Who Chooses the Risk in Your Retirement Planning?

Like most of you, I remember the playground where I grew up and choosing sides for teams.  Standing in line, hoping to get picked (or not picked) by a certain team captain was always a little stressful, especially if you were chosen by the team you knew had no chance of winning!  The biggest problem was that I always preferred doing the choosing.  The reason is simple: I know what I’m getting when I’m the team captain making the decisions.

As I’ve traveled the country speaking with advisors about financial planning, I’ve come across a mindset that is consistent throughout the industry.  Rather than letting clients choose the risk in their portfolios, the advisor does it for them.  This practice becomes more apparent when the subject of annuities enters the conversation.

Much like the playground, the financial planner doesn’t let you, the client, choose the amount of risk you want in your portfolio; rather the planner, like a team captain, chooses for you.  Often, advisors don’t listen very well.  The reason is that they are predisposed to use certain types of assets that feel comfortable to them, but may not be in your best interest.  Some advisors are so fixated on products they forget that the priority is people first.  They need to listen well, by using a client-friendly planning process, ending with a plan in which products are best deployed for your benefit.  These priorities are brought to you by the letter “P”: People, Process, Plan, and Product, in that order.  Advisors need to listen to you to determine the amount of risk you want in your portfolio and create a plan using assets that adhere to your risk tolerance.  You should choose your own risk.  After all, you’re the one who has to live with it.

The reason so many advisors around the country utilize the ABC Planning Model is to help investors like you be your own team captain and choose the amount of risk you want in your portfolio.  In the ABC Model, you choose the amount of cash assets, the amount in protected money savings, and the amount at risk in stock or bond type of investments.

I suggest that if an advisor asked you what percentage of market risk you would want in your portfolio, neither you nor any other boomer or senior would say 100%.  Yet, if an advisor puts a large percentage of your assets in variable annuities (VAs) for “safe-money planning” and the rest into mutual funds or other market assets, they’ve done just that.  What might you say?  Would you want to risk 70%? 50%? 30%?  Who knows?  Only you do!  And certainly you don’t, if no one asks you.  Why wouldn’t the advisor ask you?  See what you answer and then develop a plan based on your wants and needs, not what the advisor wants.

When an advisor uses the ABC Planning Model, they place fixed index annuities (FIAs) and VAs in the correct category of risk. In fact, they let you determine where they belong.  The FIA is the middle ground between low CD rates and the volatility of the market.  The VA is a market risk asset and subject to the volatility of the market.  People saving for retirement could make better choices if an advisor would simply ask questions to properly position their solutions.

Lastly, an advisor building his/her practice solely on the basis of commission, and not thinking of you and your needs first, is obviously a person to avoid.  Commission-driven advisors are this industry’s bane. They are usually the guys asking you to make a huge financial decision n 90 minutes!  Sounds like the TV show Deal or No Deal.  Yet, if looking at your total portfolio, listening to your concerns and dreams and the percentage of risk you want, they decide that one product fits better than another to meet your needs, then they’ve done their job.

Advisors must simply do what’s right for you regardless of their pocketbook.  Make sure an advisor “ABCs” your portfolio to determine your exposure to risk and develops a plan accordingly.  Do it in a planning process that determines your goals, needs and wants, and you’ll have a very successful retirement with tremendous financial rewards.  Choose the right team captain, one who understands the ABC Planning Model and the ABC Planning Process.  If not, you may end up working the rest of your “golden years” at the “Golden Arches” with some of your old teammates!

Check out the ABC Planning Model at www.planningwithabc.org and call an ABC-trained advisor today for a complimentary ABC Profile Review.

Dave Vick
President, Vick & Associates, Inc.
March 2013

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Outliving Your Money in Retirement

The greatest fear of most retirees is the risk of longevity: outliving their money. The meltdown of retirement accounts, rising medical costs, uncertain entitlement programs and higher taxes have added to the risk. Facing 30 years of retirement living on past savings and Social Security benefits is a scary reality. What can be done?

