Month: October 2012

Not surprisingly, saving for retirement is a popular topic of discussion for a financial adviser like myself. But what is surprising, at least to me, is the lack of true commitment most people make to retirement savings.

To that point, a recent survey by the Employee Benefits Research Institute (EBRI) found that 56 percent of American workers admit that they and their spouse haven’t even calculated how much they should have saved by the time they retire.

Not surprisingly, the same survey found that over half of Americans are either “not confident” or “not too confident” they’ll have enough money saved to live comfortably through their retirement years.

Unfortunately, retirement savings is not a “cross that bridge when you come to it” type of problem. If you don’t plan and save for retirement now, you’re not even going to have a bridge to cross in the future.

Saving is the key to your future comfort.

The Center for Retirement Research suggests that people need about 80 percent of their pre-retirement income in retirement to maintain their pre-retirement living standard. The savings rate needed to hit this target depends on several factors including earnings, the age at which you start saving, retirement age, and asset returns.

For example, the average earner who starts saving at 35 and retires at 67 needs to save 18 percent each year, assuming a 4-percent return. The comparable rate for low earners is 12 percent and for high earners the rate ticks in at 22 percent.

Those are big (and daunting) percentages no matter where you fall on the earnings spectrum. It is possible to notch the percentages down a bit if you start saving earlier and work longer, but the reality is still there — You need to save (more than you think) now to ensure you’ll have money to spend later.

If you aren’t coming close to saving at least 15 percent for retirement don’t roll over and give up. Instead, bump up your savings rate a percent or two each year for the next few years. Studies (or a compounding interest calculator) show that in the early and mid-stages of retirement savings accumulation, how much you save is much more important than investment performance.

Many of the factors that go into retirement planning are out of your control. You don’t know the exact age at which you will retire, you don’t know exactly how much money you will need, and you certainly don’t know how long you will live. The one thing you can control is your savings rate. Taking control of it today could lead to a much happier tomorrow.

Parenting skills may be at their most critical level during the early morning hours associated with the kids leaving the house and getting on the school bus.  “Bobby did you finish your breakfast?  Bobby did you put your homework back into your school bag so you can turn it in?  What about your lunch money?  Don’t forget that I will be picking you up at the athletic field after practice.  I just listened to the weather report: high likelihood of rain.  Please wear your rain coat!  What do you mean you don’t want to?  Just because nobody else wears a rain coat does not mean that you can’t. OK, how about taking my umbrella?  And please will you not leave my umbrella at school.  Please, do not sit in the back of the bus, sit up front where the bus driver can keep an eye on you.  (Bobby walking out the door….)  I love you, and please be careful.”

Notice how the parenting skills went from addressing specific risks to addressing the overall risk of “be careful.”  In money management, the major change over the last 50 years has been the acknowledgement of risk as being capable of being managed for.  Prior to the 1970’s the risk was the gamble.  The gamble was that the stock pick and subsequent investment in that same stock would go up in value.  Pretty simple…  Actual use of the principle of portfolio management was rolled out to institutions in the 1970’s.  In its first rendition it was called diversification.  The basic principles of diversification were:  1. Treat your entire list of investments as a unity (your whole portfolio).  The actions of the individual investments were watched to see what the net results were in totality.   2. Adjust the investments in your portfolio so the way that they interacted with the other investments produced maximum reward for the risk taken… that’s what we call optimization.  The previous sentences may seem pretty obvious today, but back then it was a new thought.  Pivotal in this summary of diversified portfolio management is the assumption that we do want to manage for risk.  In much the same way that parents may have to manage for risk during the breakfast pre-school bus hours, the critical question becomes:  Which Risk?

Previously, I have written two other articles addressing the issue of risk:  Robin Hood and the Objectification of Risk and, The Pain Chart.  You may want to read them first before proceeding.  The take-away ideas from the articles are:  Can we really anticipate risk in advance?   And, do modern risk questionnaires make it any easier?  Then I wrote:  What Is Investment Policy?   This article, summed up, spoke to the importance of anticipating a process of assessment, the results of which might not be achieved all that easily; but were worth the work.  The point of “Splitting the Risk” is that the process of attempting to assess future risk, done using a questionnaire, summed up in a written investment policy statement that is yours and yours alone in the most subjective meaning of the word, may be best fulfilled by splitting the risk.  To be clear:  it may be the best use of principles of portfolio management to address different kinds of risk with in the same portfolio.

