Helping Clients Close the Retirement Gap

Wednesday, November 2nd, 2011

“How do I close the gap on hit­ting my retire­ment goals?”

If you’re meet­ing with clients in their 40s and 50s, chances are you’re run into that ques­tion. Weak equity mar­kets over the past decade, low inter­est rates and a new con­sen­sus on a muted out­look for future returns means that some clients who five years ago were on track to retire at 60 or 62 can no longer be con­fi­dent about doing so.

It’s here that advi­sors can add real value, as you’re able to engage clients fac­ing a short­fall in a dis­cus­sion about the six options avail­able to them:

• Option 1: Work longer
• Option 2: Work part time after retirement
• Option 3: Increase the risk in asset mix before and dur­ing retire­ment to increase poten­tial returns
• Option 4: Change retire­ment plans; down­size houses ear­lier or cut back on spending
• Option 5: Reduce spend­ing now and invest more lead­ing up to retirement
• Option 6: Buy lot­tery tickets

Set­ting aside option 6, every solu­tion to clos­ing the gap en route to retire­ment will likely include some com­bi­na­tion of these alter­na­tives. And it’s here that finan­cial advi­sors can add real value; clar­i­fy­ing alter­na­tives and help­ing clients under­stand the trade­offs avail­able to them.

His­tor­i­cally, some advi­sors have been reluc­tant to get into con­ver­sa­tions about client bud­get­ing and spend­ing, focus­ing on the invest­ment side of the equa­tion. That may have worked in the past, but for clients look­ing to close a short­fall in retire­ment plans, you can’t ignore the impact of spend­ing, both now and in retire­ment. As part of that, an inter­ac­tive new web site gives clients the tools to quan­tify and man­age those reductions.

Quan­ti­fy­ing “the latte effect”

Most advi­sors have heard of “the latte effect;” the big impact that a small reduc­tion in non-essential spend­ing make on retire­ment portfolios.

And while many clients are vaguely aware of this, the chal­lenge is get­ting them to take action.

Iner­tia is an incred­i­bly pow­er­ful bar­rier to change. Telling peo­ple they need to alter behav­iour doesn’t work; they have to dis­cover this for them­selves. That’s why an inter­ac­tive sav­ings cal­cu­la­tor on a web­site called bills​.com (http://​www​.bills​.com/​w​a​y​s​-​t​o​-​s​a​ve/) offers an effec­tive way to show clients what hap­pens if they reduce spending.

There are three sim­ple steps. First, clients choose the return that they’ll earn on their sav­ings from 1% to 10%. Next, they select the length of time for which these sav­ings will be main­tained; any­where from 1 year to 30 years.

Finally, the site allows peo­ple to look at 20 ways they can cut back. From daily cof­fees and snacks to bot­tled water, gym mem­ber­ships, lot­tery tick­ets, enter­tain­ment and din­ing out. You pick a cat­e­gory and how much you think could be cut. Depend­ing on the expen­di­ture, the sav­ings are shown on a weekly or monthly basis. As peo­ple go through the dif­fer­ent cat­e­gories, there is a run­ning tally of how much bet­ter off they’ll be as a result.

Clients could go through this process in two dif­fer­ent ways. One is to go through each cat­e­gory look­ing for sav­ings and see where they end up. The other is to set a monthly sav­ings goal and then go through each cat­e­gory look­ing for ways to get to that goal.

Help­ing clients stick to their plan

Imag­ine that a 45 year old cou­ple chooses a 20 year time­frame and a 6% return on the amount they save, based on an all-equity port­fo­lio of qual­ity div­i­dend stocks. Hav­ing done that, they decide to elim­i­nate their two daily lattes while at work. At $4 each, that adds up to $80 a week that they put into a TFSA. By doing this alone, in 20 years they end up with an extra $160,000 in retire­ment sav­ings; at a 4% with­drawal rate, that works out to an extra $125 a week to spend in retirement.

Or let’s sup­pose they iden­tify weekly sav­ings of $200, adding up to $10,400 annu­ally. Of this amount, half goes to fund quar­terly long week­end mini-vacations in nearby cities, the other half goes into a TFSA for retirement.

After 20 years, that $100 a week into their retire­ment fund accu­mu­lates to just over $200,000. One way to trans­late this into con­crete terms is to tell clients that at a con­ser­v­a­tive 4% with­drawal rate, set­ting aside an extra $100 a week for the next 20 years results in an extra $150 a week for the dura­tion of their retire­ment, indexed for inflation.