 To handle other unaffordable risks you buy insurance. The same companies that protect your home, life, health and auto can also protect you from the risk of longevity. The basic principle of all insurance that makes coverage affordable is “pooling of risks”. Since the greatest fear of retirement is outliving your money and your remaining life span is uncertain, the solution is to insure the unaffordable risk. Let’s see how this is done.

 Insurance companies issue fixed annuities, which can be turned into guaranteed lifetime incomes. You can accumulate your retirement money in an annuity over time, or you can fund the annuity lump-sum. Fixed annuities are backed by the assets of the insurance company, guaranteed to give you a positive rate of return which is free of income taxes until the earnings are withdrawn, and offer you numerous other choices. At the date you select, you can turn your annuity into a lifetime of monthly checks you cannot outlive. The insurance company guarantees you a lifetime of income, regardless of how long you live. You can later change your mind, stop the income and take your money lump-sum. If you die prematurely, your heirs are paid the balance of your account.

 Let’s look at a hypothetical example that most insurance companies offer. Let’s say you are age 57, have $350,000 in an IRA account and plan to retire at 65. Parenthetically, you can put money in an annuity at any age and can start immediately to take an income. You’ll get the following by moving your IRA money to an annuity: (1) a 10% premium bonus that boosts your income account to $385,000; (2) a guaranteed growth in your income account of at least 8% annually; (3) the right to start a monthly income at any time after 591/2; (4) an annual lifetime income equal to 5.5% times your income account value at age 65; (5) the right to withdraw your money lump-sum if you change your mind; (6) no taxes on the annuity earnings until you start withdrawals; (7) no fees or commissions except 0.40% annual premium taken from earnings for the lifetime income guarantee. At age 65 and retirement what can you expect?

 At age 65 the income account will be at least $712,608 since you were guaranteed at least 8% annual growth on your initial annuity premium plus the 10% bonus. Your annual guaranteed lifetime income will be $39,193 (5.5% of your $712,608 income account balance). If you should die prematurely, your account balance, if any, will go to your beneficiaries. If you change your mind, have an emergency, find a better value or whatever you can take your remaining money lump-sum. There are no medical requirements or other hassles. You are now insured against the risk of longevity and cannot outlive your money.

 Insurance companies charge for their services and make a profit; thus, retirees that die too soon will subsidize those that live too long. The same as those whose homes were not damaged subsidizes those whose homes were damaged. Your retirement objective of a guaranteed lifetime of income was insured at a reasonable cost by pooling your longevity risk with that of other retirees. Combine your guaranteed lifetime income with Social Security benefits, and you have a comfortable and safe retirement with very little planning. Ask your financial advisor today about a fixed annuity with a Guaranteed Lifetime Income Benefit Rider.

 Shelby J. Smith, Ph.D.

January 2013

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NEW: A Fixed Indexed Annuity Designed Exclusively for 401(k) Plans

Financial professionals who help prepare employees participating in 401(k) plans for retirement face a challenging task: finding a conservative investment option inside the 401(k) that protects participants from outliving their money.   For years financial professionals have been advising clients to maximize their contributions to their company’s 401(k) plan and balance their allocation for highest growth within their risk parameters.  Now, as retirement looms on the horizon, many 401(k) participants must find ways to direct those funds into more conservative investments that generate income throughout retirement.  The reason: traditional approaches lack full reliability to deliver income for life. 

 The insurance industry’s fixed indexed annuity is an answer to meet the retirement income challenge but certain obstacles have prevented its addition to the options within 401(k) plans on an equal footing with traditional investment options like mutual funds.  Thankfully, the barriers to entry have finally been dismantled by a major insurance company’s recent introduction of a Fixed Indexed Annuity exclusively for 401(k) plans.  This annuity allows those approaching retirement and the risk averse to complement traditional 401(k) investment choices by offering a lifetime income guarantee to protect them from outliving their hard earned money.

 Some of the concerns faced by the retirement-minded that can be overcome with Fixed Indexed Annuities include:

  1.  If my current contributions and employer matches continue unchanged, what will be the value of my 401(k) on my planned retirement date?
  2.  How much guaranteed annual income will I get from my 401(k) money on my planned retirement date?
  3. Is this income guaranteed to last as long as I live regardless of market or interest rate changes and regardless of how long I live?
  4. If the stock market falls dramatically as it did in 2000-02 and 2008-09 will my family’s plan for retirement be affected?

