Posts Tagged ‘Asset Mix’
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/ways-to-save/) 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.
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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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.
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.
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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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.
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.
|5 rules that make Johnson & Johnson a winner — Apr. 22, 2009*|
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.strategicimperatives.ca/blog/?p=120
Lessons from the NHL playoffs: http://www.strategicimperatives.ca/blog/?p=168
Steps to boost your resiliency: http://www.strategicimperatives.ca/blog/?p=144
Framing events to increase motivation http://www.strategicimperatives.ca/blog/?p=151
The last resort for achieving motivation http://www.strategicimperatives.ca/blog/?p=158
For more information, please visit http://getkeepclients.com.
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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