As for the other half of their sav­ings that’s allo­cated to quar­terly mini-vacations, this is dri­ven by two pieces of behav­ioural research.

One relates to the need for short term rein­force­ment to main­tain dis­ci­pline. Quite sim­ply, most peo­ple need more than the prospect of a more com­fort­able retire­ment in 20 years time to sus­tain short term sac­ri­fice. That quar­terly mini-vacation pro­vides reg­u­lar imme­di­ate rewards en route to that long term goal.

The other research is on the pay­off from hol­i­days, some­thing I’ve writ­ten about before. There are three ways that peo­ple get a lift from vaca­tions; the antic­i­pa­tion lead­ing up to them, the enjoy­ment while on hol­i­day and the pos­i­tive mem­o­ries after­wards. What’s fas­ci­nat­ing is that as a gen­eral rule, the most pow­er­ful of these three ben­e­fits from vaca­tions is the antic­i­pa­tion in advance of get­ting away.

The con­clu­sion is very sim­ple: In addi­tion to tak­ing peri­odic longer breaks to decom­press and recharge, we’d all be bet­ter off if we sched­uled more fre­quent, shorter hol­i­days, so that we always have some­thing com­ing up to look for­ward to. That’s true for us and it’s just as true for our clients.

A last obser­va­tion on this site: Many clients who are fairly fru­gal or who don’t have to be con­cerned about their retire­ment still worry about the “live for today” mind­set of their chil­dren. The site can be a use­ful resource for your clients, but can be even more effec­tive if they can per­suade their kids to spend some time with it.

Note: The extra dol­lars at retire­ment are actu­ally greater than shown on the site, since the cost of those lattes and gym mem­ber­ships will go up with infla­tion. Off­set­ting that, the dol­lar amount the site shows clients end­ing up with down the road is in today’s dol­lars and will have lost pur­chas­ing power. In the inter­est of sim­plic­ity, I sug­gest you set this aside when hav­ing this con­ver­sa­tion with clients.

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Tags: 40s, 50s, Asset Mix, Closing The Gap, Consensus, Conversations, Financial Advisors, Future Returns, Gap, Inertia, Investment Side, Low Interest Rates, Option 1, Retirement Goals, Retirement Option, Retirement Plans, Retirement Portfolios, Shortfall, Tradeoffs, Work Part Time
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The Bond Hedge

Wednesday, August 4th, 2010

This arti­cle is a guest con­tri­bu­tion by Michael Nairne, President, Toronto-based Tacita Cap­i­tal.

As the stock mar­ket ral­lies, investors can eas­ily lose sight of the real risk that they face – a long-drawn-out period of dis­mal equity returns. This month’s Com­men­tary inves­ti­gates the prob­a­bil­ity of this occur­rence over the next twenty years and ana­lyzes the impor­tant role of bonds in reduc­ing this risk

For the long-term investor, risk is not about volatil­ity – it is about a long-drawn-out period of dis­mal stock returns. Investors in U.S. equi­ties are suf­fer­ing the full brunt of this real­ity, as evi­denced by the fol­low­ing graph that depicts the cumu­la­tive value of $1.00 invested in the S&P 500. Investors have endured eleven years of ups and downs to find they are back to where they were in March 1998.

And mind you, this gloomy per­for­mance is before the per­for­mance drag of costs and taxes. For retirees liv­ing on invest­ment returns, the result has been noth­ing short of catastrophic.

How­ever, the risk of pro­tracted bleak per­for­mance has always been a facet of equity invest­ing. The nexus of exces­sive stock val­u­a­tions and a mas­sive eco­nomic shock that leads to plung­ing stock prices, mon­e­tary insta­bil­ity and sub­par growth can result in years of dis­ap­point­ing returns.

This risk becomes appar­ent when you look at the range of stock val­ues that could arise in the future. The fol­low­ing graph is a sim­u­la­tion of poten­tial val­ues of the S&P 500 over the next 20-years start­ing with an ini­tial value of 1.00. Based on the aver­age return and volatil­ity of the S&P 500 since 1926, it uses long-term his­toric expe­ri­ence to extrap­o­late a range of pos­si­ble outcomes.

The median out­come as shown in green (i.e. the 50 per­centile) is the rea­son growth-oriented investors empha­size equi­ties in their asset mix — $1.00 invested today could grow to $6.28 in 20 years. On the upside shown in red, there is a 5 per­cent chance (i.e. the 95th per­centile), $1.00 could grow to $25.35 or more. Equity investors in Jan­u­ary 1980 actu­ally enjoyed such a rare and for­tu­itous outcome.