 Today’s traditional 401(k) plans have not provided acceptable answers to these important questions because most 401(k) options available to participating employees are investments that move up or down in value as markets and interest rates change.  What’s more, two stock market meltdowns in this millennium, high market volatility and an uncertain global economic landscape highlight the risk of traditional 401(k) investment options.   The potentially safer fixed rate options currently available offer meager growth and no inflation protection. What should a 401(k) plan participant do if they want predictability and income protection?

Today’s Fixed Indexed Annuity is the answer for 401(k) plan participants who are approaching retirement or who are risk averse.  Here are the reasons:

 If contributions and matches continue until the planned retirement date, the roll-up interest rate of this annuity with a guaranteed lifetime income rider makes it possible to know exactly the minimum balance in the annuity’s income account. 

  1. Since both the minimum income account balance and the age of the employee are known on the planned retirement date, the minimum amount of guaranteed lifetime income from the annuity is also known. 
  2. The guaranteed lifetime income continues until the annuity owner dies, even if the account value of the annuity goes to zero.  In addition, the owner has the flexibility of stopping and re-starting the income at any time or withdrawing all or part of the annuity balance in a lump sum.
  3. Until income is elected under the guaranteed lifetime income rider, the annual changes in annuity’s value can only be sideways or up, never down, regardless of market or interest rate changes.

 The Fixed Indexed Annuity exclusively for 401(k) plans is a major improvement that offers those approaching retirement and the risk averse a safe harbor to protect their hard-earned retirement money from market and interest rate uncertainties.  There are other features and benefits of Fixed Indexed Annuities that the retirement-minded will find attractive and cannot currently be obtained from the other options now available in their 401(k) plan.   If your retirement plan does not currently offer the Fixed Indexed Annuity option, I suggest you ask your employer to consider its addition since it will not eliminate any other option now available in your 401(k) but will add important features that appeal to older workers fearful of the market exposure and younger workers who are risk averse or simply wants non-market diversification for their retirement savings.

Shelby J. Smith, Ph.D.

December 2012

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Financial Advisors Promise but Do They Deliver?

According to Financial Planning magazine, November 2012, page 19 the Financial Planning’s Retirement Advisor Confidence Index rose for the second straight month in October (2012), indicating continued optimism among advisors that now is a good time to move into equities. Here are two quotes from the article:

“Advisors reported a continued rise in risk tolerance, again shifting clients assets into equity-based funds, while decreasing the amount held in cash.” 

 “The index reflected a two-month decline in assets held in cash – from about 50% for August to 41.7% for October – as well as another gain in risk tolerance.”

On October 01, 2012 the DJIA closed at 13,515.11 and on November 16, 2012 it closed at 12,588.31.  This 927-point drop represents a 6.85% loss in value in the DJIA and punctuates the danger of trying to anticipate movements in markets during uncertain economic times.  The wrong “guess” by the collective “advisors” also highlights the fact that no one knows the direction or magnitude of future markets.  Here are quotes from a January 2012 article from Forbes On-Line written by Rick Ferri:

A recent Jefferson National survey found that 75 percent of financial advisors now believe they can beat the market using tactical asset allocation strategies. They are delusional. It’s not going to happen.” 

  “This strategy has not added value to client accounts in the past and will not add value in the future.  Multiple studies measuring mutual fund cash flows prove that advisors have no skill in timing investments and there is no evidence they are getting better at it.” 

 Financial advisors are not market gurus and shouldn’t pretend to be.”

Here’s a quote from a 2004 article in FA Magazine written by Christopher Parr:

“Within the institutional investment community there is a long-running debate over the likelihood of active mutual fund managers outperforming a passive index over extended time periods. Depending on the time period selected, it is not uncommon to find studies claiming that anywhere from 50% to 85% or so of active managers fail to beat ‘the market’.”

