Since we last wrote, the only real “new “news in the markets has been that the Federal Reserve finally announced their long-anticipated tapering of asset purchases. Many predicated that this event would lead to more volatility in both the stock and bond markets and cause at the least a correction of 10% in the stock market. Once again, the markets showed their resiliency, yawning on the day of the announcement. At least for now, the Fed’s strategy of talking about this eventual tapering (…for months upon months) before actually doing it prepared the markets for it.
Now that tapering has begun, the attention now focuses to when will be the first interest rate hike? Market pundits are out making all of these crazy predictions as to when it will be and how many rate hikes will happen in years like 2022, 2023, etc. Again, smart investors know not to put too much faith in these predictions. Otherwise, corporate earnings have continued to provide positive support to the markets.
Of course, there are always things to cause us concern about the markets. To just name a few, the Wall Street Journal recently reported that 4% of investors quit their jobs to trade cryptocurrencies full time. In another WSJ story, they quote a 57 year-old investor looking to retire soon saying that he started trading penny stocks to get rich faster because buying blue chips would require much bigger dollars to invest and they grow too slow. There’s been a significant increase in single stock call buying on popular tech names because it takes much fewer dollars to control 100 shares of Microsoft in options compared to buying the stock outright. These are just 3 simple examples of greed and speculation- I can go on and on. As well-respected strategist Rich Bernstein says, “Bubbles pervade Society”. Our view continues to be similar to Bernstein’s- that there are bubbles within the markets, but that doesn’t mean every investment/sector/stock/etc. is overvalued.
How Much Can You Spend in Retirement?
As we’ve written about previously, determining the appropriate portfolio withdrawal rate for spending in retirement is one of the most highly debated questions in financial planning today. For years, the standard thought process was that a 4% withdrawal rate with annual inflation adjustments had a high degree of sustainability. But today, given where interest rates and bond yields are and the fact that equities are relatively high (by historical standards), is 4% still viable?
In her research on this subject using a balanced portfolio of 50% stocks/50% bonds, Christine Benz from Morningstar contends that this 4% standard may, in fact, need to be lowered (… to 3.3%.) However, she is quick to point out that this does not necessarily mean that it should be recommended, as she still believes that the estimates used to come up with the 4% rate are conservative.
Yet, nonetheless, there are a number of other variables that need to be considered by each individual when calculating what is an optimal rate for themselves. For example, when is the first withdrawal taken and in what amount? Will the portfolio withdrawals be adjusted for inflation? Is the retiree willing to accept less certainty (by taking on more risk and higher withdrawals) about not outliving his/her assets?
The bottom line is that given current conditions, retirees will likely have to reconsider at least some aspects of how they define their “safe” withdrawal rate. Morningstar’s research finds that if a retiree is willing to adjust some of these variables (a lower success rate, forgoing complete inflation adjustments as examples), they may be able to enjoy a higher starting withdrawal rate and higher lifetime withdrawals.
One of the more impactful factors is whether the withdrawals are fixed or variable; that is, does one take the same amount each year or are they willing to forego some in one year, taking more in another. We often recommend to clients to follow the strategy of taking variable withdrawals based on the performance of their portfolio; that is, in positive return years, the retiree may take more, while in down markets, he/she may take the same amount or perhaps less. Morningstar supports this: “Our research finds that some flexible withdrawal systems would support a nearly 5% starting withdrawal rate”.
Morningstar points to 3 key items that warrant a re-evaluation of the safe withdrawal rate:
1-Today’s starting bond yields
2-High stock valuations
To us, bond yields and the retiree’s bond allocation (both in the total percentage of a portfolio in bonds and the exact makeup of that bond portfolio) present the greatest challenge to a future safe withdrawal rate. Remember, Morningstar’s research is based on 50% of the portfolio in bonds. And a safe 10-year treasury bond doesn’t even pay 2%. So how do you get 4%, if 50% of your portfolio is in bonds? High quality, low risk bonds do not pay anywhere close to 4%. From our perspective, this is what has to change; a retiree probably can’t have 50% in bonds anymore to withdraw 4% plus in retirement.
However, most retirees can’t stomach the volatility of a stock heavy portfolio. And this is where the rubber meets the road: How do you invest less in bonds, more in stocks and/or other asset classes that can grow more than 4% AND keep risk and volatility from becoming too high? We’ve written many times about some of the ways investors should invest to address this question.
In summary, there are steps that people can take outside of their portfolio withdrawal rates that can help their overall retirement situation. Delaying social security and working a little longer to name two. But when it comes to determining the “optimal” withdrawal rate, each person will have a preference on the consistency in their cash flows; they will have a different capacity for risk (i.e., withdrawing more and possibly outliving their assets); everyone will also have their own view on legacy and whether to leave assets to heirs. However, just as each situation is always unique, it is important that retirees take into consideration as much as possible to make the best-informed decision.
Just like there are numerous ways to invest a portfolio (passive or active, mutual funds or ETF’s or individual securities), there are a number of withdrawal strategies to follow. We favor the guardrail strategy where we have a range of “allowable” spending for each client and adjust when/if necessary. The key is open and honest communication with each client and setting the right expectations up front about the potential range of possibilities (both good and bad).