On the down­side shown in blue, there is a 5 per­cent chance that $1.00 could grow to a mere $1.55 or less in twenty years. In this gloomy sce­nario, stock returns are deeply in the red for seven years and barely turn pos­i­tive after twelve long years. It is this poten­tial out­come of long-term poor equity returns that must con­cern investors, par­tic­u­larly retirees, in their port­fo­lio planning.

The anti­dote to this risk is diver­si­fy­ing into high qual­ity bonds; in par­tic­u­lar, bonds backed by “the full faith and credit” (i.e. the full tax­ing author­ity) of gov­ern­ments. The fol­low­ing graph depicts the ten-year rolling returns of U.S. intermediate-term gov­ern­ment bonds (in green) com­pared to those of the S&P 500 (in red). It illus­trates that there have been lengthy peri­ods in the late 1930’s/early 1940’s and the mid 1970’s/early 1980’s where the ten-year return of gov­ern­ment bonds out­per­formed that of stocks. Most recently, gov­ern­ment bonds had a ten-year aver­age annual return of 6.1%, a decided con­trast to the –1.7% return of stocks.

There are two rea­sons that gov­ern­ment bonds offer a port­fo­lio down­side pro­tec­tion. One is self-evident; gov­ern­ment bonds offer a high cer­ti­tude of future cash pay­ments due to their neg­li­gi­ble default risk – tax­ing author­ity is a pow­er­ful instru­ment in a wealthy soci­ety. The result is a much lower down­side, as illus­trated in the fol­low­ing graph which depicts a sim­u­la­tion of poten­tial val­ues of intermediate-term gov­ern­ment bonds over the next twenty-years based on an index value of 1.00 as of June 2009.

In the rea­son­able “worst case” sce­nario depicted in blue (i.e. the 5th per­centile), the gov­ern­ment bond value turns pos­i­tive in just over two years and after twenty years has a final wealth index value of $2.07 — sig­nif­i­cantly higher than stocks at $1.55. The oppor­tu­nity cost, how­ever, is mate­r­ial — the higher return poten­tial of stocks is entirely foregone.

The sec­ond rea­son is more sub­tle. On aver­age, gov­ern­ment bond returns are not cor­re­lated to stock returns — there is no real pat­tern of co-movement. Bonds will some­times do well when stocks are doing poorly and vice versa but other times they will per­form in uni­son. How­ever, cor­re­la­tions are not con­stant and dur­ing peri­ods of extreme eco­nomic con­trac­tion and defla­tion, the cor­re­la­tion between gov­ern­ment bonds and stocks goes deeply neg­a­tive – gov­ern­ment bonds do well and stocks do poorly.

The result is that when gov­ern­ment bonds are com­bined with stocks you get a more diver­si­fied port­fo­lio that pro­vides supe­rior down­side pro­tec­tion with a rea­son­able oppor­tu­nity for growth. This is evi­denced in the fol­low­ing graph that depicts a sim­u­la­tion of the poten­tial val­ues of a bal­anced port­fo­lio com­prised of 60 per­cent stocks and 40 per­cent intermediate-term bonds over the next 20-years.

In the rea­son­able “worst case” sce­nario depicted in blue (i.e. the 5th per­centile), the bal­anced port­fo­lio value suf­fers only mod­er­ate losses ini­tially, turns pos­i­tive in six years and after twenty years has a final wealth index value of $2.13 — higher than both bonds at $2.03 and stocks at $1.55. Yet, the median out­come results in a twenty-year wealth index value of $4.96, nearly 80 per­cent of the much riskier stock median value of $6.28, and sig­nif­i­cantly ahead of the bond median value of $2.84.

In short, in nor­ma­tive mar­kets, the bal­anced port­fo­lio cap­tures much of the upside of stocks. Only dur­ing extreme long-term bull mar­kets like the 1980’s and 1990’s is the oppor­tu­nity cost of a bal­anced port­fo­lio high.

In invest­ment jar­gon, a hedge is a posi­tion in one asset that off­sets the price risk of another asset. For the long-term investor, gov­ern­ment bonds are an essen­tial hedge against a long-drawn-out period of dis­mal stock returns. The cur­rent robust rally should not blind investors to this fun­da­men­tal reality.

About the author, Michael Nairne
Prior to co-founding Tacita Cap­i­tal, Michael was the Chief Oper­at­ing Offi­cer of Lor­ing Ward Inc., a fam­ily office located in New York and Los Ange­les. Michael was also a co-founder and Vice Chair­man of Assante Cor­po­ra­tion, Lor­ing Ward’s for­mer par­ent com­pany, prior to its sale in 2003. Dur­ing his tenure, Assante grew from $1 bil­lion to over $20 bil­lion in assets under administration.

