Diversification In Its Present Form Is For Suckers. So, Don’t Be A Sucker.

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“If you have large cap, mid-cap, and small-cap, and the market declines, you are going to have less cap.” – Martin Truax


The financial services sales forces as mass storytellers, have morphed once noble, efficient constructs into treacherous fairy tales.

red-riding-hood

Tenured financial concepts which define the core of advice in the brokerage industry go relatively unchallenged. Investors, due to lack of experience about such matters, have a difficult time challenging the status quo or ask the right questions.

The easiest way to convince investors to “stick with an asset allocation or investment plan” is to use the past as a pacifier, regardless of current market cycle. In other words, if it’s broken there’s no need to adjust the guidance.

The industry just needs to isolate and showcase a cycle where the old confines worked, push that specific period of time into the present and extrapolate the positive, perpetually into the future.

Hey, it’s what the industry does best.

I believe nothing changes in practice on financial front lines, as the priority remains pushing products. Brokerage firm margins are embattled by the profit-draining effects of lower-for-longer interest rates.

I don’t blame the mouthpieces as much as I do the senior management and compliance departments that channel, reward or benefit from the behavior.

As a regional manager at Charles Schwab told me:

“It’s always about shareholders first.”

There are Holy Grail concepts that are rarely revisited except by academics and a select few in the private sector and for their work, I’m grateful.

From experience I’ve experienced how somewhere between academia and implementation in the field, updates or improvements to dogmatic strategies` get lost or ignored, especially when they conflict with the short-term focus on shareholder and analyst expectations.

The insidious or naïve (take your pick) roads most selected are designed to mollify fears and at the same time, leave investor wealth exposed unnecessarily to danger.

An egregious stretch of the truth emboldens the heavily-protected sanctuary of diversification.

It’s a word that makes investors feel good.

It rolls sweet off the tongue. It represents warmth of a blanket fresh out of the dryer, the scent of fresh-baked cinnamon rolls.

cinnamon-rolls

However, don’t be duped. Today, diversification as pitched by your broker, is a wolf dressed as Red Riding Hood. Many financial professionals have fooled themselves regarding its effectiveness. At least the way it’s defined, currently.

You must understand what diversification is and most crucial, what it isn’t. Certainly, it’s not the panacea it’s communicated to be.

The outdated definition of diversification requires a tune up. There’s no ‘free lunch,’ here, although I continue to hear and read this dangerous adage in the media.

The word gets thrown around like a remedy for everything which ails a portfolio. It’s the industry’s ‘catch all’ that can lull investors into complacency, inaction.

So, who buys into this free lunch theory, again?

After all, what is free on Wall Street? Investors who let their guard down, buy in to the myth of free lunches on Wall Street, ostensibly find their money on the menu.

Due to unprecedented central bank intervention, there exists extreme distortion in stock and bond prices. Interest rates ‘lower for longer’ and in several cases, negative, have created a frenzied reach for yield in dividend stocks. Global risk-averse investors have purchased bonds with a voracious appetite.

A way to effectively manage risk has morphed into two disparate perceptions. The investor’s definition of diversification and that of the industry has parted, leaving an asset allocation plan increasingly vulnerable.

Today, the practice of diversification is Pablum. Watered down. Reduced to a dangerous buzzword.

First, what is the staid, mainstream definition of diversification?

According to Investopedia – An internet reference guide on money and investments:

  • Diversification strives to smooth out unsystematic riskevents in a portfolio so the positive performance of some investments neutralizes the negative performance of others. Therefore, the benefits of diversification hold only if the securities in the portfolio are not perfectly correlated.
  • Diversification benefits can be gained by investing in foreign securities because they tend to be less closely correlated with domestic investments. For example, an economic downturn in the U.S. economy may not affect Japan’s economy in the same way; therefore, having Japanese investments gives an investor a small cushion of protection against losses due to an American economic downturn.

Now let’s break down the lunch and examine how free it is.

 

Unsystematic risk – This is the risk the industry seeks to help you manage. It’s the risks related to failure of a specific business or underperformance of an industry.

To wit:

  • This is a company- or industry-specific hazard that is inherent in each investment. Unsystematic risk, also known as “nonsystematic risk,” “specific risk,” “diversifiable risk” or “residual risk,” can be reduced through diversification.
  • So, by owning stocks in different companies and in different industries, as well as by owning other types of securities such as Treasuries and municipal securities, investors will be less affected by an event or decision that has a strong impact on one company, industry or investment type.

So, think of it this way: A ‘diversified’ portfolio represents a blend of investments – stocks, bonds for example, that are designed to generate returns with less overall business risk.

While this information is absolutely valid, the financial industry encourages you to think of diversification as risk management, which it isn’t.

Here’s what you need to remember:

Ketchup (consumer staples) and oil (consumer cyclicals) all run down-hill, in the same direction in corrections or bear markets. 

Sure, ketchup may run behind, roll slower, but the direction is the one direction that destroys wealth – SOUTH.

Large, small, international stocks. Regardless of the risk within different industries, stocks move together (they connect in down markets).

Consider:

What are the odds of one or two companies in a balanced portfolio to go bust or face an industry-specific hazard at the same time?

What’s the greater risk to you? One company going out of business or underperforming or your entire stock portfolio suffers losses great enough to change your life, alter your financial plan.

You already know the answer.

Diversification is not risk management, it’s risk reduction.

  • When your broker preaches diversification as a risk management technique, what does he or she mean?
  • It’s not risk management the pros believe in, but risk dilution.
  • There’s a difference. The misunderstanding can be painful.

To you, as an investor, diversification is believed to be risk management where portfolio losses are controlled or minimized. Think of risk management as a technique to reduce portfolio losses through down or bear cycles and the establishment of price-sell or rebalancing targets to maintain portfolio allocations. Consider risk dilution as method to spread or combine different investments of various risk to minimize volatility.

Even the best financial professionals only consider half the equation.

Beware the lamb (risk management) in wolf’s clothing (risk dilution).

The goal of risk dilution is to “cover all bases.” It employs vehicles, usually mutual funds, to cover every asset class so business risk can be managed. The root of the process is to spread your dollars and risk widely across and within asset classes like stocks and bonds to reduce company-specific risk.

There’s a false sense of comfort in covering your bases. Diversification in its present form is not effective reduce the risk you care about as an individual investor – risk of loss.

Today, risk dilution has become a substitute for risk management, but it should be a compliment to it.

Risk dilution is a reduction of volatility or how a portfolio moves up or down in relation to the overall market.

Risk dilution works best during rising, or up markets as since most investments move together, especially stocks.Think about betting on every horse in a race.

  • In other words, a rising tide, raises all boats.

So, why is risk reduction but not risk management, the prevailing sentiment?

Sales Goals: Most financial pros are saddled with aggressive sales goals. Risk dilution is a set and forget strategy. Ongoing risk management is time consuming and takes time away from the selling process.

Diversification can be stronger than it is right now. Unfortunately, the financial industry as a whole, has watered it down and widened it so much, it’s become absolutely ineffective as a safeguard against losses. One reason is the sales targets that forces financial representatives to spend less time with client portfolios.