The foregoing is a strong argument that (a) the market is risky, (b) financial advisors may not deliver good results and (c) if you cannot afford to shoulder the risk the market is not a place for you.  This is especially true for those already in or approaching retirement because they have a finite amount of money to last them for the remainder of their life and no way to replace it if lost to a bad “guess” in the markets. 

 A much safer approach for the risk averse and the retirement-minded is to determine how much they can afford to lose without destroying their retirement and safeguarding the remainder from loss of principal.  Even better, why not lock up a guaranteed lifetime income with your “I cannot afford to lose retirement money” by choosing a fixed annuity to deliver the peace of mind you should be seeking in retirement?  Unfortunately, you’ll not get “annuity advice” from most financial advisors because fixed annuities are “museum pieces” that hold no excitement and no chance for on-going commissions or fees.  However, fixed annuities do deliver the guaranteed lifetime income as an option you can exercise plus you retain the flexibility and predictability that is needed for the longest and most expensive journey you’ll ever take: retirement.  Check out fixed annuities and see if they’re suitable for your retirement needs.

Shelby J. Smith, Ph.D.

November 2012

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Taming The Longevity Risk Of Retirement

The biggest risk faced by the retirement minded, and their greatest fear, is outliving their money. This longevity risk is the most overlooked aspect of retirement because advisors and workers concentrate on accumulation rather than decumulation. The focus is on “how tall” rather than “how long” when planning the longest, most expensive and most hazardous journey of life. Many workers do not know how much money they’ll have on the day they retire, and if the amount were known, a guaranteed income throughout retirement would still be uncertain. Extrapolating from Census numbers, this “how long” conundrum will be faced every 7.5 seconds by a baby boomer from now through 2030. There are solutions, but one size does not fit all.

Addressing Certain Uncertainties

Monte Carlo simulations are used to judge the performance of diversified portfolios. Such simulations assign probabilities of running out of money early using various investment portfolios. Nonetheless, there always remains the possibility of a surprise. The most recent such surprise was the “highly unexpected” Great Recession of 2008–09 that scrambled retirement nest eggs, sent retirees back to work and slammed the door to jobs for many in retirement’s red zone. Current economic, financial and geopolitical uncertainties are harbingers of future surprises. Given the certainty of future uncertainty, diversified portfolios may not offer the advertised protection from longevity risk.

Another commonly touted solution to address longevity risk is to annually withdraw an inflation-adjusted percentage of retirement money, such as 4 or 5 percent. The recent-year market volatility, along with historically low interest rates, has cast doubt on this approach. For example, a 5 percent withdrawal from a million dollars would yield $50,000 annually; however, if markets again nosedive as they did in 2000−02 and 2008−09, retirement savings and incomes will again be cut in half. What’s more, maintaining income by withdrawing a higher percentage rapidly depletes principal. As many retirees now know, drastically lower interest rates yield the same outcome. Accordingly, the 4 percent−5 percent rule is a questionable solution for longevity risk.

Most retirees choose one or the other of the foregoing solutions, but retirement money is at risk in the market or in fixed-rate places. Such one-sided allocations occur because employer-sponsored retirement plans offer only market choices, bankers do not specialize in investments and brokers do not favor fixed rates. Also, the inertia of lifelong habits inhibits the changing of investment risk exposure as retirement approaches. Much attention is paid to reducing market risks by using lifestyle mutual funds, moving from stocks to bonds and other age-related investment adjustments, but retirement money is still exposed to the markets and longevity risk exists.

Financial advisors may use a holistic approach to retirement planning and investments, but most retirees continue as do-it-yourself money managers. Following retirement-threatening investment mistakes, many retirees abandon the do-it-yourself method by increasing their financial literacy through study, carefully selecting a financial advisor and repositioning their retirement money slowly after understanding all options. It is best to not rush any of these steps.

Insuring Longevity

A relatively new development is longevity insurance, whereby a fixed amount of money buys a guaranteed monthly income from an insurance company that starts at a stipulated future age. If the income trigger age is reached the income starts, but if not reached there are no payments. This use-it-or-lose-it feature is unacceptable to many but has merit for those more interested in managing longevity risk than the risk of dying early.