Michael has writ­ten and spo­ken exten­sively on wealth man­age­ment mat­ters, and has co-authored a best seller on fund man­age­ment. For sev­eral years, he chaired the Invest­ment Com­mit­tee of LWI Finan­cial Inc. which cur­rently man­ages over $4 bil­lion in assets.

Dis­claimer:
Tacita Cap­i­tal Inc. (“Tacita”) research has been pre­pared with­out regard to the indi­vid­ual finan­cial cir­cum­stances and objec­tives of per­sons who receive it and is not intended to replace indi­vid­u­ally tai­lored invest­ment advice. The asset classes/securities/instruments/strategies dis­cussed may not be suit­able for all investors and cer­tain investors may not be eli­gi­ble to pur­chase or par­tic­i­pate in some or all of them. The appro­pri­ate­ness of a par­tic­u­lar invest­ment or strat­egy will depend on an investor’s indi­vid­ual cir­cum­stances and objec­tives. Tacita rec­om­mends that investors inde­pen­dently eval­u­ate par­tic­u­lar invest­ments and strate­gies, and encour­ages investors to seek the advice of a finan­cial advisor.

Tacita research is pre­pared for infor­ma­tional pur­poses. Nei­ther the infor­ma­tion nor any opin­ion expressed con­sti­tutes a solic­i­ta­tion by Tacita for the pur­chase or sale of any secu­ri­ties or finan­cial prod­ucts. This research is not intended to pro­vide tax, legal, or account­ing advice and read­ers are advised to seek out qual­i­fied pro­fes­sion­als that pro­vide advice on these issues for their indi­vid­ual circumstances.

Tacita research is based on pub­lic infor­ma­tion. Tacita makes every effort to use reli­able, com­pre­hen­sive infor­ma­tion, but we make no rep­re­sen­ta­tion that it is accu­rate or com­plete. We have no oblig­a­tion to inform any par­ties when opin­ions, esti­mates or infor­ma­tion in Tacita research changes.

All invest­ments involve risk includ­ing loss of prin­ci­pal. The value of and income from invest­ments may vary because of changes in inter­est rates or for­eign exchange rates, secu­ri­ties prices or mar­ket indexes, oper­a­tional or finan­cial con­di­tions of com­pa­nies or other fac­tors. There may be time lim­i­ta­tions on the exer­cise of options or other rights in secu­ri­ties trans­ac­tions. Past per­for­mance is not nec­es­sar­ily a guide to future per­for­mance. Esti­mates of future per­for­mance are based on assump­tions that may not be real­ized. Man­age­ment fees and expenses are asso­ci­ated with investing.

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Tags: 95th Percentile, Asset Mix, Brunt, Cumulative Value, Economic Shock, Eleven Years, Initial Value, Investment Returns, Investor Risk, Monetary Instability, Next Twenty Years, Performance Drag, Stock Prices, Stock Returns, Stock Valuations, Stock Values, Term Investor, Ups, Ups And Downs, Volatility
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Three ways to inspire clients

Wednesday, June 30th, 2010

What’s your main goal when meet­ing with clients?Given the beat­ing their port­fo­lios have taken and the gen­eral mood of pes­simism, often it’s to have them leave feel­ing more opti­mistic and upbeat about their future prospects and in par­tic­u­lar about your role as their advisor.

After all, peo­ple shouldn’t see meet­ing with their advi­sor as a pre­scrip­tion for pain, sim­i­lar to going to the den­tist. Instead, your goal should be to have clients walk away from meet­ings feel­ing bet­ter than they did when they came in.

Here are three ways to do that, with­out pre­tend­ing we aren’t fac­ing real issues putting our cred­i­bil­ity at risk.Help clients regain control

These days, many investors feel pow­er­less and out of con­trol of their finan­cial futures, vic­tims of forces beyond their con­trol. That sense of pow­er­less­ness weighs down on clients and cre­ates stress and a pes­simistic outlook.

Often, the first step to inspir­ing clients is to help them regain con­trol of their finan­cial future by tak­ing a plan­ning approach to their affairs.

When you work through how much money clients will need to retire when and how they want to and com­pare that to a con­ser­v­a­tive esti­mate of how much they’ll have, there will often be a gap between those two numbers

That means they feel pow­er­less — and here’s where you can roll up your sleeves and work with clients to help them regain con­trol of their future.