Compliance Departments: A targeted diversification strategy places accountability on the advisor and poses risk to the firm. A wider approach makes it easier to vector responsibility to broad market ‘random walks’ so if a global crisis occurs and most assets move down together, an advisor and the compliance department, can “blame” everything outside their control.

  • “Hey it’s not our fault, it’s the market!”

Convenient excuse, isn’t it?

Diversification requires a shake-up, a smarter approach.

The Clarity team decided to go back to the drawing board. Consider how investors perceive diversification, then create a thoughtful definition which incorporates part of the old along with important enhancements.

My revised definition of diversification:

  • A targeted selection of investments designed to manage risk within an allocation that’s behaviorally connected to who you are and the goals you seek to achieve. An allocation that fits the macro-economic environment driven by specific investment buy and sell disciplines.

That’s diversification for the new world, post-great recession.

Revised diversification strategies require actionable rules.

The following guardrails should help you identify and avoid the pitfalls that define diversification as it’s practiced in the field of financial services.

Random Thoughts:

Watch for over-diversification. Too much of a good thing can increase risk. That’s not your objective. Do not allow your financial advisor to spread your investment dollars too thin: All you’ll do is create an expensive index fund alternative.The more investments you own, the more a portfolio may mirror or move in unison with the underlying markets (you can do that on your own in a less expensive manner).

Control the number of securities you own or add. Proper diversification can be achieved with as little as 5 to as much as 15 separate investment to represent stocks and fixed income options. You must understand the reasons behind every new investment. Is it additive to increase return or lower risk, or is it duplication of an investment you already own? Most likely it’s duplication.

You don’t need to own every asset class at all times to be diversified from a risk management perspective. For example, where is it written that a portfolio must always hold international stocks when most domestic or U.S.-based companies have formidable international revenue streams?

Why must small, mid, or large-cap stocks be eternally represented in a portfolio, never to be fully liquidated? An active approach to risk management may exclude several asset classes. Frankly, at times it may help returns and reduce risk.

Think outside the box for real diversification. For effective diversification consider passive income from rental real estate, development of human capital (your skill set) to increase earned income, perhaps fund a privately-held business (a riskier option). Remember ‘owning ketchup & oil’ through turbulent markets may not be an optimum risk management strategy.

And speaking of risk management…

Without a sell or rebalancing strategy, diversification can only go so far. This step is more work for your advisor, but that’s what he or she is paid for. To help minimize losses, a portfolio requires periodic rebalancing to take profits and a liquidation component to reduce losses that may be tough to recover from.

Beware the “lunch room effect.” You own 3 mutual funds from the same fund company, XYZ Financial. All have different names, different managers, and different objectives. Every day, the three fund managers have lunch. They discuss the weather, the hometown sports team, and their investment choices.

Manager # 2 based on the parameters of the mutual fund, likes what Manager # 3 has to say about Acme Corporation. She eventually decides, after further investigation, to add Acme Corporation to her fund holdings, too. This is stealth, industry-specific risk that destroyed tremendous wealth during the tech bubble. So the lesson here is to never own more than one mutual fund per fund group to avoid overlap.

The tendency is to perceive diversification a panacea, a Snuggie that allows portfolios to be forged then forgotten, as diversification is considered the ultimate free lunch (that’ll wind up eating your lunch).

Diversification today is a convenient cop-out or weak replacement for risk management.

Schedule a meeting with your financial partner to discuss your concerns.

Ask for a definition of diversification. See if you agree.

If not, it may be time to move on.

And save enough money through risk management to happily purchase your own lunches.

 

10 Questions to ask your Adviser. Right Now. Today.

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He was annoyed with me after a while. He said I asked too many questions.”

It’s tough for me to imagine speaking these words to a client or anyone seeking guidance.

I don’t have the guts. Or the hubris.

Or the stupidity.

I wonder about (and I’m thankful) for complacency among some advisers. It allows me to continue to gain thoughtful, inquisitive clients who never feel that I’m annoyed by a passion to learn.

The noblest efforts we undertake as trusted financial partners are to listen, answer questions, validate good behaviors, empower improvement and communicate effectively to our audience.

How does a prospective client – One who has a genuine curiosity in her finances, a successful saver and investor, ask “too many questions?”

If you’ve been with an adviser long enough to feel comfortable together, or maybe you’re exploring a new financial relationship, asking questions should be encouraged.

There’s no such concept as “asking too many questions.” You query enough to satisfy your need for information requested. I’ve noticed how the more self-aware an individual is about their financial situation, the more questions that arise.

There’s no reason to feel intimated or stifled.

You’ve earned the right (and the money).

Channel your inner Columbo.

Remember Columbo?

Columbo

The disheveled, inquisitive, seemingly frazzled (like a fox), detective was a master of detection. His questions on the surface were unassuming. Some appeared silly. However, underneath, there was a method to his madness.

Columbo knew the importance of questions no matter how insignificant they appeared

And when you were convinced he was done with the investigation.

There was always “just one more thing.”

It drove the perpetrators crazy.

Columbo was intrusive, occasionally annoying and he couldn’t care less. He was purposely oblivious. He felt he had the right to ask.

So do you. When it comes to your family’s financial well-being every question you have should be addressed.

Now’s the perfect time, too.

Why?

The market is complacent. Volatility is low.

Yet, dark clouds are forming on the horizon.

storm clouds

Political ill-wind is beginning to stir and capture the market’s attention, bond yields around the world are falling (some are negative). The 10-year U.S. Treasury yield is at it’s lowest close May 2013. A clear sign of economic distress. U.S. corporations are in their fifth quarter of negative earnings growth.

There’s never been a more perfect time to ask these ten questions: It would be a mistake not to.

Are you a registered investment adviser or a stock broker? There’s a difference.  A big difference. When people ask me I respond: “Well, I don’t really want to help you break anything. Most likely, I’m going to help you mend something a broker, broke.” You need to ask the question and comprehend the difference.

A registered investment advisor or “RIA” is held to a fiduciary standard. According to www.thefiduciarystandard.org, a committee of investment professionals and fiduciary experts who formed in June 2009 as advocates for fiduciary-level advice:

“Registered representatives of broker-dealers are subject to a suitability standard under the Securities Exchange Act of 1934, while investment advisers are regulated as fiduciaries under the Investment Advisers Act of 1940.”

What does that mean to you? Plenty.

Fiduciaries are held to a high standard of ethics and care which affects all the advice they provide. It’s a much stricter standard. There should be no conflict of interest and if one exists, it requires clear disclosure.

The Committee for the Fiduciary Standard outlines 5 core principles of a fiduciary:

  • Put the client’s best interests first;
    • Act with prudence, that is, with the skill, care, diligence and good judgment of a professional;
    • Do not mislead clients–provide conspicuous, full and fair disclosure of all important facts;
    • Avoid conflicts of interest;
    • Fully disclose and fairly manage, in the client’s favor, unavoidable conflicts.

 “Suitability” guides a broker to recommend an investment that is appropriates for your situation, is not held to the same standard. A broker is required to know your risk tolerance, tax bracket, and time frame for the money you seek to invest. All skeletal in nature. Yet legitimate. Well, it’s suitable.

Feels like something is missing, doesn’t it?

My belief, based on how brokerage firm compliance departments operate and an unpleasant experience with a former employer, is that suitability has been misaligned to protect the financial organization from lawsuits or arbitrations and NOT designed to safeguard individuals seeking guidance.

