Tag Archives: risk tolerance

I Resolve: Six Resolutions for Retirement Planning in the New Year

  By petillo | December 31, 2011 - 7:49 am | 401k, Boomers, commentary, debt, ETFs, exchange traded funds, financial planning, index funds, IRA, Paul Petillo, Repercussions: A Retirement Review, Retirement Planning Target 2025, risk, women and finances, women and retirement
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Jimi Hendrix once wrote: “I used to live in a room full of mirrors; all I could see was me. I take my spirit and I crash my mirrors, now the whole world is here for me to see.” When it comes to the reflection staring back at us, our retirement, like those images, are a search for imperfection. We don’t look at ourselves to admire how good we look; we look for flaws. We don’t imagine a future; we see the relics of past decisions.

If you consider yourself a Baby Boomer, the reflection in the mirror is an image that polarizes: we are comfortable in the what the future holds or we are worried. There is good reasons for this feeling of either hope or dispair, with no real middle ground. This group has seen the demise of the defined benefit plan (pensions) and the introduction of the defined contribution plan (401(k)). You have seen the greatest bull market in investing history and witnessed two major crashes that have rattled your confidence in the decade following. You are the first generation to realize that your future is in your hands and you were not ready for the responsibility.

If you are younger than a Boomer, you are the first  generation to have never seen any other opportunity to finance your future than with a 401(k). And you have come to realize that this is not the plan it was intended to be. 401(k) plans were not designed to be the one and only vehicle for retirement. We were sold a notion that this was the end-all-to-be-all plan that would afford us a better retirement than our parents only to find out that it hinged on two extremely volatile concepts: your ability to consistently earn money and your level of contribution. Your 401(k) became your anchor and your wings.

I imagine that many of you will look back on the highlights of 2011 and find yourself in either one or two camps: you were able to hold onto your job, pay your bills and put some money away for retirement or you will be looking back at a year of indecision, regret and the promise to do better in 2012. You may be celebrating simply getting through it or wishing it never happened. To that, I offer some simple resolutions to embrace in 2012.

One: Revisit your idea of retirement. You can promise to save more money for your future, increasing your contribution to your plan or perhaps, in the absence of a plan, begin one of your own using IRAs. But you do this without really looking at that future. Retirement will not be the same of any two of us. For some it will be a life of struggle, an ongoing effort to make ends meet when they may never  met while they were working. For some it will be the realization that the balance between the now and the future relies on a level of personal sacrifice we were smart enough to embrace while we were working. For others, it will simply be a resignation of sorts, a belief that it will never happen.

Retirement is three things: A time when we find new opportunities outside the confines of what we called a career, a place of unimaginable risk and/or a chance to take a breather. It is not a place of no work and all play. It is not a time spent waiting for the end to come. It is not what we imagine because, if we looked closely at that image we see flaws. So we don’t look as closely at those who are retired, examine how they live and ask if this is what they had planned. In revisiting the idea of retirement, your concept of that future, consider looking closer. If you don’t like what you see, resolve to change it. But don’t look away.

Two: Don’t reflect on what you’ve done. You made mistakes; we all have. Some of us took too much risk, some not enough. Some contributed as much to their retirement as their budgets allowed, others did not. Some of us made poor mortgage or credit decisions, others did not. No matter what you did or didn’t do, looking back will not improve the look forward.

Looking forward doesn’t mean turning your back on on any of those events. It means focusing all of your energy on fixing them. This is a twofold effort, the first being getting the budget you may not have in line with your paycheck and focusing on paying down your mortgage (keep in mind that even if your home is underwater – meaning your mortgage is greater than the value of the house itself – the interest you pay on than loan is eating away at your future invest-able or save-able dollars). Does this mean you should not put money away in a 401(k) plan and redirect every dollar to the day-to-day? Not at all. Keep in mind that a 5% contribution will, in almost every instance, not impact your take home pay.

Three: Don’t over think the process. From every corner of the financial world you will hear: rebalance your 401(k). If you chose a minimum of four index funds spread across four sectors, or four ETFs that do the same thing, rebalancing is a waste of time. You diversify so you can capture ups in one market and downside moves in another and your contribution doesn’t allow you to buy more when one market moves up and allows you to buy more when it goes down.

