Who's In Your Corner?

The U.S. Department of Labor recently issued a new Rule for advisors dealing with retirement accounts.

Some background is in order here. Advisors are held to a legal standard of conduct when dealing with investors. But different advisors are held to different standards. Registered Investment Advisors (RIAs) which we are, are held to a “fiduciary” standard of conduct. This means the advice we give has to be in the best interest of the client. Period. This sounds pretty obvious, right? Why would an advisor who is being paid by a client not give advice that is completely in the best interest of the client?

Well, there is another standard that other advisors are held to, a ‘suitability’ standard. Let me explain the difference. Let’s say that there are two investment products that are both appropriate for a client. They each have the same expected return, the same level of risk, the same diversification, etc. But, one investment charges a higher fee/commission than the other. A ‘fiduciary’ can only recommend the product with the lower fee. This makes sense. An advisor held to the ‘suitability’ standard can recommend the higher fee product. Yes, the fee is higher which favors the advisor, but the product is still ‘suitable’.

The question you might ask is why are all advisors not held to the highest standard? Well, where you stand depends on where you sit. Many advisors who are held to the suitability standard are fighting like mad to protect their turf. The Department of Labor feels this push back and is therefore only requiring that the highest standard be met in retirement accounts. If you are advising on non-retirement accounts and were previously held to the suitability standard then you are still held to that suitability standard.

The new Rule will be implemented in 2018 so expect a lot more legal jostling and political pressure between now and then. The chart below shows the importance of retirement accounts to Americans. It is vital that investors get good advise that is in their interest, and their interest alone.

Stop Freaking Out About Retirement...

This does not come from some rose colored glasses, “The future is copacetic” kind of article. It comes from ConsumerReports, a pretty sober and practical publication. We have all read the stories that Americans are not saving enough and it’s probably true. It is estimated that 14% of Americans over 65 have no retirement savings at all and 33% of those between 30 and 49 also have nothing salted away. We need to do better.

But at the same time, says ConsumerReports in their October 2014 issue, Americans who are already in retirement say things are not bad. Seventy-one percent told ConsumerReports that they are highly satisfied with their retirement. In addition, the Social Security Administration’s model shows that current and future retirees as a whole have relatively small savings shortfalls. 

This doesn’t mean we can go blithely forward with no concerns. As Andy Grove, the former chairman of Intel likes to say, “Only the Paranoid Survive.” Retirement will work but only if we do the heavy lifting. Here are some suggestions from ConsumerReports.

1. “Take care of what is difficult while it is still easy.” Start saving as early as possible. The chart at the bottom shows the result. Saving early and letting compound interest do its thing is the miracle of finance.

2.  Do the math. Know your individual situation and be prepared to replace 80% to 90% of your pre-retirement pay. And remember, spending in the early years of retirement will often be more expensive as you get to your travel/hobby wish list.

3.  Work as long as you can. The best retirement plan is keeping some or all of your day job in order to hold off spending retirement assets. I realize this is not always possible for everyone (see chart below).

4.  Don’t take Social Security too early. Your Social Security benefit increases 8% per year between 62 and 70. The longer you wait the more you get.

5.  Be educated. The best book we know of on investing is Burton Malkiel, “A Random Walk Down Wall Street” (paperback, WW Norton). ConsumerReports also recommends “The Little Book of Common Sense Investing” by John Bogle (John Wiley). Get them. Read them.

6.  Don’t avoid risk. In retirement the real risk is living to 105. You need to have a decent amount (at least 50% we think) in things like stocks which will keep up with inflation in retirement.

7.  Enjoy life.

You Can Retire Very Comfortably If

The ending of the title sentence here is . . . if you start saving when you’re young. Yes, the big secret to being able to retire comfortably is no secret at all, but the remarkably simple directive to start saving early. Get on a program of regularly socking away a percentage of your paycheck in your twenties, be half-way prudent with your investing, and your chances of retiring comfortably are quite excellent..

I understand that you may wish to stop reading here. We all know this. We’ve heard it before. We’ve seen the charts that show how much more powerful our savings are when we start early (see chart below). And yet, it’s clearly not something that we all do.

As has been pointed out by many, telling people to save as much as they can is kind of like telling someone who wants to lose weight that all you have to do is eat less and exercise more. We know it, and yet we’re not all thin. As remarkably simple as it is, it’s remarkably hard to execute. On any given evening, it’s far easier to eat pizza and watch TV than it is to go running. And on any given day when you’re 25, it’s far easier to get cable, fancy lattes, or a slightly too nice apartment than it is to think about what it will be like to be a poor retiree in four or five decades.

Investment thinker Charles Ellis recently wrote that we humans are not very good at thinking clearly about money or long periods of time. We find it hard to talk about money, even with people we are close to, and investing is a puzzle for many of us. On top of that, we find it very difficult to think more than a few years out. A retirement in four decades is unimaginable. Combining our difficulties with money and time, it really isn’t surprising that we do not plan for retirement. Just like those who eventually regret having spent their teen years smoking or tanning themselves too much, Ellis says that too many retirees will end up wondering, “Why, oh why, didn’t somebody tell me?”