The Fiduciary Standard is a high calling. It’s there to position the client front and center in the financial advice model, as it should be for every professional who assists consumers with their financial decisions.

 On April 6, 2016, the outdated foundation of financial services was slammed and cracked to make ground for hopefully, a safer, increasingly objective industry with the issuance of the Department of Labor’s Fiduciary Rule.

Mind you, it’s the genesis of a higher standard of care for brokers, so there’s much to be accomplished. I expect the Rule will be pushed, pulled, fine-tuned before it fully takes effect on April 10, 2017 and final policies put in place by January 1, 2018. My thought is this will be a continuous work in progress long after 2018. That’s ok. It’s a step in the right direction.

The new rule resurrects the definition of fiduciary from the 1974 ERISA – (Employee Retirement Income Security Act) and expands upon it. ERISA’s fiduciary standard outlines how a retirement plan fiduciary must act prudently and with undivided loyalty to the participants. Obviously, the retirement landscape in 1974 was very different. The 401(k) plan wasn’t in existence. Defined benefit plans, or pensions, were the most popular retirement vehicles.

Crucial elements of the rule – advice provided must be in a client’s “best interests,” full disclosure of conflicts of interest, and charge no more than “reasonable compensation,” for services. Generally, the fiduciary must sign a “Best Interests Contract” with the client that outlines how he or she will provide advice in the client’s best interest.

A broker’s financial institution will also be subject to the rule. Ostensibly, sales quotas, contests, awards or special compensation that may tempt an adviser to stray from his or her fiduciary responsibilities, will be prohibited.

The message is growing strong (there’s a long way to go), to an industry driven by sales pressure: Change your culture. In other words, those ads you run that give the appearance of fairness, caring and client first that not one consumer takes seriously? Make them reality, not fantasy.

Ethical employees who serve financial clients in publicly traded brokerage firms are torn between serving clients holistically for the long term and at the same time are up against the wall every quarter, starting from scratch, to meet outrageous quarterly sales goals and tremendous pressure to sell the hot product of the day (these tactics still exist). The internal friction can generate great turmoil and perhaps push an employee to make sales first and fail to responsibly counsel.

The mixed message from senior corporate puppets to do what’s right for a client and oh, meet big sales targets (or you’re out), builds conflict and distress. Talented workers become discouraged, burned out and move on. It’s an ancient business model. Change is required and it appears to be coming.

Slow is better than no.

Unfortunately, the recent ruling only covers retirement accounts. For now. The Security & Exchange Commission is expected to release a fiduciary standard in 2016 which would cover fiduciary responsibilities for taxable brokerage accounts. Although a uniform fiduciary standard (with the DOL), would be welcomed, it’s too early to draw any conclusion that this will occur. Nor is there any assurance that the SEC will adhere to an October release.

While the Feds work to figure it out, ask the question. Keep in mind, not every professional you engage will operate in a fiduciary capacity regardless of federal rulings. My suspicion is you’ll be hearing interesting, articulate, creative responses but not a clear “yes” or “no.”

Based on the answers received, you’ll gain valuable perspective about what’s best for you and your family’s finances.

Think fiduciary over suitability.

How much will I pay for your services?

 Simple question deserves a simple answer. Unfortunately, not so simple. People share with me their frustration as they’re unclear how their current financial professionals get paid or are compensated for selling investment products.

It’s especially perplexing for mutual fund investors sold multiple share classes and perpetually unclear of how charges are incurred. A clear comprehension of the class share alphabet (A, B, C), is as thick and jumbled as the inside of Campbell’s Soup can.

B &C share classes are popular selections on the product-push list. They represent the finest alchemy in financial marketing. As consumers are generally hesitant to pay up-front sales loads like in the case of A shares (even though when taking into account all internal fees and expenses, they’re the most cost-effective choice for long-term investors,) B & C shares were created to mollify the behavioral waters.

To avoid having a difficult conversation or facing reluctance about opening your wallet and shelling out 1-4% in front-end charges that reduce the principal amount invested, the path of least resistance is to offer share classes with internal fees, marketing charges and deferred sales charges. Either way you pay. With B & C shares generally, you pay more. However, big fees reduce returns, they’re stealth. Thus, they feel less painful to invest in (even though they’re not).

Frankly, the only funds worth considering are no-load mutual funds where you can purchase or sell anytime without a commission or sales charge. Avoid the A, B, C’s all together. Meet with an hourly-fee based Certified Financial Planner or a fiduciary to help you assess your current mutual fund holdings and for recommendations based on your personal situation.

A financial professional may be compensated hourly, by annual flat fee, a percentage based on assets under management, commissions or perhaps a combination. Regardless, to make an informed decision, you must understand how your adviser puts food on the table. If you can, get it in writing.

 There’s no ‘right way’ to be compensated as long as it’s fair and reasonable for services rendered. You also want to understand what motivates your broker or adviser to recommend investment vehicles. If you’re not getting straight answers, well you know what to do. Move on.

How do you incorporate my spouse, life partner and children when it comes to planning for me? You don’t exist in a vacuum. An adviser should maintain a holistic approach to financial planning and that includes communicating with loved ones and teaching children how to be strong stewards of money. The meetings, communication must be ongoing. At least annually.

Why did you select financial services as a career? I recall vividly how the stock market intrigued me through my teenage years. I never missed an episode of Wall Street Week. As early as 13 years-old I was fascinated with how markets worked.

In grade school I enjoyed helping classmates understand how our passbook savings accounts (and compound interest) worked. Every Wednesday, a bank representative from Lincoln Savings Bank would meet with our elementary school class and collect deposits and stamp our passbooks.

This question should be used to gauge a perspective financial partner’s penchant for helping others and passion for his or her role as a mission, not a job. How do you know whether a professional sincerely cares about your financial situation and goals? You’ll know it, intuitively.

 What are your outside interests? A successful life is about balance. This question gets to the weekend and evening person behind the financial professional you observe from behind a desk, charts, book, and computers. You may discover activities you have in common and develop rapport on a personal level.

To gain a complete picture of the kind of person you’re entrusting with your investments is a crucial element of your interviewing process. By the way, it’s not prying. It’s curiosity. Ostensibly, you should like the individual you and your family may be working with for decades.

Can you tell me about your firm’s service standards? You want to know how many times a year you’ll be meeting with your financial partner whether in person (preferably), over the phone or web meeting like Go To Meeting. Is it quarterly? Every six months? How would you like to work as a client? What are your preferences? Will you be receiving calls and e-mails throughout the year about topics important to your financial situation like the market, economic conditions, financial planning, and fiscal changes that may affect me?

What is your investment philosophy? Recently, I meet a couple who was upset how their broker placed a million bucks into the market in one day. They believed there would exist a more thoughtful strategy for implementation especially in the face of the second-highest stock market valuation levels since the tech bubble. But THEY DIDN’T ASK. Are you ‘buy and hold?’  You seek to discover  whether the adviser is merely towing the employer’s line or does outside research and shares his or her personal opinion based on research and study.

Is there a portfolio sell discipline? What is it? Frankly, if the word no, or something like it comes up, excuse yourself politely and find another adviser. This investigation is over.

