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Investment Insights

Sequence Risk May Be The Biggest Problem For Retirees
by Mike Jones

Over the next several years professionals in the financial services industry are going to be called upon to solve an extremely difficult problem: providing income to millions of retirees who have placed the majority of their life savings into publicly traded securities.With interest rates still hovering around historical lows and stock market prices setting record after record, it is correct to ask, “Where do we go from here?” and “How in the world do we attempt to sustain a fixed or inflation adjusted standard of income from a portfolio of volatile assets?”

The problem is one of simple math. As stated above, millions of investors are depending on investment returns from volatile assets to deliver income from the time they retire until their death. Using averages for investment returns or simulations that work 85% of the time provides no comfort to such investors. It is the sequence of returns that matters most.

What good is it to a retiree to make 50% on your life savings if you have lost 50% the prior year? That would mean your $1,000,000 fund is worth $650,000 after just two years (assuming a 4% distribution rate). Keep that up and you will be broke before you know it. Avoiding a large negative return in the early years of one’s retirement is CRITICAL to making the money last.

Dr. Wade D. Pfau, CFA®, is a Professor of Retirement Income in the PhD in Financial and Retirement Planning program at The American College of Financial Services. He is also a contributor to the College’s Retirement Income Certified Professional® (RICP®) designation program curriculum.

Dr. Pfau graciously shared information from his forthcoming book, How Much Can I Spend in Retirement, to subscribers of the FA (Financial Advisors) website. In the article “Managing Sequence Risk for Retirees,” Dr. Pfau suggests four techniques retirees may employ to mitigate the threat of running out of money in retirement:

1.Spend Conservatively. This techniques advises investors to keep reducing the amount they distribute from a portfolio the more aggressive they make that portfolio. At least at first. This allows the more aggressive investment strategy time to succeed thus enabling the investor a chance to harvest bigger sums down the road. While this is mathematically feasible, it is highly impractical for most retires.

2.Maintain spending flexibility. This approach only works for those retirees who have other sources of income. It espouses a fluctuation in income that is mirrored to the fluctuation in return.  If you have a meager year in performance you take out a meager distribution.  If you have a robust year, it’s party time. This greatly reduces sequence risk but is an option only to a small percentage of investors.

3.Reduce Volatility (when it matters most). I actually like this one and subscribe to it in many cases. A portfolio of reduced volatility risk is a portfolio of reduced sequence of return risk. This concept can be applied two ways. The first is to greatly reduce the risk factors during the early years of retirement. Since it is the investment returns during the first 5 to 10 years of retirement that reek the most havoc on the eventual outcome, then why not just lower the risk? One can also reduce volatility after a period of economic growth and market expansion, i.e. dynamic asset allocation. Not losing money when others are can certainly benefit a retirement portfolio as money will be available to make investments when they become attractive again. Please don’t try this one on your own. It must be applied with discipline.

4.Buffer Assets. This final technique encourages investors in the securities markets to buffer against down markets by setting aside money that can be a resource when markets turn down. The return on these assets cannot be correlated to the securities market as they would not provide a buffer if that were the case. In other words, diversify. But diversify intelligently. Many investors forget that last admonition.

The road ahead for retirees and their investment professionals is going to be a tricky one. We know that. Fortunately, many brilliant minds are thinking ahead to ways to avoid the worst of those potential problems.

If you are nearing retirement and haven’t done so already, talk with your financial advisor about his or her recommendations on how you should approach tapping into your retirement savings to best avoid sequence risk.

 

Market Brief-October 2017

Each month, our Heritage Investment team publishes a market brief to provide an overview of the major factors influencing the US economy, including a summary of key sectors and the current positives & challenges.

Click Market Brief October 2017 for updates.

Here are some key highlights

POSITIVES:

  • Although, the income and spending trend has been downward over the past 3 years,consumer spending and personal income are still growing and inflation is low, which makes our dollar go further.
  • The PMI Manufacturing report (reflective of activity in private sector economy) continues to report moderate growth. September figure of 53.1 compared to 53.0 in August, shows little change. Hurricane effects can be seen in delivery delays which has slowed the most since Feb 2016.
  • ISM Manufacturing index has strengthened to an index of 60.8 in September, which is a 13-year best, signifying that there has been growth in the manufacturing sector. Hurricanes increased input prices but did not slow down production.
  • European equities (except for Spain, due to the Catalan referendum) have been up in the last week of September, partially due to weakening of the EURO. Gains ranged from 0.2% to 1.9%.

CHALLENGES:

  • September payrolls are likely to slow down. Forecasters predict only a 95,000 rise for September non farm payrolls (compared to 156,000 increase in Aug). The risk is that Harvey and Irma could further impact the results.
  • Jobless claims in Texas rose early in September, while claims in Florida began to rise mid September. We are yet to see the effects on Puerto Rico.
  •  House sales in the south

The 50/20/30 Rule of Budgeting

by Whitney Hufnagel, Heritage Trust

Life is all about making decisions. From the time you wake up each morning to the time you go to sleep each evening, you will have likely made hundreds of decisions. Most daily decisions seem small and routine, and every now and then a major life decision is sprinkled in the mix. Most of us can probably agree that it is easy to see how major life decisions can have a large impact on our financial situation, but how many of us realize the compounding effect these seemingly small daily decisions can have on our ability to reach our financial goals?

Our daily decisions, whether good or bad, help form habits. The habits we create have the ability to carry us successfully towards or destructively away from our goals. Creating a budget is just one tool that can help foster and maintain healthy financial habits. Budgets allow us to make sure we are spending our dollars wisely and in a manner that is appropriate for our unique situations and interests. Often times, people don’t attempt to budget or give up on budgeting because it can be time consuming, confusing, boring, unrealistic, or feel too restrictive; however, used in the right way, a budget can be very powerful and aid in daily decision making.

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The article below discusses a simple 50-20-30 rule to budgeting that may make budgeting easier for a novice and quicker for a pro. Simply put, 50% of your income should go towards living and essentials, 20% should be allocated towards financial goals, and 30% should be allocated towards those things you want but don’t need. As the article mentions you can adjust the percentages in a way that fits your unique situation. However, try not to reduce the 20% allocation toward financial goals. If anything, increase that allocation.

Please remember, this is a rule of thumb and does not ensure financial success. It is simply a tool that can help you determine whether your decisions and habits are financially healthy, help you identify areas of improvement, and help you maintain a level of awareness to make sure you are spending your dollars in an enriching way for your unique lifestyle. If you would like to discuss budgeting or financial planning in more detail, please contact us to see how we can help you.

New to Budgeting? Why You Should Try the 50/20/30 Rule – Forbes.com

If you’re new to budgeting, figuring out how to manage your money each month can feel overwhelming. Not only do you need to organize, but you also have to make difficult decisions about how to spend your cash. Relying on the experiences of others can help only so much, because your income and expenses are unique. Someone may be able to spend $2,000 per month on rent in Arlington, VA, but that kind of spending may not work for you.

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