Labeling and determining all the various kinds of risk is daunting.  Identifying the various risks would produce a very long list … a long list, which in theory might not be of very much value to investment policy.  Remember investment policy primarily has significance in that it applies only to your situation.   And the major determinant of policy seems to be:  How much money do you have relative to your personal goals?  In theory that would mean that you either have enough money or you do not.  The logic here is that if you have sufficient money you can be more conservative.  And if you have insufficient money you might want to be more aggressive.   The affliction in personal investment policy is that you have the right to do just the opposite.  So the question becomes how is one going to deal with this conundrum?  Moving back to identifying risks, let me suggest that relative to modern personal and social problems that the main risk is not having enough money.  Government, private and public corporations just cannot afford to reward employees with a pension.  A pension is defined as a guaranteed monthly income in retirement.  The pension benefit is income based.  Savings plans like a 401k, 403b, traditional IRA or Roth IRA are focused on the contribution side of things…the more you save the more you have.  The problem is, of course is that does not address the issue of whether the saved amount will be sufficient to generate enough income.  The income would in no way be guaranteed, unless private alternatives to pensions were used like annuities.  Annuities do not solve the problem of enough income; they just solve the problem of predictable income.  Thus, my suggestion, that having enough money is the ultimate risk.

Obviously the lack of money is not a portfolio risk!  The lack of money may be the result of portfolio risk.  But it is this very result that we want to guard against.  So within the modern context of lack of money equals lack of income let me suggest three portfolio risks.  Most risk is defined as portfolio volatility.  Volatility is different from absolute loss.  Volatility, negative volatility, implies that this state would be temporary.  Just how temporary is of course the topic of a whole other discussion.  Staying within the definition of risk as volatility let us break this down.  1. “End of World” risk:  50% volatility risk.  2.”Normal Market” risk: 10 to 20% negative volatility.  3. “Beat the Market” risk: risk assumed in attempting to beat a specific index, implying that you assume 100% of the risk of that index, whatever that index might be.

Here is a quick summary of what these risks are all about. “End of World Risk” assumes and implies that all risks be covered in much the same way that “the parenting skills are used in the breakfast arena moving Bobby to the bus”.   The ultimate risk management technique applied to manage volatility in “Bobby’s World” is “Be Careful”! This statement implies the futility of managing for the specific risk, “make sure you bring home the umbrella”, and instead goes for the “End of World” approach…. “Be Careful”.  “End of World” management, as defined in war like terms, may wind up shooting a few good guys.  The goal of “bringing home Bobby alive” takes on a supervening importance. “ Normal Market Risk” is an approach that is willing to assume in advance that it is NOT worth shooting some good guys as a method of protection.  A market correction is defined typically as 10% negative volatility.  Periodically the 10% correction may broaden to 20%.  This degree of risk will be tolerated.  And finally “Beat the Market Risk”  presupposes an indeterminate amount of risk that could theoretically exceed 50%.  In the past an attempt to “beat the market” presumes that more risk must be assumed to make the beating possible.  The classic statement is:  if you want to beat an established index you must take on additional risk.  My approach instead, uses the seasonal differences in the market to execute a “Beat the Market” without taking on additional risk.

Ok, let me finish on this note: why is it important to define risks into these three:  “End of World”, “Normal Market”, and “Beat the Market”?  The answer is that a growing understanding of what your investment policy should be requires a deliberately defined and protected world.  Gaining experience is clearly the answer.  The more you learn the more you know.  Being able to watch the performance and volatility associated with 3 different approaches gives you the room to grow. We at  Minich MacGregor Wealth Management are all about risk management.  The gist of this article is that there are varying types of risk.  It is possible that your success in meeting your goal of having enough money can be furthered by splitting the risk.