The dirty little secret in financial services is that ‘sell’ is a four-letter word. I’m certain you’ve heard about missing the 10 best days in the market (brokers preach this ad nauseam). How detrimental it is to portfolio return. And it is. But what about the other side of the coin? What about the math of loss?

Math-Of-Loss-122115.png

Per Lance Roberts, Clarity Financial’s Chief Investment Strategist:

Clearly, avoiding major drawdowns in the market is key to long-term investment success. If I am not spending the bulk of my time making up previous losses in my portfolio, I spend more time growing my invested dollars towards my long term goals.

Markets can’t be timed. That’s true. However, risk management is about controlling the math of loss which can be devastating compared to possible gains. Your broker or adviser should have a strategy you believe in to guard against market storms.

Whether it’s a conservative portfolio or asset allocation right from the beginning, or a specific sell and re-entry discipline to minimize portfolio damage, a sell strategy is crucial.

Academics and influential financial service providers are on the band wagon when it comes to sell disciplines. Whether it’s Dalbar, the nation’s leading financial services market research firm, or MIT Professor of Finance Andrew Lo, there’s a growing body of work that shows how investors spend most of their investment life (20-30 years), making up for losses, playing catch up.

Investing, closing your eyes and hoping for the best is not a wise strategy especially in a market propped up by central bank intervention and a P/E 10 ratio at 25.7, the second-highest level since the tech bubble at 44.2. The historic average is 16.7. Real price/earnings over 10 year averages are not going to drive market returns in the short term. However, as an investor, you must be aware of the environment you’re dealing with. Placing 100% of your stock allocation into the market at these levels should be a strategy you avoid, especially if you’re 5-7 years from retirement.

How will I have access to you and your team? A caring adviser will make sure you have the ability to text, access to a cell phone number, the phone contacts and e-mails of support staff and make you feel comfortable to reach out at any time. You should also expect a prompt response to voice mails within 24 hours or less.

When can I meet your clients? Advisory clients possess knowledge and intellectual gifts they love to share with others. Intimate client gatherings provide clients opportunities to communicate, generate business, form friendships. It’s rewarding to witness. The ability of clients to gather and know each other also helps new retirees transition to their next life adventures easier by hearing the life stories from people who have been there already.

Questions are an integral part of any relationship. As a friend recently taught me – not asking them in a timely fashion can create resentment and anger.

You’re not being nosy.

You’re not a nag.

You’re seeking information to make an informed decision.

About a topic close to your heart.

Financial well-being.

No questions asked.

Unless you’re Columbo.

Then keep asking.

How To Survive a Retirement: The 3 Questions.

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In the AMC’s hit drama “The Walking Dead,” where the world is overrun by rotting corpses with a desire to feed on the living, there’s something even greater to fear.

The survivors.

negan two

Staying alive in a post-apocalyptic society appears to bring out the worst of what’s left of humanity. People are ruthless killers. Strength in numbers is the best defense, yet poses an interesting dilemma.

One wrong move, one bad decision, and you’re history.

Just like that.

Sometimes, overcoming the most complicated of challenges comes down to the obvious. Nothing’s perfect however complexity fosters confusion which can shift focus, divert your attention. And when your enemies, especially within, outnumber you, it’s only a matter of time before.

Well. You know (it isn’t good).

negan three

The good guys devised a simple screening method.

An initial shield to determine if strangers they encounter are worth entry into their community.

Three questions.

questions

Let’s see how you do. Will you pass or fail?

Are you team material?

Or are you best left alone to fend for yourself?

How many walkers (corpses with an appetite for the living), have you killed?

To safeguard others, a survivor must be willing to take out the undead (a shot or blow to the head does it). Plain and simple. If your zombie kills are minimal or non-existent there will be doubts about your contribution to the survival of the group.

How many people have you killed?

Unfortunately there are instances when tough decisions must be made for the sake of self-preservation.  Best the number of walkers taken out exceed the number of people otherwise you may become a victim yourself.

Why?

Tread carefully. The reasons for taking out the living best be because of personal survival. Or request. You see -There are sad instances when victims of zombie bites would rather die honorably, in their control, rather than expire from the disease they carry.

They would rather not wake up. Walk around.

zombies walking

As I ponder the power of simple questions, whether in fact or fiction, I have come to realize how most situations, no matter how serious, can be broken down to three questions you ask yourself or others ask you.

When it comes to preparing for retirement, there are so many differing rules, theories, planning tools –  in my mind I need to consider retirement similar to a zombie apocalypse.

Sort of puts things in perspective, doesn’t it?

If today, you could clear all the noise, reduce retirement planning to what concerns you the most, what you need to do to protect yourself – What three questions would you ask?

As I work with individuals to formulate personalized retirement strategies, three questions emerge consistently. As a matter of fact, it’s rare when one of these queries doesn’t arise.

Once you strip out the confusion, target the basics.

Focus comes down to three main concerns.

Random Thoughts:

A confident retirement comes down to the money coming in to a household.

Cash flow is everything.

Question #1: How much spendable income may I have on a monthly basis post-tax to keep me, or me and my spouse comfortable for 20 years? Simply put, how much can I have?

Why 20 years?

Let’s face it. The odds of becoming a centenarian are as slim as the dead coming back to life. OK, not that slim but infrequent enough to understand that age 100 shouldn’t be a default setting for retirement plans.

Everyone I counsel is asked to complete the thorough, thought-provoking life-expectancy calculator exercise at www.livingto100.com.  Eight out of ten outcomes come in between 80-85 years old. Women average longer life expectancies at 83-86 years old. Per calculator results, men rarely live past 84 years old.

Thought leader Dick Wagner and author of the new book “Financial Planning 3.0,” in a recent interview with the Journal of Financial Planning, stated “financial planning is very, very young as a profession. If you believe that 1969 was the first year for the profession, then we’re into our 47th year. That’s not very many years if you compare it to other authentic professions.”

So who are we as advisers to indiscriminately assume that retirees are going to live to 100? I’m not sure why I see this occur so often. Maybe it feels safe. Perhaps it’s CYA. Regardless, it’s inaccurate.

Candidly, even if the profession were a thousand years old, longevity analysis would remain a slim, educated guess at best. I am 100 percent certain however that establishing retirement income plans to conclude at age ‘unrealistic’ is an exercise in disappointment. People won’t adhere to goals, milestones they find impossible to achieve.

Please plan for reality. Not fiction. A reach to age 100 will most likely lead to unsuccessful plan outcomes. You won’t feel secure enough to retire or you’ll wait too long thus placing the quality of life in retirement, in jeopardy.

If you believe, based on family longevity and state of health, that there’s a great probability of living to 100, by all means, don’t ignore preparing for the possibility.

The topic is challenging and uncomfortable to discuss. It requires acknowledgement of our own humanity.

A seasoned adviser doesn’t overlook or dance around the topic of longevity. He or she should handle the conversation with grace and honesty. After all, we are all going to die (and hopefully not return to life like in The Walking Dead).

It’s something we all have in common. We don’t seem to like to think about it happening before age 100, especially when it comes to retirement planning.