Insurance companies also offer immediate annuities paying a guaranteed lifetime or period-certain income, but inflation protection is generally not available; however, a ladder of fixed annuities can be constructed to provide a lifetime income that does offer inflation protection. An annuity ladder involves a series of individual annuities providing sequentially increasing income with the last tranche having a guaranteed lifetime income. The fixed annuity ladder eliminates the use-it-or-lose-it aspect and has the added advantage of immunizing retirees against market declines, falling interest rates and inflation.

The flexible, predictable and simple solution is a fixed annuity with a guaranteed lifetime income rider. The annuity is funded with single or installment payments and commencement of the guaranteed lifetime income can be deferred up to 20 years. During deferment, an earnings rate is guaranteed regardless of what happens to markets and interest rates. In the case of premature death, the unused portion of the accumulated value of the annuity is paid to the beneficiary. The annuity owner generally has the ability to stop or reduce the income in favor of a lump-sum settlement.

This solution is ideal as a Social Security or pension supplement and is gaining ground as a prudent solution for longevity risk. The use-it-or-lose-it problem is solved and your investment return is determined by how long you live. For those concerned about “how long” rather than “how tall,” an annuity solution deserves careful consideration.

October 2012

Shelby J. Smith, Ph.D.

Copyright © 2012 American Society on Aging; all rights reserved. This article may not be duplicated, reprinted or distributed in any form without written permission from the publisher: American Society on Aging, 71 Stevenson St.,Suite 1450, San Francisco, CA 94105-2938; e-mail: info@asaging.org. For information about ASA’s publications visit www.asaging.org/publications.  For information about ASA membership visit www.asaging.org/join.

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Human Capital, Retirement & Risk

“Human capital” is the ability to make money by supplying your labor, skills and knowledge. A rough measure of human capital is your expected remaining lifetime earnings. For example: if you continue working for forty years at an average annual salary of $50,000 your human capital is $2 million. Human capital helps determine the suitable amount of “investment risk” for your age. Losses from risky investments early in your working career are small compared to your human capital, plus there is time to recover from an investment setback. When your working years end your human capital is small, earned income has ended and time to recoup losses is less. Investment risks may be taboo!

Many retirees have won “the retirement game” by saving enough, but they continue to risk their retirement by owning risky investments. If you’ve already won the retirement game, why risk losing it? Snatching defeat from the jaws of victory is not smart! Yes, risky investments might pay off and you might hit it big; however, bad luck, the wrong investment or a market meltdown could result in pushing a shopping cart or doing without some basics. If you’ve won at retirement, why continue taking risks?

Financial planners counsel those preparing for retirement to set aside, in safe places, enough money to pay for thirty years of income shortfall. Let’s say your Social Security and other “for sure” retirement income will be $40,000 annually, but you’ve estimated your retirement lifestyle to cost $50,000. This $10,000 annual shortfall times 30 years is what must be risk-free to safeguard your retirement. Retirement planning is complicated by inflation, taxes, interest rates & other surprises and that’s why professional help is needed. Once you and your financial advisor (yes, you need one) have done the arithmetic for your retirement, you’ll conclude one of three things: (1) you’re short and need to increase your savings rate, work longer or change your retirement plans; (2) you have more money than required and some investment risks are okay; (3) you have only the required amount and must protect it. Always err on the conservative side, but if you’ve clearly won at retirement, stop taking investment risks – it’s that simple.

Dave Vick’s “ABC’s of Conservative Investing” is an excellent retirement strategy. Here’s how it works. First, pretend all your money is 100% liquid and you can invest it as you wish. Divide your money into three colors: yellow, red and green. Yellow should be readily available without loss, red can be at risk and green must be safe because it’s your core retirement money. How much is needed in each color depends on your circumstances, tolerance for risks and many other things, but you need some money in each color. The best color combination is determined by working with a financial professional who understands all available options. Managing retirement money is difficult; nonetheless, some retirees try but oftentimes with regrettable results.