“Hotel policy: no pets allowed!” “Our policy is a 2 night minimum.”  “Corporate policy forbids use of social media for business purposes.”  “I am sorry; it is our policy that we do not accept credit cards.”  “I don’t know about you but it is my policy that I like to eat dinner early.”  “You know when we were kids my Mom and Dad’s policy was that we all sat down to eat dinner together… needless to say it was frowned upon to be late for dinner.”  “Stores like Wal-Mart seem to have a liberal return policy, as long as you bring the receipt with you when you are doing the return. “  “United States policy is that we do not negotiate with terrorists.”  The word “policy” crops up everywhere.  Defining “policy” is somewhat challenging since the very words that define policy are subject to definitional and usage problems as well.  My personal favorite definition is: principles or values that guide a course of action.  The operative words are: principles and values.  The easy part of the definition is a “course of action”.  If the stated principle or value is present then “this” is the applicable course of action.  So essentially you will set up in advance a course of action that is justified based on values and principles.  The heart of the matter is:  what are those principles and values?  You have to make a choice.

The choice is yours.  You can have a policy about anything.  And in an extreme sense your policy need only be justified by your personal opinion.  You can infuriate the gods if you so choose.  You can infuriate your customers if you so choose.  In fact you could have a policy that would be so totally unreasonable that your policy would be treated as ridiculous.  But, it would still be your policy!

If policy is a choice, and it is all about your choice, how do you establish what your policy is?  I think there are 2 ways.  First you can adopt the judgment of someone else.  Good example:  accepting what your parents tell you.  “Well daughter, it is my experience if you want to get ahead in life you need to put your nose to the grindstone.”  What is the principle?  Hard work pays off.  Second you can develop your own opinion based on your life’s experience.  “You know I have spent the last ten years trying to get ahead, but it was only when I put in long hours, and many years, at one project, that it began to pay off.”  What is the value?….hard work and consistency.  On the other hand, your experience and your values could be stated:  “I never got ahead until I robbed a lot of gas stations at night.”  Clearly, the wrong principle and a bad value?  Yes of course, but your policy nevertheless.  Coming to the conclusion that your policy is wrong may, in the gas station example, be the right conclusion.  But it also points out that we humans have an intuitive sense that there may be a right and wrong way to do things.  Obviously this is true.  But, it has a tendency to hold us back from making our own policy based on the fact that we may be wrong!  Stated another way: What do I know?”  “How can I be sure that I am right?” In many ways you have the right to be wrong.  It is the essence of policy that in fact you may be wrong.

Ok, so how does this relate to investment policy?  Policy is personal. Personal policy can be right or wrong.  Part of the success of personal policy is the struggle to determine what is right for you.  It is in the struggle to define what works for you that determines your comprehension of the problem.  Investment policy is essentially the struggle to define what level of risk is acceptable to you as a private investor.  The financial services industry has taken just the opposite approach to the struggle.  Questionnaires are the most popular approach to determining risk tolerance.  (Please see the Pain Chart article that I wrote.)  Unfortunately questionnaires engage in framing the question in such a way that it predisposes the answer.  And, most importantly, removes the struggle.  No struggle, no insight, no commitment to the result.

What I have seen over time, is a mortal conflict between “What I want” and “what risk can I take.” Mortal in that, high performance, and in many cases, extraordinarily high performance, is required to bridge the gap between “what I need” and “what risk I can take.”   “Based on the total of my investments for retirement, comparing it the total amount I actually need for retirement, I only need a 30% annualized rate of return!”  The assumption is that a 30% rate of return is possible but entails a great deal of risk.  Investment policy is essentially three thoughts:  1. what results do I need? 2. How much risk do I want to assume?  3. What investment strategy bridges the gap between 1 and 2?  So to be clear, investment policy is a personal choice as to what investment results are needed to reach a personal goal – typically retirement, getting in touch with how much volatility can be withstood in achieving that goal, and then matching up to an investment strategy that strengthens your belief that if you stay the course all will be well!