In the same interview financial futurist Dick Wagner continues his thoughts on the financial planning profession:

“The mission and purpose of financial planning is to work with individuals and families and their personal relationships with money and the fearsome forces that it generates. There’s something about ‘fearsome forces’ – it’s terrifying. I mean, it’s a quintessential challenge of the 21st century: just try to survive with this money stuff. People do something that’s really hard, which is to anticipate their needs of the last 20-30 years of their lives. Now how do you do that? You have no idea what your health will be, you have no idea what your date of death is, you have no idea how long you can continue to earn a living.”

Financial planners deal with plenty of their own fearsome forces. One source of angst is to have straightforward, yet sensitive discussions; balance the thin line between a portfolio and human life because as Dick Warner lamented, there are plenty of unknowns.

Take it from me – we’re not fond of zombies in the planning process but they do exist.

Before you look to have a retirement plan completed, take it upon yourself to go through a life-expectancy calculator. Sit with the outcome for a while. Do the results make sense?

Once you’re at peace with the information, share it with your financial planner. Incorporate it into your analysis. You’ll both be in sync. You’ll tackle fearsome forces together. The synergy will lead to reasonable goals, follow up and fulfillment.

Question #2: Will Social Security be there for me?

The assumption that Social Security is a dying social program, regardless of the generation, runs pervasive. Don’t underestimate the importance of properly integrating Social Security into your retirement arsenal. For the majority of Americans, this is their sole income for life.

So, let’s clear up several misconceptions.

According to financial planning thought leader Michael Kitces in a recent voluminous Kitces Report on the topic, the Social Security system is often considered “going broke” by 2034. At that time it’s believed the Social Security trust fund will be exhausted.

Most planning clients have a difficulty believing the funds will last that long. Per the analysis, the majority of benefits will still be paid through tax revenues on workers paying payroll taxes at that time.

Social Security recipients usually receive Cost-Of-Living Adjustments each year. An added bonus to an income you cannot outlive is inflation protection. Unfortunately, COLA is not in the cards for 2016 (a rare occurrence), however overall, Social Security remains the best lifetime income deal available to the masses.

It’s best a retiree in good health plan to wait until at least full retirement age (66, or 67) or possibly later to apply for Social Security. By the time I’m consulted for formal retirement planning, many recipients have already applied for benefits early – at age 62, in fear of not being “grandfathered” into the system and losing future benefits.

Unfortunately, unless a household is cash-strapped or a recipient’s health is poor, there’s rarely a reason to apply for Social Security before full retirement age.

Starting early will have a lasting impact to monthly payouts. For example, a person with a full retirement age of 66 who started Social Security at age 62 would experience a permanent 25% annual reduction in benefits.

When I began my career in financial services during the great bull market of the 80s and 90s, the numbers worked out favorably for a Social Security recipient to apply for benefits early and invest the difference.

Since the year 2000, this strategy has been less effective. Over the last sixteen years I’ve witnessed improving life spans, people working longer and unattractive returns on investment assets, which has made Social Security a formidable hedge against longevity and adverse portfolio conditions.

In addition, Social Security has become a stealth, forced ‘savings’ program for a majority of households stressed to save for retirement in the face of rising college costs, financially caring for elderly parents and adult children, underwater mortgages and chronic underemployment.

For most recipients, waiting until age 70 to take advantage of an 8% delayed retirement credit is a smart strategy. In a majority of cases a retiree should seek to postpone Social Security, enjoy a permanent 8% bump in benefits, along with annual COLA (Cost-Of-Living-Adjustments).

Question #3: What should I be afraid of? I don’t really know.

This retirement game is unfamiliar territory. You’re outside the safe or familiar zone (which in The Walking Dead, is a dangerous place to be). Don’t be shy. Nothing is off limits. After all, this is a new experience. You’re not an expert (yet) at this next life phase.

Why not ask a tenured planner what you should fear? Better yet – ask friends and associates who have been retired – what did they find scary about this new world? What had they overlooked? What are the mistakes they’ve learned from? What were their greatest oversights?

There could be enemies hiding in plain sight (it’s tough to trust anyone in a world overrun by zombies), that may be overlooked because you’re too close to the situation.

Frequently I receive questions about fear in retirement. They usually have little to do with money. Ostensibly, information regarding Social Security, healthcare costs in retirement and other crucial topics, is widely available. A comprehensive retirement plan will cover all important financial concerns as well.

What’s difficult to find because a person needs to live it to learn it, is information on how emotionally challenging it is to navigate from the accumulation side of the household balance sheet to the distribution mindset – The new reality where a retiree must depend upon his or her assets to survive. Being outside the protective walls of a job or career is rarely discussed in financial planning circles.

From my experience, it takes at least a year for a retiree to gain comfort with a change in lifestyle, a satisfactory portfolio withdrawal rate, a new purpose for a life away from the office.

Never lose sight of the power of simple questions.

If they can keep the survivors of a zombie apocalypse alive.

Think about what they can do for you.

 

 

 

 

 

 

 

 

 

Rules To Live & Die By: Life, Money & Otherwise.

Aside

I appreciate rules.

Rules derived from the heart and mind have saved me.

Rules, forged from experience, can safeguard precious resources – financial and otherwise.

They will protect you from losing your pants.

just got naked

Naked rules are best.

Pure, simple, raw.

Here are mine.

What are yours?

 

Random Thoughts:

Part I: Life Rules.

my life my rules

 

If a woman can’t listen to the Eagles’song Lyin’ Eyes without wincing, or quickly changes the station, run.

Beware of people who carry a stash of ’emergency’ condoms (indeed run, but feel free to have sex first).

You can’t wipe your ass enough (especially men – we’re the worst). When you believe it’s all clear in the deep, take another swipe. Just to be safe.

Never trust a person who rarely uses turn signals.

Be cautious of those who judge based on past mistakes when they’ve made the same ones or worse.

Don’t step back without looking (there’s a dog there, especially in the kitchen).

Never let open wine go to waste. Never. (Did I say never?).

Distrustful people are black pitch through the soul. Avoid them.

Be wary of those who can’t maintain close long-term relationships of any kind.

When I ignore rules I create, bad things happen.

Misjudgments remain with me. I see injury in the mirror every day. I lose a spark that will most likely, never return. Perhaps it’s part of a natural process, like aging.

Living without a personal guide book can hurt you.

Along with Clarity’s Chief Market Strategist Lance Roberts, we’ve created rules to help you protect and understand the key drivers of your wealth.

Remember – For every beginning there is an end. Investments have a shelf life. Eventually you’ll need to liquidate them to fulfill a financial goal, create a paycheck in retirement, gift to loved ones. Whatever. Money is to be spent, enjoyed.

Not hoarded.

And yes, you can indeed sell investments to protect capital.

Huh? What?

Sell: The scariest 4-letter word on Wall Street.  Just the mention of it and you’re branded a loon. Leprotic, running amok and licking the neighborhood children.

Part II: Investment Rules:

Cut losers short. Let winners run. Underperforming positions are reduced or removed from portfolios on rallies.

Set financial life benchmarks and take action. Every position purchased has a sell target. Investments without goals are arbitrary, which increases portfolio risk.

Emotional biases are not part of the investment management process.

Follow the trend. 80% of portfolio performance is determined by the underlying trend.

And the current trend is south. 

SP500-MarketUpdate-011516-2.png

When markets break their long-term bullish trend supports combined with important long-term sell signals and a sharp decline in momentum, it has historically denoted the start of a “bear market trend.” The red highlight denotes the start of the bear market. The yellow highlight shows the ensuing bear market completion.

