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Two Keys to 401(k) and Retirement Investment Planning Success

Want to know a secret? The two keys to 401k investment and retirement success* are:

  1. Save and invest aggressively when young
  2. Manage risk well in allocations as you approach and enter retirement

I know those are oversimplified but they are accurate. Knowing this, when was the last time you evaluated how much you’re saving or made changes to the investment mix in your 401k; or for that matter, any of your investment accounts? If you’re like most Americans, it’s been a while.

According to an ICI.org analysis of over 30 million defined contribution plans in 2018, only 7.1 percent of 401(k ) participants made changes to the allocation of their existing 401k balances and only 4 percent made changes to new contribution allocations. Compare this to finding from this same research taken ten years earlier (2008) where 14.4 percent made changes to the allocation of their existing balances and  12.4 percent made changes to new contribution allowances and it’s apparent people do not stay on top of their retirement savings investments. Some of this complacency is due in large part to a long-running bull market where complacency towards risk management has taken control. You may be saving well, but if you’re not managing risk it will come back to bite you.

Recent research from Research Affiliates reiterates that there are two keys to success in the investment world: investor contributions and investment returns. “Well, duh! Of course!” you may say. But what seems simple is rarely easy. Contributions and returns today can have a large influence on how well your retirement plan serves you into retirement. But, as this research also shows, each of these has distinct effects over your time of saving.

Let’s take a look at both of these and I’ll make some suggestions for you to implement immediately if you want to grow and protect your retirement savings.

 “When” trumps “How Much”

When you save can be more important to success than how much you save. The obvious challenge with trying to save when you’re younger is that there are competing demands on a smaller income.

You’ve probably seen the multitude of tables that illustrate the dramatic impact saving early can have on your future. Not too long ago I was able to illustrate this to a young man who came seeking advice. We looked at the tremendous impact of just a single annual Roth IRA contribution beginning in his twenties and lasting for just twenty years (ignoring taxes and inflation).

We assumed a 25-year-old making an annual contribution of $5,500 into an account earning 6% annually. Over twenty years this creates a balance of ~$207,038 at age 45. With no further contributions, at his age 65, the balance would be ~$663,998. Only $110,000 of this value represents contributions.

Now, take the same case above but reduce the annual savings rate to $3000 for the first 20 years. At 45 he has ~$112,929 and at 65 ~$362,178. He actually contributed $60,000.

The takeaway with our example is that starting early makes a huge difference and the more the better. Even if you can’t save the maximum amount, just start saving now! Unfortunately, many savers wait until their 40’s to begin saving, putting themselves at the detriment of time instead of using time early to multiply their money.

While the rate of return is certainly important, it’s more important that you ‘just do it!’ when you’re younger. For example, in the initial scenario above, if the rate of return were 8% instead of 6% over the first twenty years the increase in the balance is about ~$55,000. That’s certainly better, but not nearly as important as the fact he started early. Considering 55 percent of Americans have less than $10,000 in retirement savings (Cameron Huddleston – GOBankingRates) I’d say he’s off to a great start.

Rate of Return Matters More – Later

In the latter stages of saving (like in our 45-65 example above), the rate of return on your money, rather than adding more to it, is the principal driver of the ending value when it’s time to start living off of your life savings. I’m not suggesting that contributions are unimportant; but the facts are that your rate of return is more important. A $25,000 contribution in one year into a balance of $750,000 is only 3% of the total. An 8% ROR producing $60,000 on that same balance is much more significant. Higher rates of return on larger pools of money in later years makes a bigger difference than additions (combined they’re even better obviously). The problem here is that just when this ROR need is most prevalent is when you must begin to think about reducing risk ergo rate of return to some degree.

Allocation Matters Most

So how do you balance return needs knowing there’s a risk trade-off? A primary way is to be in the right part of the market at the right time. We refer to this as ‘asset allocation’. However, because no one can time the market, most investors embrace a buy and hold approach that allocates assets across many asset classes in the thought that the winners will outweigh losers over time. Just ride it out and let time be your friend.

Our approach by comparison is to actively monitor the different asset classes and market sectors and do our best to regularly navigate between them, even being willing to move out of them altogether to seek to avoid periods of extreme volatility (risk of loss).

Another way to increase return is to use lower-cost instruments. Your 401k account and many advisors most likely offer mutual funds. Many mutual funds have internal fees and sales charges that are typically more expensive than comparable exchange-traded funds (ETF’s).

With respect to the younger readers – start now.

With respect to older readers – proper positioning matters considerably more to risk and return than any time in your life.

If you want clear direction for your retirement and you’d like a no obligation analysis of your holdings, please call to arrange a time to do so. You may be shocked at what you really own!

* Asset Allocation does not guarantee a profit or protect against a loss in a declining market. It is a method used to help manage investment risk.