We want to think we are in control when in fact, the only thing you actually control is how much money you want to put in. Markets will do what they do best: move. It might be up one day and down the next. It doesn’t really matter. What matters is that you do something and in 2012, it should be significantly more than you are doing now.

Four: Stop being selfless. One of the hurdles we are told, for women investors specifically, is their inability to put themselves before their family. This is a cause for concern of course but not  a disaster in the making. Take a good long and hard look at your family and ask yourself: could I spend my retirement years living with any of them? Do they want you to?

Five: Embrace the truth. Now there will be an increased amount of pressure from every financial professional to get advice on your investments. This educational effort will evolve in the next several years from long, drawn out seminars on how your 401(k) works to short, ADD friendly videos that last several minutes and offer key points on what to do. The truth still relies on your ability to put more money away. Five percent will net you 25% of your current take home in retirement. A ten percent contribution over the average working career will pay you about 50% of what you earn today in retirement. Fifteen percent contributed to a 401(k) plan with average (modest) historical returns will allow you to live on 75% of your current income. Can you handle that truth?

Six: Stop worrying about it. According to HealthGuidance.org, you are killing yourself with worry. Michael Thomas writes: “Worrying leads to stress and stress has been linked with a number of health problems. People who suffer from high levels of stress are much more prone to cardiovascular disease, gastrointestinal issues, weight problems and there has even been a link made between stress levels and certain cancers.” Instead resolve to do more saving than you have ever done, spend less than you did last year and embrace the reality of what fixed income is. Retirement is fixed income. Resolve to live like that now.

Your Retirement Plan: Safety Isn’t the Issue

  By petillo | November 30, 2011 - 6:07 am | 401k, commentary, financial planning, Paul Petillo, personal finance, Profitable Investments, Repercussions: A Retirement Review, Retirement Planning Target 2025, women and finances, women and retirement
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We like to think, even assume that we are reasonable. When it comes to investing, this “reason” is often called rational and when it comes to retirement, the rational is often the replacement for risk. Three Rs: reason, rationality, and risk and each one plays a role in our success and almost just as often, our success at investing, both in the present tense and in our future plans. Which makes the argument that safety somehow plays a role in not only how far we go but how long our money is likely to last.

Our reasonableness is worn as a badge of experience. We think therefore we are apt to make reasonable, well-thought out decisions that have both the benefit of our experience and the foresight that experience has brought us. Except that we were as the saying goes, “so much younger then, we’re older than that now”. And that youthfulness we once wore in such cavalier fashion has given way to our ability to take a lofty position when it comes to our retirement.

That’s right, lofty. It is something Peter Singer, professor of bioethics at Princeton and author of “The Expanding Circle” termed as an “escalator of reason” lifting us to a vantage point where we finally see that our interest are intertwined with the interest of others and because of that, do not matter more. As we plan for the future, we tend to make the mistake that is often considered a “good move”, we play it safe.

Safe means never getting on that escalator, never looking for a vantage point and never believing that we are all somehow tied to the same raft – or balloon. Our feeling that we are in this alone, the world of investing is the enemy and we are either smarter than the rest or, on the flip side, not as dumb, has propelled us into dangerous territory.

Reason has led us to believe we are smart and smart is good. Right? Yet, where has it gotten you? Smart now is not as smart as it was in the past. The Flynn Effect, named  for the philosopher who suggested that since I.Q. test were first administered, we have been getting smarter. Keep in mind that these tests, even as standardized as they are, become more challenging in each successive year, test your abstract reasoning. Not math, not language, not the tools we use to portray how smart we are, but the way we use them.

To be reasonable is no easy feat. It should lead to rational behavior. It should make us more cognizant of the potential of each decision and allow us to understand exactly what risk is and what role it plays. So we are smart enough – at least the rising I.Q. scores point towards that and in the last decade or so, the increased number of women into the investment community to assume that this should have made everything more stable. At least a reasonable thinker might assume that: we are smart and women are more pragmatic and that said, volatility should more or less level out, even to the point where it is only discussed in passing.