Never let a profit turn into a “loss.”

Investment discipline is successful if consistently followed.

Losses are part of the investment process. Losing positions are regularly culled to reduce portfolio risk and free up capital for better investment selections. However, you can’t completely avoid losses. Sorry. If that’s the case you’re better off in certificates of deposit. You can minimize but not eliminate. You play, you pay.

Math-Of-Loss-122115.png

As fiduciaries of OTHER PEOPLE’S money, the biggest concern is not how much money we make during market advances, but rather how much we keep from losing during market declines.

While this seems counter-intuitive, in reality it is where long-term gains are generated. As William Lippman, CEO of Investment Management at Franklin Templeton quipped:

“Better to preserve capital on the downside rather than outperform on the upside”

A strict discipline of portfolio risk management will NOT eliminate all losses in portfolios. However, it will minimize the capital destruction to a level that can be dealt with logically, rather than emotionally.

This isn’t market timing, people. That doesn’t work. ‘All-or-none’ is a losing strategy. Never go all cash. From a management standpoint, this is a bad idea. Trying to “time the market” is impossible over the long-term and leads to very poor emotionally based decision making.

The objective is to reduce portfolio risk to manageable levels to preserve capital over time. We can do that by increasing and reducing our exposure to equity-related risk by paying attention to the price trends of the market.Odds of success greatly improve when the fundamentals are confirmed by the technical indicators (see? Another rule).

Don’t add to a losing position. This is called “averaging down” and rarely is it effective. How many investors are caught in the energy sector value trap? Or treated master limited partnerships ‘safe’ as fixed instruments?

The slide has been ugly and getting uglier.

XLE-011516

Don’t be a hero. Buying energy or “averaging down” at this juncture will most likely be hazardous to your wealth.

Markets are “bullish” or “bearish.” Remain neutral or long in bull markets. In bear markets be neutral and increase cash.

When markets or portfolio positions are trading at extreme deviations from long term trends, do the opposite of “the herd.”

If you haven’t trimmed positions yet –Wait for an opportune time. Most likely, a  market bounce is coming. Trim your weakest holdings into strength especially if your gut is in turmoil or you’re 5 years or closer to retirement.

A goal of portfolio management is to achieve a 70% success rate. No process is perfect. Consistency wins the long game.

Manage risk and volatility, not returns. Also, manage emotions. Humans are not wired to invest. Knee-jerk reactions, overconfidence, seeing trends that don’t exist will only destroy portfolio returns.

Never discount the importance of financial planning. The investment process is an element of a financial plan. An important one. However, it’s not the full story. It’s the sexiest chapter, I know.

There’s more to consider.

So we created.

Part III: Clarity’s Financial Planning Rules.

Take a holistic approach. Proper planning integrates all assets, liabilities and sources of income for a complete perspective.

Money is fungible. For planning to be effective, remove the mental boundaries around the dollars you earn and save so they may be allocated to their highest and best use.

Don’t discount Social Security strategies. Take steps to maximize earned benefits. Coordinate Social Security withdrawals with those of other accounts to minimize the impact of taxes.

Healthcare costs including Medicare, and senior housing options must be included in the planning process.

Successful plans are grounded in financial self-awareness which includes prioritizing needs and wants.

Conversations with loved ones and friends about aspects of your financial plan are important. Make sure your estate, gifting and future housing intentions are clearly communicated.

Don’t Get Fooled By Averages. The financial markets do not return 8% a year. A realistic financial plan includes variability in returns, including losses, over time.

Accountability Matters. A financial plan not followed is not a financial plan at all. Long term financial goals need to be broken down into monthly objectives and you and your adviser are accountable in meeting those objectives. (It is easier to consider a savings goal of $500/month versus $6000/yr.) Mental trickery works. Milestones broken down to millstones will convince your brain to take action. Move forward.

Rules.

Boundaries.

They work.

Follow them.

Survive.

With less wear on your face.

Less dark circles under the eyes.

You’ll preserve joy in your heart.

Stamina.

Will be yours.

And you’ll live to play another day.

For a glossy (fancy) copy of our investment and planning rules email me at RichardRosso@myclarityfinancial.com.

Charts by Lance Roberts. Sign up for his weekly market/economic newsletter at http://www.realinvestmentadvice.com.

10 Resolutions in ’16: Simple Steps to Your Financial Best.

Most likely money is at the top of your resolution list – Whether it’s to increase savings, pay down debts, find a new job, purchase a house or auto, financial aspirations abound in January.

Resolutions start strong. Unfortunately, as the novelty of a new year fades, so does motivation to stick to a list.

happy new year vintage

What if I told you that financial goals don’t need to be onerous to make an impact to your bottom line.

Millstones, as I call them, lead to milestones. You’ll be empowered, less frustrated if you keep your financial improvement list simple.

Here are ten ideas to consider for 2016.

Finally ditch the brick and mortar bank. An unusual event occurred after the Federal Reserve raised short-term interest rates by a quarter-point after seven years of holding steadfast to a zero interest rate policy. Several banks were quick to increase lending rates to creditworthy customers but kept deposit rates unchanged.

Historically, deposit rates on savings accounts, certificates of deposit, and money markets tend to correlate with changes in federal funds rates. Not this time. Savers lose again. In 2016 take a stand. Transfer your emergency cash or savings to a virtual bank. Online banks are FDIC-insured and with less overhead costs, offer attractive yields compared to a bank with physical bank locations. Several offer ATM fee rebates, too. Check out Nerdwallet’s list of top high-yield online savings accounts.

Keep an eye out for yet another refinancing opportunity. I know – Most financial ‘pundits’ are claiming higher interest rates in 2016. I see a sluggish economy ahead. Since mortgage rates are driven by demand and moves in the ten-year Treasury rate, don’t be surprised if 2016 provides another chance to refinance your home mortgage. A decision to refinance should be based on additional monthly savings and how long it will take to breakeven after closing costs. An easy-to-use refinancing calculator is available at www.zillow.com.

Initiate a balance transfer. According to Nerdwallet, the average American household carries $15,355 in credit card debt. Be proactive in 2016 and move your high-interest debt to a balance transfer credit card. If your household credit card balances are $5,000 or greater, consider reducing retirement contributions to the company match and direct additional cash to paying off credit card debt.

Use smartphone applications to save on purchases and track spending. Make technology your financial partner in 2016. Use the Mint app to track financial activity, Shopkick to browse products and find deals at major retailers. Download Ibotta, an Android and IPhone app that allows users to unlock rebates to earn cash on purchases.  

Buy off-season. Maintain an ‘off-kilter’ sense of finance. Purchase holiday décor and greeting cards after the respective season. Think Christmas cards in January. Shop for real estate during winter, summer items in the fall, and so on. Thepeacefulmom.com has thoroughly researched and lists by month the best times to buy everything.

Do a better job protecting your identity. Avoid public Wi-Fi to access secure information or shop, password protect your electronic devices and check your credit card statements monthly for suspicious activity. Place a freeze on your credit files with the three major credit bureaus. Before applying for credit a freeze can be removed easily using a password or PIN. There may fees to initiate security freezes. However, costs are nominal ($5-$10) and worth it to protect against identity theft. The Federal Trade Commission offers a FAQ  page to make it easier to understand how credit freezes work.