When your working years have ended your retirement money cannot be replaced because your human capital is gone, you’ll have little, if any, money from earnings and time to recover losses is growing short. If you’ve saved enough and won the “retirement game”, stop playing the “investment game” by taking risks that could make you a “retirement loser”.

Shelby J. Smith, Ph.D.
October 2012

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There is a Solution for Retirement’s Biggest Risk

You have to squint to see the interest rates paid by bankers; stocks up big one day and down big the next; dividends from blue chip stocks are not guaranteed and neither is their favorable tax treatment; safe bonds pay tiny returns; investment real estate is for the brave; gold, silver and other precious metals are a crap shoot; get rich quick schemes are crazy if you want your money back. We judge our retirement money by how big it is (how much) rather than how long it is (years it will last). Rather than focusing on “how big” let’s think about “how long”.

The greatest fear of most retirees is running out of money before they draw a last breath. This is called longevity risk and is probably the most overlooked aspect of retirement. We faithfully save during our working years (401k, IRAs, investment accounts, etc.) yet we have no idea how much money we’ll have on the day of our planned retirement. What’s more, if we did know the exact amount we’d have at retirement, how much lifetime income it would buy would be a mystery. Furthermore, even if we knew the lifetime income there is no guarantee it would last as long as we do. This riddle is faced by someone every 7.5 seconds because that’s how rapidly baby boomers are turning 65 from now through 2030.

If you’re interested in a guaranteed income for life that you cannot outlive regardless of what happens to the stock market, interest rates or real estate prices, the insurance industry has come to your rescue. I would like to encourage you to watch two videos that can be obtained free on-line and both are great strategies to avoid outliving your money. The first is called “PayCheck for Life” and is about eight minutes in length. The video explains how you can get a guaranteed paycheck for life by putting some of your retirement money in a fixed index-linked annuity – no maybes, no guessing and no hoping. There is a companion twelve minute video entitled “Retain Your Gains” that explains in detail how fixed index-linked annuities offer you the advantages of stock market investing without the downside risks. Both videos explain the guaranteed lifetime income option that is available. While fixed index linked annuities and guaranteed lifetime income are not for everyone, every serious retirement-minded person should at least investigate the possibilities. Both of these videos are also currently available at www.TheRetirementPros.com.

Retirees and working adults are increasingly responsible for making and understanding sophisticated financial decisions involving investments, diversification, retirement and money management. Many lack the basic knowledge to assume these responsibilities, placing their financial wellbeing and retirement lifestyle in jeopardy. It is generally a mistake to take your retirement money as a lump-sum and then “invest” it without professional help – the results are oftentimes disastrous and lead to the fulfillment of your greatest fear: running out of money in retirement either because you lost it by taking unsuitable risk or earned little by being too risk adverse. Similarly, it is important to understand the suitability of financial and investment advice given by those who advice you; therefore, make it a goal to raise your financial literacy so that your financial decisions in retirement are suitable for your circumstances. A good starting point is to watch the aforementioned videos and if locking up a guaranteed lifetime income [which may or may not be a high yielding investment as your longevity is uncertain] find and engage the service of a professional that knows annuities. The videos will give you the knowledge needed to determine if annuities are for you.

Shelby J. Smith, Ph.D.
August 2012

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Getting More from Social Security

Many fear that Social Security benefits will be stopped or reduced; however, 55+ million retirees now getting SS will vote out any politician who supports stopping or lowering benefits. Over 70% of current SS recipients started benefits before normal retirement. This has proven to be a huge financial mistake for those that could have afforded to delay benefits. It’s time to stop worrying about SS ending and turn attention to maximizing lifetime SS benefits. Here are some ideas.

If healthy and financially able to forego SS early in retirement, delaying benefits is a very smart retirement decision. The earliest starting age is 62 but if you continue working, benefits will be reduced until normal retirement age is reached (66 if born between 1943 & 1954); however, you can file for SS and suspend without penalty so a dependent spouse can have benefits. Benefits grow for each month you delay SS from age 62 to 70. If your annual benefits would be $12,000 at age 62, delaying until 66 raises them to $16,000 and waiting until age 70 yields $22,000. These amounts are before the annual increase for inflation. Where else can you invest money to earn 7.877% with no risk, backed by a government promise, annually adjusted for inflation and tax-favored when received? That is what you get by postponing SS. Also, the surviving spouse gets, for the remainder of his or her life, the higher of their own benefits or those of the deceased spouse. An average couple can have over $200,000 more in lifetime SS benefits if the primary breadwinner delays until age 70 rather than starting at age 62.