 

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Rethinking Retirement Income

A frequently asked question in our office is related to the subject of Social Security income and whether it will continue in its current form, be changed or be there at all in the future. Since Social Security checks are many people’s primary source of retirement income, what people are really asking is how their primary source of retirement income may be affected and their ability to circumvent a problem should it arise.

In short, no one truly knows what changes will ultimately happen with Social Security. Those decisions are left to our politicians and we see how well decision-making and compromise works in that world don’t we?

Everyone reading this is either retired or aspiring to be at some point in the future, so let’s unpack this a little and see if we can provide some help in how to think about your retirement income needs. Please understand as you read, I am not associated with or endorsed by the Social Security Administration or any other government agency.

The OASDI (Old-Age, Survivors, and Disability Insurance) Trust Fund (also known as the Social Security trust fund) has been in trouble for quite some time in terms of long-range solvency. The Social Security Administration’s website is not shy about touting this fact.

The last seven Trustee Reports have indicated that without some type of change by lawmakers, Trust Fund reserves will be depleted between 2033 and 2034, under the economic and demographic assumptions they use. In summary, in under 15 years…maybe sooner…scheduled Social Security tax revenues will only be sufficient to pay about three-fourths of the scheduled benefits after depletion of the Trust.

In my opinion, Washington got us into this mess through a whole host of things it has either caused, allowed or refused to address. Now they want to lay the problem at the feet of those who’ve already paid into it the system or are currently paying in…those who have earned it and depend on it the most, right when they need it the most. Not fair, not right, but it’s where we are.

In fairness, lawmakers have been proposing ideas through legislation for many years. Nine proposed pieces of legislation were filed in 2017, seven in 2018 and 2019 has seen filings as well. The problem is that few legislators have the political will to follow through with substantial changes because of the fallout they fear may ensue at the ballot box.

The purpose of this article, however, is not to discuss politics and how Social Security may change. Anybody’s guess is good. What we do know is what will happen if nothing changes and that’s not good either. I happen to believe that certain segments of the population (such as current recipients) will be “grandfathered” from future changes, but we will see.

Social Security was originally never intended to be the sole, primary source of retirement income. Instead, it was meant to be a backstop or helping hand for retirees. As we already pointed out, for most people, it is their only retirement income.

Let’s look at the implications for two groups: Those who have not yet retired and those who have.

Aspiring Retirees

As you are approaching retirement, it is good to know not only how your current financial situation looks in relation to your retirement goals but also what options you may or may not have, should life throw you a curveball. When we design financial planning strategies for our clients, we look at many different areas, with income being just one important piece.

For instance, while we plan around Social Security in its current form, we can also forecast a “what-if” analysis showing how your income would be affected. What would you do if this or that happened? Would you have to reduce expenses? Sell your home? Would you have enough retirement assets to make the retirement you envisioned work?

Speaking of work, would you have to work longer or indefinitely to some degree because of a change with your Social Security estimates? It’s always better to be prepared and informed in decision-making.

Already Retired

For our readers who are already retired and likely receiving or soon to be receiving Social Security benefits, many of the principals that I’ve just mentioned for aspiring retirees apply to you as well. As mentioned, I believe if changes are made to the OASDI system those already receiving benefits are less likely to be affected. However, that’s not guaranteed! Therefore, prudence would say be ready, know your options and have a handle on what changes you could make if your benefits were suddenly cut. How would it affect you and your retirement?

Social Security is simply one aspect, but a very important aspect, of an overall income strategy for retirement. There are five critical pieces to any strategic retirement plan. Do you know what they are and more importantly, do you have a written plan? Most people don’t.

Every day we help readers just like you find clear direction for their retirement. We’d love to help answer the questions you have about navigating your unique situation. Give us a call or come see us, I look forward to meeting you.

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We Salute Our Military Veterans!

Today is Veterans Day and we want to express our gratitude to all the brave men and women who have served in the U. S. military. Thank you for your years of service.

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Automated Financial Advice – Robo or No Robo?

Clients hear a lot about different types of financial risks they are exposed to when they plan for retirement; however, when you boil it all down they really care about only one risk and that is the risk of loss.

Investors have lost 40% of their portfolio value since 2000… twice! One loss alone requires a recovery of 67% to get back to even and again this has happened twice within 20 years. So what does this have to do with Robo advisors? Perhaps some history and description is in order to begin.

The Rise of Robo Advisors

Robo advisors appeared primarily after the 2008 financial crisis but the term was coined back in 2002 following the Enron collapse and the world of intense 401k anxiety generated by this this major corporate debacle. Robo advisors are essentially technology that allow investors to access automated investment advice. The supposed benefit to investors is that if offers an affordable and convenient investment advice solution.

There are robo advisors that serve two different customer types: business to consumer (B2C) and, business to advisory business (B2B). B2C robos are directed toward the end user investor while B2B focus more on helping advisors help end-users.

B2C advisors are meant to primarily serve the “underserved” investment community, meaning the young and the end user investor, while B2B focus more on helping advisors help end users.