Now, at this point, I must beg your forgiveness.  Explaining what investment policy is, is much easier than actually defining what YOUR investment policy is.  As a way of sharpening your focus on this problem, allow me to share with you a quote from a mutual fund company’s annual report:

“We will remain concentrated and hold a portfolio of 20 to 25 high-quality securities.  However, many believe because small caps are more volatile it is better to be more diversified with hundreds of holdings.  We do not equate risk to volatility.  We view risk as the permanent loss of capital. (My emphasis)  We are diversified across industries and feel that we mitigate risk by understanding a select number of high-quality businesses that have the balance sheets and cash generating ability to survive virtually any type of market environment. “(Page 29 FAM Funds semi-annual report June 30, 2012)

This is a particularly good comment in that it uses words that are at the heart of the conflict of what risk is all about.   1.  Is 20 to 25 securities enough – if they are “high quality”?  2. If diversification is the answer to the problem of risk, how many securities need to be held in any one portfolio?  3. Is volatility defined as absolute loss (E.g., Enron) or merely the drop in the value of a portfolio?  In today’s portfolio management environment this could be the ultimate issue.  My suggested answer to these questions is why it is important to submit to the struggle of developing a personal investment policy.  My answer is that there is not a “one size fits all answer” to these questions.  For example, classic statements about how you “ought” to invest for retirement are:  When you are young you can take more risk because you have more time to recover from market downturns, when you are older and close to retirement you should take less risk because you have less time to recover from market downturns.  Do these statements necessarily apply to you?  Even if they do, is this what you want to do? Yikes!

At Minich MacGregor Wealth Management we believe that investment policy – personal investment policy – is a process.  Your policy should be reviewed frequently.  Your beliefs are shaped by your experience.  Your policy should be flexible enough so that it can adapt to your changing views.  We like to think of ourselves as providing and environment for growth and change.  The investment strategy that you pick to represent you in the ebbs and flows of the capital markets will change over time.  We have multiple strategies available to meet most investment policies.

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(Investment Policy Defined:  An investment policy statement is a document that describes a plan’s investment strategy as well as the specific needs of the plan.  A properly drafted IPS should outline the prudence and diversification standards that plan fiduciaries must follow, and should include such elements as investment philosophy, risk tolerance, time horizon, preferred asset classes, rate of return expectations, and long term goals for the plan.  In other words, the statement serves as a blueprint that is used to determine how investment decisions are made.)

This year is shaping up to be a strong year for the U.S. stock markets.

Last week, the S&P 500 was up more than 16 percent for the year, a strong gain by any measure. However, when I talk with individual investors, their overall perception is that the markets have not gone up.

This is further reinforced by recent research by Franklin Templeton, a mutual fund company. In its study, when 1,000 investors were asked whether they thought the S&P was up or down during each of the past three years, 66 percent thought it was down in 2009, 48 percent thought it was down in 2010 and 53 percent thought it was down last year. But the truth is the S&P gained 26.5 percent in 2009, 15.1 percent in 2010, and 2.1 percent last year.

Why such pessimism? I believe that investors are bombarded with so much negative financial news (thank you, cable television) that it overshadows the actual data that has been quite good. Plus, you’ve got the lingering effects of the 2008 financial crisis. Yes, 2008. Even though that crisis unfolded more than four years ago, many investors remain shaken, bitter and wary. And it’s no wonder.

Turn on any financial program and you’ll be met with dire predictions and overblown coverage of every little downturn. And it’s not just by chance. Television producers know that bad news is always a better draw than good news. Faced with 24 hours of air-time to fill, fear-mongering and fiction fill the bill quite nicely.

For example, in the past few weeks I’ve heard at least a dozen permutations of what is going to happen to the economy if the Democrats get re-elected. No, wait, did I say Democrats? I meant Republicans. That’s what’s really going to be bad. No, wait, that’s what happens if the Democrats win. But wait … you get the point.

While it’s tempting, I’m not going to suggest you throw away your television. What you should do is pay more attention to what’s actually happening in the market rather than what television programs tell you is happening. Pick up a newspaper or log on and take a look at the numbers and trends. If the market takes a real turn, consider making some changes. But otherwise, ignore the hyperbole, avoid the drama, stay calm and invest on.