Retirement Roadmap Leads to Success

If I told you that six out of ten diners trying to reach Casa Bonita set forth without an address or map, you would probably be surprised to find any of them at the final destination. Yet the majority of workers set sail for retirement without a plan, but are surprised to find themselves adrift in a sea of uncertainty while the miracle of compound interest eats away at their retirement chest. Failing to plan, some say, is a plan to fail. But no one wants a failed retirement. Obstacles to planning rob savers of security, success, and peace of mind.

For too many people, a “financial plan” is either an outdated document gathering dust on the shelf or a painful memory of an expensive process where a financial salesman rifled through their private affairs in search of a commission opportunity.

Without a plan, however, people wrestle with retirement choices without the facts needed to make a good decision. Investors don’t know how much they need to invest in order to achieve their unspecified goals. In fact, the whole season of retirement raises a frightening series of questions when it ought to be an exciting reward for a lifetime of hard work and achievement. Humans have a thankless habit of converting luxuries into problems. Without solid planning, we may convert the once unheard-of privilege of retirement into a myriad of quandaries and dilemmas. It is even worse when workers plunge into retirement before they are financially ready to make the leap from earned income to living off their pile of financial assets.

Those who do try to plan often end up asking a financial salesman to design the plan, which ends up being biased toward whatever product he sells. Others rely on do-it-yourself rules of thumb that fail to account for individual circumstances. Free web-based tools typically fail to address the real world problem of return volatility. A more robust solution would use a Monte Carlo analysis to examine what happens when stocks start out the retirement period by underperforming the original expectations. Printed plans that sit on a shelf fail to address the year-to-year changes that impact our lives, and our financial resources, as time goes by.

At May-Investments, financial planning is an ongoing process. Just as we continually monitor the markets to search for new opportunities, our approach to financial planning is also dynamic – ever changing as client circumstances evolve. Our plans are flexible and dynamic, a continuing dialogue about clients’ unknown futures so that we can make changes to the real-time strategies we’ve employed.

Plans don’t go stale because the planning process is never “done.” Sophisticated financial planning tools help individuals identify risks, collaborate with other professionals (CPA’s and estate planning counsel) during the process, import assets directly from their investment accounts and tweak goals and assumptions throughout the year. Comprehensive financial planning clients are more confident about their futures, and feel more in control of their future. With better financial direction, more know they are on track to realize their goals. There is also a correlation between the amount of assets accumulated and their willingness to participate in a comprehensive planning process – although there is a question of which came first, the plan or the assets.

Sadly, the folks who could most benefit from participating in a financial planning process are probably among the least likely to be reading this article. Those who have the worst sense of direction aren’t particularly interested in articles comparing compasses. The benefits to planning, however, are even more profound for those who haven’t done much of it in the past. We actually use something called a “financial roadmap” as the basis for our planning process. Don’t leave home without it.
 
 Douglas B. May, CFA, is President of May-Investments, LLC and author of Investment Heresies .

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Four Things To Know Before You retire

Is “retirement” an experiment that failed? The difficulties facing our country, and retirees specifically, make us wonder whether the plans people have made to spend more than half their life outside of the workforce are realistic. Succeeding at “retirement” is more difficult than many imagined. Nonetheless, we can offer four suggestions on how people can jump start their retirement planning effort.

The politicians competing for the Presidency debate whether Social Security is “a Ponzi scheme” or merely an entitlement program headed for insolvency. Wall Street seems to be focused on using retiree funds for their own enrichment with little or no regard for the impact of its actions on taxpayers or even its own customers. Academic research assumes that investors should adopt a “buy and hold” strategy throughout the business cycle, forcing many investors to take on more volatility than they can stand. And the complexity of the decisions confronting retirees grows worse, it seems, with each new law that Congress passes.

As a result of these problems, few retirees are able to negotiate the labyrinth of choices alone, and are understandably wary of trusting the advice that comes from financial service professionals. Forced to move forward without trustworthy guidance, investors may too easily panic when the market environment turns negative, which turns a paper loss into a real loss to investors’ net worth.

Hopefully the following four steps will help workers prepare of the onset of retirement.

First, investors should put “Social Security” into the proper perspective. Know that Social Security is a “social insurance” program that was never intended to be, nor funded as, a true “retirement plan.” Governor Perry calls Social Security a “Ponzi scheme” and in a sense, he is right. The older generations live off of contributions by the younger generation. As a “retirement plan” it has never been actuarially sound. However, the program was not designed to be a place where contributions are invested to be withdrawn at retirement.

Social Security is an “insurance” plan. It is designed to insure against the risk that seniors out-live their savings. When the program was established, the age when benefits could be withdrawn was higher than the average life expectancy of its participants. The average contributor was never expected to withdraw a single dime from the system. Only the oldest of the seniors – those who lived beyond the average life expectancy – were expected to access those funds.

When we started living longer, politicians refused to “cut back on the entitlement” and raise the age at which benefits could be withdrawn. The perception of voters shifted to social security as the place where funds are invested in order to facilitate retirement – and the earlier the better. This doomed the program to insolvency and investors need to re-orient their thinking or risk their retirement on the rocky shores of political expediency. Workers are not “entitled” to an early retirement. Not in Greece. And not here. If workers want to retire early, they need to save for that goal.

Successful retirees should view social security as an insurance policy that provides an income stream in the event that they live longer than normal, which puts them at greater risk of out-living their financial resources. Therefore, in order to retire “early,” workers need to create a separate retirement account where they can invest additional funds to provide income during the years after retirement, and before taking social security. Politicians debate the passage of legislation to create “private retirement accounts,” yet we already have a myriad of retirement accounts (IRA’s, SEP’s, SIMPLE plans) that fit this need. We don’t need legislators to create another new type of retirement plan, we need politicians with the integrity to stand up and fess up to voters that social security is not now, nor has it ever been, a “retirement plan.”