Check your credit report. Every January make it a habit to check your credit report for free at www.annualcreditreport.com. Examine your report closely for discrepancies and rectify promptly with the credit reporting agencies. The Consumer Financial Protection Bureau outlines common credit report errors to identify.

Curb your impulses. Make 2016 the year of the wait. Before a purchase of greater than $50, delay for 7 days. If you still want the item or service after the wait period, move forward. Holding off will reduce impulse spending and allow you to think before spending. Seven days has been an effective time frame from my experiences with people I counsel. If super-ambitious, wait 14 days. If you can’t wait days, at least give the decision 24 hours.

Purchase a shredder. Simple identify theft solutions remain effective. Shredding documents should be an ongoing exercise. Shredders are inexpensive. Invest in a micro-cut shredder for maximum security protection. I’m shocked by the number of times I’m told that shredding seems unnecessary. Throwing intact personal documents, bills, statements in the trash is asking for trouble.

Develop a money principle. Dig deep. Early in the year is a great opportunity to develop or fine-tune a money philosophy. Keep your thoughts short. Make them passionate. Consider how money fits positively in your life and what you can do to reach goals, control spending, reduce debts or earn a higher income this year.

Financial resolutions are strongest when simple. Consider these 10 small steps to financial enrichment and live a fiscally healthy new year.

 

 

5 Ways To Be Pet-Savvy & Money Smart This Holiday.

A version of this writing appears in MarketWatch’s Retirement Weekly.

puppy antlersThe stockings full of toys and treats, new collars, novelty costumes, sweaters, holiday photographs and personalized tree decorations.

The list can take a bite out of your holiday budget.

This year I polled 500 pet owners and discovered they’ll spend a record average $125 on their wet-nosed companions this holiday season. An increase of 13% over 2014. According to the American Pet Product Association, Americans spend in excess of $5 billion dollars annually on holiday gifts for pets.

I’m guilty of overspending. It’s not only my fur family that gets spoiled. Animals awaiting good homes in shelters benefit from my generosity, too.

It’s easy to get carried away as spending on our pets generates feelings of well-being.

I discovered ways to be in greater control and exercise money smarts this season and yet still fulfill my need to pamper and delight.

Here are some money-savvy ways to collar your pet spending for the holidays.

Random Thoughts:

Upgrade food and treats to reduce long-term pet care expenses. Don’t skimp on the quality of food and treats to save money. Here’s why – Pet healthcare costs are increasing at a rapid rate. For those I counsel, roughly 11 percent a year.

Nutrition-dense, high-quality foods may keep your pet healthier for a longer period and help you minimize large medical bills later. Think of it as part of a preventative health regimen for your four-legged brethren.

Chemically-processed food is disruptive to pet health.  According to the International Boarding & Pet Services Association, better food provides an overall boost in the immune system and improved health over the long term with less stress on a pet’s organs. The cost of higher quality food over the life of a pet will be offset by lower veterinary bills and reduced risk of health issues that are a result of improper nutrition. Meat or meat meal should be the primary ingredients with minimal grains.

There are several ways to save on the cost of quality pet food and treats. The simplest way is to receive e-mail updates directly from the manufacturer. For example, www.merrickpetcare.com is a high-quality provider. They provide special offers and product updates for consumers who join their mailing list.

Shop online at www.petfooddirect.com for sale items on name brands and save at least 15% when you establish auto-ship on many high-quality varieties of food and treats.

Investigate pet insurance options as you shop for holiday deals. Years ago, I was against medical insurance for pets. Policies were expensive, choices were limited and not enough medical conditions were covered to justify the premiums.

My opinion has changed.

As healthcare expenses have skyrocketed, pet parents have become vulnerable to financial risks that come with major illnesses and emergencies, some that add up to thousands of dollars. Without insurance, an increasing number of people have had to make heartbreaking decisions when up against the potential financial impact of cost-prohibitive medical treatments that could have prolonged the lives of their pets.

The pet insurance industry has grown 13% every year since 2009. Most likely a result of the Great Recession as American families have limited ability to take on large pet-related health costs. It’s best today to mitigate risk through the use of insurance.

Search for a policy using www.petinsurancereview.com. The site has a helpful ‘compare pet insurance features’ grid which outlines reimbursement amounts (after deductibles), payout caps, deductible amounts, monthly costs, limits and items not covered.

Keep in mind – it costs more to insure dogs, pre-existing conditions will generally not be covered (so best to obtain coverage while your pet is healthy), you will pay a deductible and the most policies do not cover preventative maintenance like vaccines, heartworm prevention and annual checkups. The ones that do are not worth the higher premiums.

Monitor what you spend on holiday novelties and outfits. The cost of holiday-themed toys and cute outfits can dramatically eat into your budget. It’s not uncommon for pet parents to splurge on holiday-inspired garb without a second thought to price. Pet retailers will sell out of most of their inventory weeks or months ahead of the holiday. They rarely need to place the merchandise on sale which shows how passionate we are about dressing up our pets for the holidays.

Your best bet to save big bucks on holiday dress-up and goodies is to search deals online and purchase items post-holiday or off-season. I discovered the best clearance deals at www.doggieclothesline.com, www.baxterboo.com and www.petmountain.com.

Tis’ the season to avoid big veterinary bills. We have a tendency to overindulge during the holidays. Sweets (especially chocolate), turkey bones, adult holiday beverages and fatty, spicy leftovers may sound good, but they can cause health issues (some dangerous) for pets and unforeseen expenses for us. Seasonal plants and decorations accidently ingested can cause health issues, too.

Holiday safety tips are available at www.aspca.org. Just type in the word ‘holiday’ in the search box adjacent to the donation link.

And speaking of donations:

Consider a charitable gift to a pet-friendly organization. Whether it’s the ASPCA, a local animal shelter, or an organization that spay-neuters homeless dogs and cats like SNAP in Houston, a 501(c)(3) non-profit agency may make you eligible for a tax deduction.

Charitable contributions are deductible if you itemize. Generally, contributions can be deducted up to 50% of adjusted gross income for qualified public charities. Consult IRS publication 506, your tax advisor or ask a representative for the organization you wish to benefit.

Pets are family. Unfortunately, they’re also becoming luxuries for some households as costs to keep them healthy and happy continue to trend higher than the general rate of inflation.

A money-smart attitude will keep you out of the financial dog house year round.

cat holiday

4 Reasons To Embrace An Imperfect Retirement Plan.

Featured

A version of this writing appears in MarketWatch.

The recent downturn in the stock market has placed an important decision on the back burner.

It’s not strange to change direction through a storm of uncertainty. Through a volatile period it’s not unusual to move a retirement date out, continue to collect a paycheck, bolster savings and reduce debts.

I hear it often – “I’ll work just one more year.”

The working dead

On the surface, it feels right to wait.

I call it ‘failure to launch.’

There’s never an opportune time to retire, regardless of the preparation and the formal financial planning undertaken to ensure lift-off. Frankly, even when the stock market is on solid footing people tend to find reasons to delay the next step.

It’s perfectly understandable. It’s human to feel vulnerable at the crossroad of a life-changing moment especially when the moment has arrived.

