Viewing entries tagged
retirement income planning

Why Taking Risk In Retirement Just Makes Sense

What?

Did you use the terms "risk," "retirement," and "just makes sense" all in the same sentence?

I think you might have lost your mind. 

Well as it turns out, neither I, nor many others have lost their mind on the notion that you may actually fare better by increasing your commitment to stocks gradually through your retirement years.  

Confused yet?  We thought so, let me explain:

As it turns out, the most problematic "time zone"  for retired investors tends to come in the early years immediately after retirement. In the parlance of investment decision making, this problem is grounded in what's known as sequence risk, the potential for the early years of your retirement to be the worst years in the market. (Think, "what if I had retired in 2007-2008?")  Obviously, the decline in market values would not have been a good way to kick off the retirement party now would it. 

No, it would not have. 

What research shows is that there are more or less, three core strategies that one can consider when looking at retirement as it relates to the "how much money should I invest/keep invested in stocks?"

  • Own more stocks now and less as time goes on
  • Own the same amount of stocks now and tomorrow (this works better than the first one)
  • Own less stocks now and more over time (this actually works the best)

So this takes us back to the fact that if you had 70% of your portfolio in stocks just prior to and at retirement, cutting that back to let's say 40% for five or six years might not be a bad idea. With the understanding of course that at some point shortly after that fifth or sixth year, we're going to move that 40% to 45%, then 47% then 50% and so on.  Can you "cap out" at some point?  The research doesn't really say, but I'd suppose that you could, you might get back to your original 70% and stand pat.

So Why Does This Work?

I'd guess that there's a substantive number of mathematical reasons why it works (and there are) but we're not writing our own research paper on the matter. 

I think that viewing the issue at a distance there are some simple conclusions that most anyone could draw; 

1. the decreased allocation to stocks early on, protects against the stock market declines extracting too much value of your total assets just after retirement when you'd be the most vulnerable to steep declines; 

2. the de-emphasis of "bonds and cash" over time allows you to have more money at risk, which means more money poised for growth rather than income

3. the allocation to equities over the long term enabled your assets to better keep pace with inflation

4. good years typically happen more than bad years when taken over an extended time horizon, so your profits build as you moved through time, taking advantage of compounding

5. you were able to pursue more of a "total return" strategy; which meant that you removed your focus from "income" per se, to "cash flow"

This will mean that we'll have to reframe retirement investing from "growth assets today, but less growth assets tomorrow.." to "less growth assets today and more growth assets tomorrow!"

Counterintuitive to be sure and hence, it will escape use by but a few. 

And, for the record, the less counterintuitive bet, "less risk today and less risk over time"; isn't working and there's already "real people" math to substantiate that. It's one of the reasons that retirement in America winds up so poorly funded. 

Sometimes, things just aren't what they seem.  

Better you adjust and choose a new course of action. 





American Hustle?

No, we're not talking about craps, roulette or poker, either in person or online.  Those activities will remain for the foreseeable future. 

What we are talking about is the realization by the Federal Government that some of the more "advantageous" and "provocative" Social Security claiming strategies, which appear to benefit the recipient, have to be stopped because they have the potential to cost the "system" an extra ordinary amount of money estimated by some to be as much as $9.5 billon annually. 

Strategies such as "claim and suspend" and "claim now, claim more later" are not all that uncommon though most retirees fail to even consider such strategies. 

Upon closer examination of the "problem" the real issue might lie in the fact that many of the more provocative strategies are ideal for two wage-earner households with the caveat that the additional benefits earned through accumulating retirement credits that build future payouts even while you're collecting on a smaller one, tend to favor households with higher more balanced earnings records between the spouses, which would of course, tilt the playing field in favor of higher income households. 

It should be noted that strategies such as "claim now, claim more later" spread benefits fairly evenly across most income levels yet nearly 50% of the total additional benefits received under this claiming strategy are allocated to the top two quintiles of wealth distribution.  

If the President's fiscal-year 2015 budget passes as proposed, many of these strategies would fall by the wayside. 

How much does it matter?

This is a key question.  On their face, the appeal of these more subtly nuanced strategies lies mostly in the "interest" of the parties to game the system or to be lured by the higher dollar amount of future benefits. Over the course of a recent three month period, our firm looked at differing claiming strategies for a handful of Clients. We concluded that upon closer observation, when measured by the ability of a different claiming strategy to increase real wealth, there was almost no pick up in utility by employing a more subtly nuanced strategy. (Albeit that a case can be made for the fact that increasing levels of "guaranteed" income during retirement does potentially provide for more utility in managing "investment assets" across the retirement time horizon.)

Remember the Roth Conversion?