Finan­cial plan­ning is all about iden­ti­fy­ing trade­offs … so if there’s a gap, clients can cut back on spend­ing and save more. If one mem­ber of a cou­ple isn’t work­ing, they can get a part time job. They can extend the age at which they plan to retire, cut back on how much they plan to spend after retir­ing or decide they’re going to work part time after they retire.

The final resort is to change the expected return on their sav­ings by alter­ing the asset mix, either before retir­ing, after retir­ing or both.

The point is that most peo­ple aren’t pow­er­less, they aren’t vic­tims, and it’s an advi­sors job to help them under­stand that.

Clients will feel bet­ter as a result — and given the level of doom and gloom out there, many will find that they’re actu­ally in bet­ter shape than they feared.

Focus­ing on pos­i­tive prospects for the mid term

Many clients today are over­whelmed by anx­i­ety and bad news about the econ­omy — 60% of Cana­di­ans are con­cerned about some­one in their house­hold los­ing their job.

An advisor’s job is to help clients main­tain their emo­tional equi­lib­rium, keep highs from being too high, lows from being too low. A year ago, our job was keep­ing the highs from being too high — today it’s to keep the lows from being too low.

There are many pos­i­tive mid term sto­ries that are being ignored by clients. Many of the things that made the mar­kets hugely bull­ish a year ago are still largely in place — not $200 oil of course, but pro­duc­tiv­ity increases from tech­nol­ogy, the grow­ing pace of inno­va­tion, glob­al­iza­tion and the emerg­ing mid­dle classes in China and India.

Here’s an Globe and Mail arti­cle from last Decem­ber mak­ing the case for long term opti­mism, still rel­e­vant today.

http://​www​.the​globe​and​mail​.com/​p​a​r​t​n​e​r​s​/​f​r​e​e​/​g​l​o​b​e​i​n​v​e​s​t​o​r​/​i​n​v​e​s​t​m​e​n​t​/​n​o​v​0​8​/​o​n​l​i​n​e​/​g​o​o​d​n​e​w​s​.​h​tml

But we don’t just have to focus on the future. There are some solid good news sto­ries in the real econ­omy today that we can talk to clients about. One tack to con­sider is talk­ing about indi­vid­ual com­pa­nies that are doing well even in the face of the gloom. To but­tress your case, con­sider using pos­i­tive arti­cles on com­pa­nies; the recent For­tune arti­cle on John­son and John­son below is just one example.

Main­tain­ing a pos­i­tive mind­set yourself

For clients to leave meet­ings pos­i­tive, you first have to seem rea­son­ably upbeat and pos­i­tive your­self, hard as that might be some days. Few things are more important.

Before every meet­ing and every phone call, remind your­self — BE POSITIVE. (One advi­sor put a sign beside his phone with the let­ters BP as an ongo­ing reminder of this.)

No mat­ter how lousy you might be feel­ing, force your­self to smile and to crank up your energy level.

Some spe­cific tac­tics to help you project a pos­i­tive out­look to clients:

1. Start your day off with exer­cise, even a brisk walk will help.

2. Build in mid morn­ing and mid after­noon breaks for fresh air and sunshine.

3. Seek out pos­i­tive peo­ple and stay away from neg­a­tive ones.

4. Book a four day long week­end once a month to recharge your batteries.

Here are some recent arti­cles on strate­gies to stay positive:

Ten tips to stay pos­i­tive http://​www​.strate​gicim​per​a​tives​.ca/​b​l​o​g​/​?​p​=​120

Lessons from the NHL play­offs: http://​www​.strate​gicim​per​a​tives​.ca/​b​l​o​g​/​?​p​=​168

Steps to boost your resiliency: http://​www​.strate​gicim​per​a​tives​.ca/​b​l​o​g​/​?​p​=​144

Fram­ing events to increase moti­va­tion http://​www​.strate​gicim​per​a​tives​.ca/​b​l​o​g​/​?​p​=​151

The last resort for achiev­ing moti­va­tion http://​www​.strate​gicim​per​a​tives​.ca/​b​l​o​g​/​?​p​=​158

For more infor­ma­tion, please visit http://​get​keep​clients​.com.

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Tags: 2c, A6, Asset Mix, Conservative Estimate, Credibility, E2, Financial Future, Financial Futures, Financial Planning, Future Prospects, Gap, Going To The Dentist, Itt, Main Goal, Part Time Job, Pessimism, Pessimistic Outlook, Portfolios, Powerlessness, Three Ways, Tradeoffs, Work With Clients
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