Retirees need to create a separate “bucket” of money, typically a specific type of retirement plan, to use in funding the “early retirement” years. Lacking such a stand-alone pot of resources, workers need to plan on working, delaying the date when they start taking social security distributions as long as they can. For most people, early retirement should be fully funded by private savings, leaving social security to provide insurance against the risk of retirees outliving their own financial resources.

Second, investors need to shift their thinking to accommodate the differences between investing for “accumulation” and, in later years, using investments to provide an income for life (investing for the distribution years). The investment industry has not kept up with this need. It is still pushing accumulation strategies on its customers when that is not, necessarily, their primary need.

At May-Investments, we divide money into two buckets for the purposes of what the industry calls “asset allocation.” The first bucket, we call “green money,” is conservatively invested and designed to provide clients a secure income stream for the next five to ten years. Green money may be invested in bank certificates of deposit, a bond ladder, or fixed or indexed annuities that provide a lifetime income benefit. May-Investments does not sell annuities, but we do recognize that they are often an important part of the solution.

Because annuities have often been abused in the past, some readers may automatically “tune out” recommendations that incorporate annuities as part of the solution. However, people should know that a June 2011 Retirement Income study by the U.S. General Accounting Office suggests that annuities are actually underutilized as a tool for providing lifetime income, especially for less-than-wealthy retirees. We can e-mail copies of the report, titled “Ensuring Income throughout Retirement Requires Difficult Choices,” to anyone interested.

Recent professional research is also beginning to incorporate the value of annuities in designing portfolios for investors during the distribution phase. A 2007 study by Richard K Fullmer, CFA uses annuities as a benchmark against which traditional stock/bond portfolios must compete. Based on the principles that (1) investors should never risk more than they can afford to lose, and (2) that no one should buy insurance that they do not need, his approach uses annuitization as a strategy alternative that is most appropriate for older investors who cannot afford to risk outliving their resources. Other studies have been evaluating the benefits of adding annuities to supplement more traditional stock and bond allocations in order to reduce the risk.

Investors need to keep an open mind to the conclusions drawn by the GAO and others about the potential for including annuities in an investment program. It is impossible to generalize. For some individuals, annuities should be the primary solution. For others, there may be no reason at all to use them. Every individual is unique, and each individual’s plan draws on their unique set of resources in order to meet their unique set of retirement goals.

Third, investors need to set aside the misunderstanding that proper “asset allocation” means a “static” (never changing) distribution among asset classes. While some diehard passive investors may be more comfortable having a fixed allocation to stocks, both in good times and bad, our view is that if your portfolio advisor suggested the same portfolio in October 2007 as in March 2009, something is wrong. The risks and opportunities at the top of the market were much different than what investors faced at the market bottom. Why does it make sense that the investment portfolio wouldn’t reflect these markedly different set of circumstances. Investors who owned essentially the same portfolio in late-2007 as in early 2009 ought to be asking whether their portfolio is ‘buy and hold’ due to choice, or inattention?

Yet the common myth throughout the industry is that “market timing doesn’t matter.” We all know that isn’t true. When the market crashed in 2008, the size of the allocation to stocks was all important. In fact, the hallmark study used by the industry to justify a do-nothing asset allocation policy proved quite the opposite – that asset allocation is the primary determinant of investment returns. Rather than ignore it completely, as most in the industry do, it makes sense to manage the portfolio’s risk profile across the market cycle. When stock prices are high and economic fundamentals are weak, it makes sense to reduce portfolio risk. At lower prices, and going into an economic rebound, it makes more sense to take risk because – generally speaking – risk-taking is more highly rewarded at that point in the cycle.

Fourth, retirement planning is not just about the money. It’s about your life! There are so many factors to consider that influence investor satisfaction with how their investment portfolios are doing. For many, managing risk is far more important than maximizing return. Having an advisor who is free to pick among a variety of solutions and vendors is also important. For others, the peace of mind that comes from having established a plan, and having the discipline to monitor the plan on an ongoing basis, imparts more comfort than any specific investment discipline can provide.

At May-Investments, financial planning is an ongoing process. Just as we continually monitor the markets to search for new opportunities, our approach to financial planning is also dynamic – ever changing as client circumstances evolve. Our plans are flexible and dynamic, a continuing dialogue about clients’ unknown futures so that we can make changes to the real-time strategies we’ve employed.

Investors should take time to have a plan prepared and share this plan with appropriate family members and professional advisors. The financial roadmap that we develop with clients helps us understand their priorities, goals, and where they hope to end up. Whether you get help in preparing a plan is optional. However, the benefits of planning, whether on the back of a napkin or in real-time using a dynamic software program (our preference), are only available to those who take the time to determine what road they should take into the retirement years.

Create a bucket of savings that allows you to retire early. Adjust your investment strategies to provide lifetime income as appropriate for the distribution years. Actively manage your exposure to risk depending on where you are in the market cycle and prepare a game plan that you can dynamically monitor in order to enjoy the peace of mind which you deserve.

There is so much more to a successful retirement than what happens in the investment portfolio. On the other hand, we all know that investment failure can create stress that makes it difficult or impossible to focus on friends, family and community involvement that are the ultimate reward for a lifetime of hard work. Jonathan Clements once wrote that, “retirement is like a long vacation in Las Vegas. The goal is to enjoy it to the fullest, but not so fully that you run out of money.” With the right preparations, the person who happens into retirement – stays in retirement!

 Douglas B. May, CFA, is President of May-Investments, LLC and author of Investment Heresies .

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