We witnessed first hand a similar affect during the period when Roth IRA Conversions were all the rage. 

While the draw of the conversion was clearly positioned on two pivotal issues [a] taking what would have been taxable Regular IRA income and converting it to "tax free" Roth IRA income and [b] the ability to spread the tax bill over two years on the conversion; the actual pick up in wealth when measured by using Monte Carlo Simulation and looking at retirement with and without the conversion; there was for many, virtually no increased level of estimated retirement success probability. That is to say that Clients who may have scored Monte Carlo Simulation probabilities of 93% with the conversion, still scored 93% without the conversion. This was due mainly to the fact that what got lost in the allure of converting taxable to non-taxable income was the future value of the tax bill that the Client paid on the conversion, which absent the conversion, they'd have still had in their pocket.  Like Elvis, those dollars summarily "left the building" never to return.  A conversion of let's say $400,000 for a wage earner in the 30% tax bracket resulted in the loss of $120,000 of "other money" that was taken from savings or other investments to pay the tax bill on the conversion. 

Conclusions

Surely, pre-retirees should do much more than default to either taking benefits as soon as possible or deferring them till 65.  Perhaps a combination strategy as suggested by many research papers that the optimal strategy would be for one spouse to take the benefit at the earliest age and one to take it at the latest age is ideal?  We're not sure and we're not sure because every situation is different because every situation is impacted by other factors such as; 

  • The level of cash assets on hand
  • The level of "investment assets" on hand
  • Projected tax rates and inflation rates
  • The projected level of household spending and; 
  • Other sources of income such as pension and IRA Required Minimum Distributions

Bottom line is that "all that glitters is not gold" and simply getting a higher benefit amount does not necessarily portend greater probabilities of retirement success. 

In golf, there are a lot of golfers that can hit the ball a mile, but can't keep it within the confines of the golf course itself. Yet, if you asked most golfers if they'd like to add another 50 to 75 yards to their drives off the tee, you'd be hard pressed to not find any non-takers. (Just ask club manufacturers like Taylor and Nike who sell millions of new clubs each year based on this very premise.)

But driving the ball is one and only one (yet an important one) component of succsesful rounds of golf.  But if you can't hit any other club in your bag or putt, you're long off the tee and still shooting 105.

And, as it relates to the potential to see a closing of the provocative Social Security claiming strategies; having them guaranteed in reality very little. 

Unless we can fundamentally change the nature of "retirement" in American, either through sheer will or political change, it's likely better to not add nearly $10 billion in costs that benefit such as small minority of people if in reality, they real ever benefited at all. 

Bottom line is that "planning" your Social Security strategy will almost always trump not planning one and even if there's a repeal of the more subtle strategies, there's still strategies to plan for and with. 

Best to focus on the options that will make a real difference. 



Fixing Social Security

In a recent article in the Sun Sentinel, the author proposes how to "adjust" Social Security by bolstering it, not cutting it as some might find more desirable. 

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Our country has undergone substantive change since the enactment of Social Security, and frankly, the program itself has done little to keep up with the changes.  The addition of retirement "ages" of 62 and 70 were instituted to address the needs of women and minor mortality adjustments but there's really been little else. 

With American households dramatically under-funded for retirement, and with the advent of the end of defined benefit pensions in favor of 401(k) plans, it's not hard to see how little even the general population has done to adjust to prepare for retirement. 

While the cries of insolvency are always a concern, the fact remains that insolvency is hardly a reality either in actual or political terms. 

Nearly all but a few workers contribute 6.2% of pay to Social Security yet someone earning $400,000 a year pays 1.71% and a CEO earning $2,000,000 pays just .003%. The difference in rates is inexcusable. 

The fix then lies then not in if we index benefits, or by cutting benefits or allowing individuals to invest in the stock market, or gold or other investments. The answer lies where it has always been; funding. 

As this article portends, were we to gradually phase out the rate cap over a period of time, requiring more contributions from wealthier individuals, for the most part, the problems would be solved. 

I know, this speaks to the very heart of our shared commitment to the preservation of our economic structure.  But to my way of thinking, that's a large part of what democracy and the American way of life is about, isn't it?

The way I see it, if we can count on the greatest segment of our population to build our buildings, fix our roads and fight our wars for us, it might be nice to thank them by doing what we can to ensure that they don't live in a cardboard box during their later years. 

While to some's way of thinking, the abyss between the "haves" and "have nots" may seem like a natural order of "finance" it remains true that our "founding fathers" built a democracy based not on ramping up inequality but by doing what was necessary to prevent it. 

Here's a fix that can and should work. Which we all know means it likely won't. 

Sad as that may be.