SS benefits are tax advantaged because regardless of your income level, it will never be 100% taxed. After reaching normal retirement age you can draw spousal benefits [regardless of gender] while delaying your own benefits. Delaying SS and using other moneys (401k, IRA, investments & savings) during the early years of retirement is probably the best investment you can make in today’s world. There is no other riskless investment that can match delayed SS growth plus a dependent surviving spouse will get increased benefits for their remaining lifetime. The only way to have more of your retirement income coming from this risk-free, high-growth, tax-advantaged, inflation-adjusted, spouse-friendly source is to delay SS as long as you can up to age 70.

Let’s say the primary breadwinner delays SS until age 70 but the couple believes the higher benefits will still be short of providing the retirement they’ve planned. Why not supplement it with a “lifetime income” guaranteed by an insurance company? Let’s say that you believe $50,000 a year (in today’s dollars) will be needed for retirement but total SS benefits will only be $30,000. The remaining $20,000 (adjusted for inflation) can easily be obtained by working with your financial advisor and using an annuity with a guaranteed lifetime income option or a “ladder” of annuities. The “ladder” staggers the maturity of annuities so that when income from one stops it starts from another. This is a simple procedure that financial advisors use in retirement planning. Money not needed to supplement SS income can be enjoyed for other uses or left to loved ones as a legacy. This approach allows you to forget market fluctuations, interest rates gyrations and outliving your money. Social Security offers you an option for higher lifetime income and I strongly recommend you investigate this opportunity.

 

Shelby J. Smith, Ph.D.
August 2012

 

 

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Bipolar Markets Require a Game Plan

If you’re going to keep retirement money in the current bipolar stock market a game plan is necessary. The price swings fueled by constant rumbling across the financial landscape about geopolitical developments, rumors, institutional agendas, insider trading, manipulations and misleading information stacks the deck against those outside the heart beat of Wall Street. To have a chance at success you must have an entry point, exit plan and the discipline to resist changing either on a whim. If not what you believed to be a good bet could turn into a retirement-wrecking decision unless luck in on your side.

Today’s market thrives on the huge money of institutional investors, Wall Street insiders and market makers that are driven more by emotion and hunches than the technical information followed by the outside players. If you’re in the market because you need the thrill and excitement of dangerous activity, you might be better off sky diving: if something goes wrong at least you won’t have to deal with the consequences.

So why do so many retirees and those in retirement’s red zone keep their money in risky places? Even if professionally managed it is generally infested with fees and over a period of years most money managers underperform the index averages. The same ones who tell you to “hang in there because the market will come back” are the ones who didn’t warn you the market would crash. Contrary to what you read and hear from Wall Street and other financial pundits, when it comes to predicting the future direction of markets remember that no one knows because there are simply too many imponderables. An uncertain future spells risk and there are no exceptions; thus, proceed only if you can shoulder the risk of loss without suffering a retirement breakdown if not all goes according to expectations.

What about buying and holding, i.e., investing for the long-term? Wall Street tells us that you’ll earn 8% to 10% “long term” but study after study has documented that small investors average far less because they lack the discipline to ride the churning waves that are ever present in markets. The fact is that in the past couple of decades the market has not averaged the highly touted 8% to 10%. Is this a new trend or a temporary departure from what can be expected long-term? Again, no one knows if the next market wave is a permanent sea shift or the normal ebb and flow of the financial tides. If you think a permanent shift is impossible, review the long-term trend of Japan’s Nikkei 225 stock index that is currently about one-fourth of where it was in 1990 (38,916 on 12/29/1989 versus 8,725 on 7/13/2012). Or for that matter, the highly followed NASDAQ is currently at 2,908 (7/13/2012 close) versus 5,048 in early 2000 and the DJIA is still well below the last peak of 2007.