The financial planning process can inadvertently exacerbate “launch dysfunction.” It’s also in a planner’s nature to be conservative and advocate a decision to wait for a better time (whenever that is).

I’ve discovered after hundreds of retirement discussions and volumes of plans delivered, that the decision to wait is rooted in an overdependence on the successful outcomes of formal retirement plans designed to predict the survivability of assets to meet lifestyle expenses for three decades or longer.

But is that practical?

No.

Before you decide to undergo retirement planning, you must make peace with the fact that the entire process is extraordinarily imperfect, like you and me.

Retirement plans are 20% science and 80% forecast (or art).

Unfortunately, there are elements you will never be able to predict with complete accuracy. You may not live to 95 even though you believe it to be true.  Future market returns are an educated guess at best.

Instead of waiting for every financial star to align before retirement, consider the following random thoughts:

You’re better off with formal retirement planning, than not. People who begin formal planning early on, five to ten years before retirement, increase the odds of a successful launch date compared to those who begin late or not at all.

A plan which includes a complete inventory of assets, liabilities and future goals coupled with assumptions for inflation and realistic future investment return simulations helps you gain invaluable intelligence early that can be used to create an ongoing action plan to validate positive financial habits and minimize the impact of weaknesses.

A plan is not right or wrong, successful or unsuccessful. It’s not a threat, or a reason to be chastised for poor fiscal behavior. The first iteration is the start of a long-term educational process, an awareness and ongoing tuning of financial strengths that apex at a launch point I call ‘escape velocity.’

Consider escape velocity a financial trajectory that launches a retiree successfully through the first decade of expenses and withdrawals with minimal negative impact to investment assets. Academic studies outline how the first ten years of asset drawdowns is crucial to the survival of a portfolio over the next twenty.

Within a plan, your financial life is run through a simulation to determine probabilities of success which comes down to your money lasting as long as you do (or longer if you wish to leave assets behind for others).

You’ll see, how in the face of withdrawals and changing market returns, your asset values ebb and flow. Through great bull markets (best case), bear markets (worst case hope not) and somewhere in between.

If your assets can make it through the first ten years successfully. And I mean at a 75% or greater probability of success, you are ready to launch into imperfect retirement mode as long as expenses are monitored annually and changes are made to reduce lifestyle expenses.

I’m not saying it’ll be clear sailing. Or you won’t need to adjust mid-flight: Work part-time, cut costs, downsize.

Most likely, you will.

I’m saying there’s a delicate balance at stake. A point of no return to consider.

Either retire early enough to enjoy the experience, forsake a perfect planning outcome, take a leap of faith, or wait until your probabilities of success through the worst market cycle is 95% or greater. By then it may be too late due to health issues and aging. The retirement you hoped for may be one you regret.

You see, this is the art part. When you’re planning to travel a path three decades long, science fades into the dark pitch of road and creativity and faith take over, more often than not.

Mentally, you must let go of perfection and consider multiple detours to navigate the imperfect.

Be overly (insanely) cautious the first five years.  Academic work by financial planner, speaker and educator Michael Kitces and Professor Wade Pfau outlines how your asset allocation should be conservative in the early stages of retirement, especially in the face of lofty stock valuations.

Generally, I have retirees reduce equity exposure by 20% at the beginning of retirement and I’m not opposed to holding 2-5 years’ worth of cash or cash equivalents for withdrawals and to eventually purchase stocks at lower prices.

You’re thinking cash doesn’t earn anything. Well, it doesn’t lose anything, either. You can make up losses due to inflation. Principal erosion due to market losses is an entirely different story.

What most investors do not realize currently is that they could hold cash today and in five years will likely be better off. However, since making such a suggestion is strictly “taboo” because one might “miss some upside,” it becomes extremely important for measures to be put into place to protect investment capital from downturns.

Friend and business partner Lance Roberts provides the following chart which outlines the inflation adjusted return of $100 invested in the S&P 500 (using data provided by Dr. Robert Shiller).

The chart also shows Dr. Shiller’s CAPE ratio. We capped the CAPE ratio at 23x earnings which has historically been the peak of secular bull markets in the past. Lastly, we calculated a simple cash/stock switching model which buys stocks at a CAPE ratio of 6x or less and moves to cash at a ratio of 23x.

The value of holding cash has been adjusted for the annual inflation rate which is why during the sharp rise in inflation in the 1970’s there is a downward slope in the value of cash.

However, while the value of cash is adjusted for purchasing power in terms of acquiring goods or services in the future, the impact of inflation on cash as an asset with respect to reinvestment may be different since asset prices are negatively impacted by spiking inflation. In such an event, cash gains purchasing power parity in the future if assets prices fall more than inflation rises.

The importance of “cash” as an asset class is revealed.

While the cash did lose relative purchasing power, due to inflation, the benefits of having capital to invest at low valuations produced substantial outperformance over waiting for previously destroyed investment capital to recover.

While we can debate over methodologies, allocations, etc., the point here is that “time frames” are crucial in the discussion of cash as an asset class. If an individual is “literally” burying cash in their backyard, then the discussion of loss of purchasing power is appropriate. However, if the holding of cash is a “tactical” holding to avoid short-term destruction of capital, then the protection afforded outweighs the loss of purchasing power in the distant future.

Cash is not exciting. However, the excitement at the beginning of retirement should be about the memories you build, not the money you can potentially lose in stocks.

Real value of cash

Cover as much fixed expenses as possible with income you can’t outlive. Maximizing Social Security payouts and minimizing taxes on those payments by coordinating benefits received with withdrawals from investment assets, can add thousands to your household cash flow over a lifetime.

Social Security is an income stream you can’t outlive and should not be discounted in your retirement analysis. It needs to be a crucial element of your written plan.

Creating a pension through the use of deferred income or single-premium annuities can supplement social security and bolster your income for life.

Investors fear annuities. Financial pundits on the radio and in print advise how annuities “are bad.” If you’re purchasing annuities, you’re most likely taking money away from them as advisors. Understand the motives behind negative blanket statements about annuities.

Not all annuities are the same.

Consider the word annuity means “a fixed sum of money paid to someone each year, typically for life.”

Social Security is an annuity, right?

The combination of Social Security plus income annuities can be employed to cover expenses you must pay – think rent, food and insurance. Leaving your variable assets like stocks as supplements to your income requirements.

Avoid variable annuities. They are unnecessary and expensive. When you think negatively about annuities, it’s the variable ones you’re most likely referencing.

Decrease cash outflow throughout retirement.  The first two years of retirement is a soul-searching expedition. It’s also a period where I witness retirees highly sensitive to stress and anguish from having too much ‘stuff,’ large homes and big overhead.

Reducing financial pressure by going smaller generates great emotional benefits. Monetary bandwidth can be built into your budget. If you’re prepared to reduce portfolio withdrawal rates through rough market periods without seriously inhibiting your lifestyle, then an imperfect retirement mindset can work.

An imperfect retirement strategy is not “set it and forget it.”

Throughout, you must be willing to regularly meet with your financial partner to analyze withdrawals market cycles and adjust accordingly. In addition, you need to be receptive to change and flexibility. Even be open to part-time employment to increase household income.

Because waiting for perfection is not practical or realistic.

And a life is at stake.

Yours.

imperfect striving