The B2C investment advice is produced algorithmically and there is typically little-to-no interaction with a human advisor unless additional fees are added and typically they offer no guarantee you’ll be dealing with the same person each time you use the advisor. You simply get whoever is available at the time. While the B2C segment saw initial growth, it has actually declined over the past several years. This segment continues to attract venture capital into a business model that has yet to prove profitable and doesn’t appear to be close to doing so.

This brings us back to the risk concern mentioned above. Although I believe there is a place for the robos in our industry, I do not believe, as many do, that they will replace the human touch in our industry.

One of the larger concerns about these automated advisors is they have not experienced a financial crisis or time of economic distress. The algorithms robo advisors use aren’t battle tested and there is no personal relationship to guide you through decision-making during the most critical of times.

Because there is no personal relationship, robo advisors also offer no customization of your retirement plan. Their retirement advice will not be unique to your situation not will it come from someone familiar to you and in whom you trust. You are simply part of a computer program algorithm. If you’ve never experienced the difference you simply don’t know what you don’t know and what you don’t know can and will hurt you.

The fact that the robo advisor business model has yet to be profitable raises questions as well. It’s great that they can offer a “lower cost” product in certain respects but at what expense to the investor? If your fees can’t cover your costs and you are essentially subsisting on continued venture capital, long-term you may have a failing business plan. It is estimated that it takes one of these firms gathering $16 billion in managed assets to break-even. After 10+ years there is only one that is even half-way to this amount. Time will tell how they adjust. Adjustments typically mean cost adjustment of some type to the consumer or being bought up by a competitor.

There is also the question as to how B2C robos assess risk. Some of them and their assessments given to participants are found lacking, to say the least. A professional human advisor with a good risk assessment approach who can talk with you the investor about your risk tolerance and options will do a better job of meeting your expectations over automation.

It remains to be seen as to how B2C robos serving the individual investor masses will play out over time but I do believe they can offer valuable services, especially in the context of the B2B segment. They can and do offer ways for existing advisory firms to offer services that ordinarily would not be feasible given costs and liability.

Our 401k service, which helps our clients manage their 401k while still employed, is an example of B2B advisor that helps us provide an extremely valuable service to our clients while maintaining the same risk and investment philosophies and tools that we use for our in-house non-401k assets.

Give us a call and let us show you how we can help serve you in the personalized way you deserve.

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Investing Disaster

Avoiding Investment Disasters: It’s No Accident – Part 2

This is the second of two posts on how avoiding investment disasters is no accident. It takes careful and thoughtful planning.  

In our previous post (here) we discussed how a static risk management approach supplies too little protection in bear markets and too much in the bull markets.

In fact, a good analogy is to think of a static portfolio like an individual who dresses for all types of possible weather conditions but is actually ill-prepared for any specific condition… like someone wearing a ski parka and beanie cap while walking around in Bermuda shorts and flip-flops!

We believe a better way of managing risk is to use the disciplined and structured dynamic risk management approach. Simply put, dynamic risk management applies quantitative, fact-based assessments of three market time frames to determine overall market health and seeks to identify the conditions at which more or less risk management should be applied to a portfolio.

Imagine that…actively managing risk! The time frames are represented as Short-term (weeks-to- months), Intermediate-term (quarter-by-quarter) and Long-term(months-to-years). The sum of the time frames determines a market condition reading, ranking the broad market as either positive, neutral or negative.

The S&P 500 is an unmanaged market capitalization-weighted index of 500 common stocks chosen for market size, liquidity, and industry group representation to represent U.S. equity performance. One cannot invest directly in an index. CAGR – Compound Annual Growth Rate.
**Maximum Drawdown is the maximum loss for a peak to a trough of a portfolio before a new peak is attained. Past performance is no guarantee of future results.

As seen in the above graphic, knowing what type of market you’re in is helpful in knowing how to manage risk in your portfolio. Look at how many days were either neutral or positive versus negative. Yet, look at the dramatic difference in return and total draw-down (volatility from top to bottom) in those time-frames.

Market conditions and knowing the strategies that tend to work better or worse with those conditions is helpful in managing risk long-term, especially downside risk. This doesn’t ignore the importance of diversification** and seeking to be in the areas of the market that show the best potential for return, bonds included. It simply enhances it.

John Templeton’s maxim that “bull markets are born on pessimism, grown on skepticism, mature on optimism, and die on euphoria” is, I believe, playing out before us. How do you want to be prepared for the inevitable?

Remember, avoiding disaster is no accident. Let us show what we believe is a better way. Our firm’s constant goal is to grow our client’s capital while seeking to avoid disaster in the markets. We stand ready to help in any way we can.

Disclaimer:

The opinions voiced in this material are for general information only and are not intended to provide or be construed as providing specific investment advice or recommendations for any individual. To determine which investments may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guaranteed of future results. All indices are unmanaged and cannot be invested in directly.

This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.

* Diversification does not guarantee a profit or protect against a loss in a declining market. It is a method used to help manage investment risk.

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