So as a retirement-minded saver what should you do? First, don’t bet the farm on the market. If the market has appeal to you, then limit your exposure to what you feel can be lost without destroying the retirement that you’ve planned. Second, lock up an income you cannot outlive and if you have any money left you can then speculate in the market. Chances are you already have part of your guaranteed lifetime income as Social Security or an employer/government pension. You can round out what’s needed by putting some of your retirement money in a fixed annuity offered by an insurance company (make sure you understand what you’re buying and that it meets your needs). Third and most importantly, create a plan for the financial aspects of your retirement because without a road map there is no telling where you may wind up. If you do not have the discipline to develop a plan to follow or the expertise to make needed changes along the way, by all means find and work with a financial advisor that can help you select from among the numerous options those that meet your needs. Your retirement journey could be as long as one-third of your life and it will be the largest purchase you’ll ever make; therefore, you must take it seriously because your lifestyle, and that of your loved ones, depend on the decisions you make about your money.

Shelby J. Smith, Ph.D.
July 18, 2012

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Dealing with the Greatest Risk of Retirement

Making retirement money last as long as they do is the focus of most retirees. This “longevity risk” is faced when moving from “accumulating” to “spending” and many financial plans fall short in addressing it. For a couple now aged 65 there is a fifty percent chance one spouse will be alive at 92 and a twenty-five percent chance one will reach 97; thus, retirement plans must deal with living longer. Strategies to cope could include delaying Social Security to boost lifetime benefits, working longer to lengthen accumulation years and/or securing a guaranteed lifetime income from an annuity. No strategy for longevity risk says you have more than needed for retirement or whatever else!

There are several other retirement hazards that fuel longevity risk. The most common is the unpredictable whims of the market. A market investment strategy may be appropriate during the working years but when you’re “selling” to “spend”, major market meltdowns like 2000-02 or 2007-09 could mean disaster. The highly touted “4% Rule for Retirement Withdrawals” is flawed when markets are volatile or falling because (a) reduced values mean 4% is not enough and (b) your money is depleted faster. Japan’s Nikkei Index has fallen from roughly 40,000 to 9,000 since 1990, proving that “long term” markets are still risky. Don’t be fooled by sophisticated “Monte Carlo simulations” predicting you’ll have enough money because “theory” doesn’t always match reality. A renowned economist once said “markets can fall longer than you can stay solvent”; therefore, longevity risk will always threaten retirement.

Since lifespans are increasing and medical care is improving, health care costs are likely to continue outpacing inflation. This trend is further fueled by two additional facts that will raise demand for medical care: (1) seventy-eight million baby boomer now entering the “medical risk zone” and (2) recently mandated universal health care for all citizens. Average medical care costs for a couple are estimated to total over $200,000 between ages 65 and 80, rise to almost $450,000 by age 90 and reach over $750,000 by age 100.

Inflation and taxes add to longevity risk by eroding retirement money’s purchasing power. Historically it was difficult to hedge against inflation without having risk of loss; however, inflation-adjusted lifetime income is now available from annuities offered by some insurance companies. While Social Security is annually adjusted for inflation it faces other challenges: no inflation adjustments of tax thresholds will erode benefits and questionable financial solvency could impact benefits. Taxes can be better managed by relying on tax-deferral, tax-free Roth IRAs, timing of withdrawals from retirement accounts and other moderate risk strategies financial advisors offer.

Longevity risk management is often underestimated or overlooked in retirement planning even though outliving your retirement money would be a horrible experience. Fortunately, insurance companies assume and manage your longevity risk by offering guaranteed lifetime income as well as long-term care coverage. Such protection works by spreading risk over many policyholders – the same as insurance that safeguards your home, health, life, car, business, etc. The small premium payments deliver valuable peace of mind. If your retirement fear is living longer than your money, talk to your financial advisor or your insurance agent about “longevity insurance”. If you’re neglecting longevity risk in retirement you’re betting against reaching the older ages that medical professionals are working hard to assure.

Shelby J. Smith, Ph.D.
July 2012

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