retirement date" or turning 65 or collecting your first Social Security check, clouds our thinking.  Many retirees have a life expectancy much longer than they think that they do.  Given that, it might be best of we reframe the problem: 

"The finish line is your date of death, not your date of retirement.

I'd bet if we looked at the problem that way, we'd understand better that keeping pace with inflation and not relying on "fixed income" in a world of nothing but variables, probably isn't a wise path to take. 

The "income straight jacket" is especially concerning. 

The income straight jacket exists because too many American's believe that when they retire their time horizon for investing has now ended, they've made it, they got to the finish line. So, it would appear to be time to employ a different strategy.  Instead of investing for growth, the default becomes to position the portfolio to replace the very thing that they had when they were successfully making it (i.e., when they were working) namely income. 

Portfolios replete with high dividend paying stocks and fixed income abound. But there's a problem lurking in the shadows; when interest rates rise and the underlying value of their entire portfolio starts to drop, the decisions that need to be made become more problematic. 

Not only can't their portfolio income keep up because many of those rates are locked in; but the value of everything is declining as well, making the notion to initiate some change even more daunting. Who wants to sell as prices are dropping off the cliff?

Over the last few years there's been more than a few articles on the impact of lower than average interest rates on retirement and retirement income. But I'll submit that if you used bad math and poor judgement to build your portfolio in the first place, it's not a surprise that the "market" has found a way to make your bad decisions cost you. 

The Problem With Low Rates Is Our Reliance On Them Not To Be....

In and of themselves, lower than normal interest rates should not be much of a concern. Oh sure, they deserve some attention on how things are built and managed, but lower than average rates are not the death nell that we're hearing about. 

I'd bet that there are few people who are complaining that inflation (a number typically tied to the overall level of interest rates currently in play) isn't high enough or that you're ready to step up to the plate and have your mortgage and/or home equity loan rates move up to around 7%. 

Thinking that you're going to earn 8% on fixed income or bank investments when the inflation rate is 3% is about the same as the Client who would like to earn 10% on the stock market but just not have any risk....it isn't going to happen.  At point of fact, I'm not sure that it could happen. 

A local sports radio celebrity often comments about "mediocre" sports teams who seem to playing way better than they should be.  His comment about those teams seems true here as well; 

"The reality is that if your teams got problems, real problems, it's only a matter of time until those problems become real and your run is gonna end...."

Likewise for building a portfolio. 

Or a house, or a car, boat, sports team or business.  Weaknesses have an odd way of finding weaknesses in a relatively efficient manner. 

So stop waiting for rates to go up if for no other reason than you can't make that happen and start focusing on what you can do for yourself.

Sit down with someone who knows how to construct a plan for your retirement and your portfolio based on all the relevant factors, not just the ones we'd like to see happen. 


The Fate Of Your Predictions

Jamais Cascio in a recent posting for Fast Company Magazine may have gotten it just right in his vision about "the future" and the metaphors we use to consider it's ultimate arrival.  

The Dragon, the Black Swan and the Mule, all ring true as cautionary tales for both advisors and Clients and yet, do so in different ways.  

Here's some quick definitions;  

  • The Dragon- a segment in a topic area that is uncertain and dangerous to consider. It's something that we steer clear of, but should know much more about than we do.
  • The Black Swan- this is something we don't know much about but probably should, like the emergence of the Internet, or the fall of the Soviet Union or 9/11.
  • The Mule- this is something that we don't know much about and likely can't. It's something so far out of the realm of knowing that we can't conceive it.

I don't think that I could write any more salient a thought than the one that Jamais closes his Fast Company piece with.... 

"Here's the thing; It's easy to assume any surprise is a Mule. It's much harder--ultimately more valuable- to recognize when you are looking in the wrong direction (a Black Swan) or refusing to open your eyes (a Dragon). The task for the futurist is to be able to tell these three animals apart. Good luck." 

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The bigger question for sure, when considering personal financial matters is this; if you have no defined future (because you're not planning one or creating it) doesn't everything show up as the Mule?  And, in reality isn't the most likely of the trio to spawn an "unrecoverable event" that very thing?

Consider that spouses die, get sick, divorce or some other calamity. A Dragon to be sure but the impact of the Dragon can be measured and understood and alternative plans can be made to employ upon it's appearance. Those plans, figured out now, might well save the day. 

The stock market crash, continued high unemployment, changes to Social programs like Medicaid and Medicare? Black Swans to be sure but again, they can be measured and judged, evaluated and prepared for, at least in the realm of "contingencies" they can. 

Reality is that most people will be meet one of these intruders at some point. Be that intruder Dragon, Black Swan or Mule will largely be determined by the context it shows up in.  

Again, the admonition; "Control What You Can Control." 

You control the context if your write the context. Want to ensure that at it's worse, your unwanted "visitor at the door" is either a manageable Dragon or a less co-operative but manageable Black Swan? 

Then let your well thought out plan be your context, otherwise you're just letting the Mules in.  

Fool me once, shame on you, fool me twice....

At the outset let's state for the record this is a politically agnostic post. 

I'm not so much concerned about who's offering (or not offering, or sorta offering, etc.) a course of action as I am with the ramifications of going for something with less than the full details.

Transient

Back in the late 1980's we passed the Tax Reform Act (TRA '86) which was passed under the guise of tax relief. And it did reduce rates, with the top rate dropping from around 50% to about 28% at the highest marginal rate.

Of course, not noted so much in the effort to pass the bill was the elimination of a fair amount of itemized deductions (consumer interest to name one) and, that we had gone from about 15 tax brackets to 4. (That little "sidebar"  of 4 v. 14 was the real killer.) And yes, the argument was foisted that 4 brackets would make things simpler than 14.

First off, let's go back a bit. The reduction in brackets/taxes were almost entirely offset by the elimination of deductions. I'd venture to say that most tax payers under TRA '86 actually wound up (tell me if this sounds familiar) paying a lower rate on more income which resulted in actually paying more taxes. Hmmmmm.....history repeating itself?

But the biggest problem may not have been the rates then as much as the rates would wind up being/staying moving forward. You see, when there were 14 tax brackets the odds were pretty damn good that you'd be in one tax bracket while you were working then another, lower bracket when you retired. Your income didn't have to move up/down that much to move your bracket. That's critical because it's not just the taxes now, but the taxes then!  When is then you ask?

Then is when you retire. Folks, it make a lot more sense to put money away when your tax bracket was let's say 30% and you were working and then retire and get it back when your bracket was going to be 14%. But now, with those same TRA brackets in place more or less; you're putting away money at the 33% bracket to get it back in the 33% bracket. Where's the benefit in that to a country that can't figure out how to retire to begin with? (Note: Any financial types out there want to calculate the additional tax liability on at about 14% additional taxes per year every year, on all IRA and related pension income from let's say age 65 to age 85 go ahead. I'm summarily concluding it's a boat load of money!!)

So let's not forget two things:

1. You must know all the sides of the issue because what might seem to be good for you today is highly likely to be less than desirable for you tomorrow, and;

2. Overpaying is cumulative, not singular. As tax bills undercut your post retirement wealth it'll be harder for you to live the life you want to live in retirement. 

In closing, it is seldom either as easy or rosy as anyone makes it sound. But without the details, you can't possibly know that.