What to do? Probably nothing you haven’t heard before. Ellis points out that there are five factors that determine how well you live in retirement: 1) how long you work; 2) how much you save; 3) how well you invest; 4) how much you spend each year; and 5) how long you are retired. Since most of us don’t choose when we die, the first two factors are especially important. We should all work later into life. If our employers offer a 401k match, we absolutely must match at least that match. We should think about downsizing our homes, cutting spending, and – much like losing weight -- stick with the regimen day in and day out.

The one thing to note is that if you happen to be young as you read this, you actually have a fighting chance at a comfortable retirement without being lucky or resorting to anything fancy at all. Investor William Bernstein just released a small e-booklet called If You Can: How Millennials Can Get Rich Slowly with just this message. It takes less than an hour to read, is geared to the 20-something reader, and is available for free (or $0.99 on Amazon).

Bernstein’s advice is that young people only need to do a few things to turn out just fine: 1) Save 15% of their paycheck starting at age 25; 2) Invest in a simple set of three low-cost index funds covering U.S. stocks, non-U.S. stocks, and bonds; and 3) Rebalance once a year. He doesn’t say it will be easy. He knows that it is not easy to put away 15% of your pay when consumer temptation beckons. He knows it is not easy to stick with a long-term, low-turnover indexing plan when the natural tendency is to chase performance and buy and sell at exactly the wrong times. He just says that it can be simple.

We can quibble with some of the details in Bernstein’s advice. And if you’re an investment adviser like me, you might be offended by his warning to youngsters to steer clear of investment advisers as if they were hardened criminals (those are actually his words, though, of course, he’s an investment adviser too).  But Bernstein’s advice to start early and keep it simple is good – and so is his reminder that preparing for retirement takes discipline and acting with “purpose and vigor.”

Retirement Planning By The Numbers

For many people, the retirement world is a foreign place full of unfamiliar concepts and terminology. To help navigate the often complex range of retirement related decisions, financial planners have come up with a number of statistics. A review of some of these guidelines along with a few other related metrics follows.

80%   How Much Pre-Retirement Income You Need in Retirement.

The thinking is, even though you have more opportunity to spend in retirement, many of the expenses you incurred before you stopped working are gone. Recent research by Morningstar indicates that while retirees do indeed tend to spend less, how much less varies by income level. Those who earn more, ironically, spend a smaller percent of their pre-retirement income as many of life’s big costs (college education, retirement funding etc..) disappear. Not surprisingly, we see a great deal of variability around retirement spending habits in our own practice. For most, spending follows a U curve with higher expenses early on in retirement for things like travel, a drop later as people age and then a pick-up again at the end of life for healthcare spending (see below.)

4% The withdrawal rate that can be sustained over an average retirement.

The 4% withdrawal rate is probably one of the most widely used and least understood “shortcuts” used in retirement planning. The concept is that investors who limit their initial withdrawals to 4% of their portfolio’s market value (and then adjust that for inflation) have a 90% chance of maintaining their portfolio over a 30 year retirement. While this metric provides a decent “ballpark” estimate, investors should be careful not to rely on it too heavily for several reasons. First, the supporting research assumes that portfolios are invested according to a 60% stock and 40% bond mandate. Many investors will not adhere to this strategy throughout retirement. Second, recent studies have pointed out that the order of returns not just the average level has a big impact on portfolio longevity.  Individuals who begin retirement during a market downturn, for example, experience much worse outcomes than those who retire during a strong market.  A better approach? If you have the bad luck of experiencing poor market returns early on in retirement, consider reining in your spending until market valuations improve and then re-evaluate your withdrawals every few years.

76%  The increase in monthly benefit you can expect by delaying claiming Social Security from 62-70.

The benefits of delaying taking Social Security are well worth repeating. When Social Security began back in 1935, the average American worked until age 65 and had an average life expectancy of 66.5 years.  Today, the average retirement lasts well over 25 years. If you cannot afford to delay claiming or have reason to believe you may not live past 80 than this approach may not make sense but for many it is one of the best ways to ensure that you don’t outlive your funds.

60% The percent of total lifetime healthcare expenditures incurred during the last 6 months of life. 

Healthcare costs can be a big unknown for retirees.  Practicing healthy habits like getting plenty of exercise and eating well can go a long way to reducing the risk of heavy healthcare spending.  But consider that the average person spends $39,000 on healthcare out of pocket in the last five years of life and the top 10% can spend more than $89,000.  What to do?  Take a careful assessment of your family health history to see if long term care insurance makes sense (see last month’s newsletter). Remember, while Medicare and most private health insurance covers costs such as doctors visits and hospital stays, they do not cover most custodial related long-term care costs.

85 The average life expectancy in America today.

Just imagine how much easier retirement planning would be if we knew exactly how long we will live. While this information is unavailable to us mortals, you can take a stab at estimating your life expectancy at www.livingto100.com.