Finding the Perfect Portfolio
In a recent article, investment and retirement author, Robert Powell, highlights the challenges of creating a universal “perfect” portfolio. His assertion is that there is no perfect portfolio, but instead a perfect portfolio for “you.” In also referencing works by other investment professionals, Powell outlines the “Three P’s of Investments”: principles, process and path. First, Powell identifies seven investment principles we list below with some of our own comments:
- Consider how much time you will be able to spend on your investments; whether you can do it yourself or need a professional. NCM- you have to be honest with yourself and determine if you can do this job on your own.
- Calculate what your current and future financial needs are. NCM- You can’t build a solid plan without knowing your needs.
- Determine your own risk tolerance for gains and losses. NCM- a word of caution here- do not let your risk tolerance change. A classic mistake is feeling more risk tolerant in a good market and less in a bad market. This is one of the biggest mistakes we see investors make.
- Know your investment philosophy and how you view the markets. NCM- you must have a clear and consistent investment philosophy. Otherwise, again, you may fall prey to allowing your philosophy to change based on the current market trend.
- Create a list of all the assets you have and what you are willing to hold. NCM- get organized, consolidate accounts, simplify.
- Understand the current environment and determine how stable it is.
- Avoid obvious mistakes. NCM- HUGE. You must avoid the big mistakes to become financially independent. For example, becoming too emotional and undisciplined and selling your stock portfolio in a downturn.
The next step is process, where Powell references a book by MIT professor Andrew Lo who calls this “RISE”: Risk, Income, Spending and Environment. Risk—how much risk you are willing to assume with your investments; Income—how much do you currently earn, how much may you earn in the future; Spending—do you have a propensity to spend or are you more frugal; lastly Environment—where are we in the economic cycle: recession or expansion.
Finally, there is the path. Powell considers four “levers” which investors have available to them: the target size of your financial goals; how much you are able to contribute; the length of time you have; and the expected return. The bottom line, each person will have individual objectives and will face different financial circumstances. The overall takeaway from this type of planning is that what is right for one investor, may not be right for another.
Some may consider this exercise too involved and overly introspective, and it is likely many investors do not feel the need to engage in such a plan. However, by taking the time to answer these types of questions and becoming self-aware of what type of investor you are, what your goals are and how they will be attained, you will at least have an excellent boilerplate for a long-term financial plan, if not the blueprint for the “perfect” portfolio for you. And having a plan is the first step in any successful endeavor.
At the end of the day, portfolios are highly personal and truly should reflect your own personal circumstances, tastes, and willingness to understand and accept risks.
Paying off Mortgage in Retirement?
When facing retirement, individuals have many decisions to consider. Among these choices is the idea of paying off your mortgage (…if possible) before you stop working or keeping a mortgage in retirement. There have been plenty of opinions on how this should be handled, but like most investment decisions, it is largely personal.
On one hand, a good rule of thumb is to extinguish debt when possible. Some debt—e.g., education, medical, professional, career, etc.---may be advisable, but in most cases, debt is a negative and should be avoided. On the other hand, for most people, having a mortgage is a necessary, if not unavoidable, debt. And in most cases, having one makes sense. However, when you are near retirement facing this looming debt may become burdensome and may be one that you should try to eliminate if you are able.
For example, most people in retirement who do not have a pension will be reliant on their investments for their income. During bull markets where their portfolio is gaining, making those monthly mortgage payments may be easily absorbed and offset through their returns. However, in down markets, making this monthly payment may not only become more difficult, it may bring much more psychological anxiety. Therefore, paying off a mortgage if only for peace of mind is certainly a value----Although the extent of that value must be defined by each person individually. In short, every situation is different and the decision to pay off the mortgage will largely depend on risk tolerance, life expectancy, tax issues, as well as the size of your mortgage and the interest rate of the loan.
That said, from a pure financial standpoint, in some instances keeping a mortgage may be advantageous. Due to unforeseen expenses--such as living or medical—or just the prospect of using the funds for a superior investment, keeping the cash on hand may be a better use of funds. For example, in today’s low interest rate environment where mortgage rates are generally in the 3% range, gaining investment returns that are in excess of these interest rates may be very possible. Therefore, paying 3% toward a mortgage while earning a greater return with your investments may be appealing…and does make financial sense.
But, as earlier stated, paying off or keeping a mortgage is ultimately a personal decision and one that is not always purely financial. And while this decision should NOT be based only on short-term conditions or current sentiment, it should be made after careful consideration of one’s own situation and personal risk tolerance.
All the best,
DISCLOSURE: This newsletter contains general information that may not apply to everyone. The information above should not be construed as personalized investment advice and should not be considered as a solicitation to buy or sell any security. Past performance is no guarantee for future results. There is no guarantee that the opinions expressed in this newsletter will occur.
Investment advisory services are offered through NCM Capital Management, LLC, an SEC-registered wealth advisory firm domiciled in New Jersey. This communication is not to be construed or interpreted as a solicitation or offer to sell investment advisory services to any residents of any state other than the State of New Jersey, the State of New York, the State of Texas, or where otherwise legally permitted. For additional information about NCM Capital Management, LLC, you may request a copy of our disclosure statement as set forth on Form ADV.