If Steven Pinker’s recent book about the decline of violence “Better Angels of Our Nature” is evidence, and he suggests in what one reviewer called a “masterly achievement” that violence has declined because of, but only in part because there are so many more of us than when the world was younger, do numbers make the market? With more market participants, shouldn’t this also be the case? Shouldn’t safety in numbers level the playing field for all of us?

So where is this volatility coming from in the markets we participate in even as there are more of us involved? Is it the few dictating for the rest of us or is it some lack of reasonable and rational insight that makes us seek a risk-free, dark corner instead of the opposite? When it comes to investing, risk is needed. Any assessment of your own “tolerance” – a word that suggest we have used reason and rational thinking to determine how much risk we can stomach – should lead us to a diversified approach to this process.

Yet this assessment has instead suggested that we find the safest place for our investments. And in doing so, we agree that we have more time to plan and grow our money than previous generations. Truth is, time is on our side if we assume more risk than we have been. We rationalize: we will have to work longer, why is it that we do not use that premise to make slightly more risky choices and when we do, stick with them?

I am not suggesting that you “go all in” with your investments. But a retreat to no risk offers us no opportunity to get close to what we see as a reasonable retirement goal. Roger Wohlner writes: “As I generally say to anyone saving for retirement, your biggest risk is the loss of future purchasing power, as opposed to a loss of principal due to a decline in your investments. Said another way, the biggest risk in retirement is outliving your assets.” This is risk we base on fear  and if as Seneca wrote in Epistles “if we let things terrify us, life will not be worth living” we are missing the reasonable and rational motivations of investing.

We will live longer modern medicine and actuaries suggest. And when we hear this, we make what appears to be the next logical leap in the process: we will work longer which will allow us to save/invest more which means – based on that reasoning, so be more conservative. We tell our youth to take a risk when it comes to investing because they will have time to recover from any market swings. So why do we avoid the same advice when we add so many more years to the equation of our own working lives?

Our portfolio construction should be diversified and that means some risk is needed, even necessary. If there are more investors investing and the numbers seem to be growing with revisions to 401(k) plans (through auto-enrollment and auto-escalation to name a few), then taking some risk is both rational and reasonable. The more us that assume some risk, then lower the overall volatility And it might give you the opportunity to retire sooner rather than later.


Risk: Investment Science

  By petillo | October 10, 2009 - 6:17 pm | Retirement Planning Target 2025
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Last week, on the radio show I appear on as a regular guest, I suggested that instead of trying to determine what your risk tolerance was, you should instead think about what makes you anxious. This anxiety tolerance takes a more introspective view of who you are rather than what your investments might be doing. It requires, among other things, that you turn off the media.

Streaming into your living room is an after-the-fact representation of what the markets are doing. Even real time reports are not so much real time as a tool for edgy traders to plot their next move. If you really care about what your retirement accounts are doing, in terms of what they will provide ten, twenty or even thirty years down the road, looking at this type of data will force to re-examine what you may have previously thought was a good idea.

Although there is a science to investing, it is far less competent at coaxing the truth or any sort of conclusion from the available data. The markets, pushed by human emotion (even if it is pre-programmed into a computer via modeling) fail to give you a true perspective, something that you would consider concrete, undeniable and/or truthful. This sort of representation is enough to make even the most savvy investor squeamish.

The knee-jerk reaction, the one a vast majority of investors are considering or have already begun is a move back to less risk. As banks fail, as markets gyrate, and as the recovery, albeit jobless, begins, some basic things should be kept, not in the back of your mind, but in the forefront.

No risk means saving. This is the traditional approach to keeping your money close at hand, for emergencies. It comes with risk as well. There is the inflation risk. Currently at or around zero, inflation strips the value of your dollar by making it worth less in the future. Without the interest that savings provides, each dollar saved will have less buying power. In an inflationary environment, that interest paid to you must beat inflation (even if you use the historic reference point of 3.5%).

And it must beat taxes. These will always rise, if not right up front, the increases will be felt through the products we buy, the business we conduct or the income we earn. No risk, in other words, has some risk and it is mostly on the downside. (That doesn’t mean should abandon the emergency funds you are currently funding or stop you from getting one started.)

Your anxiety (or risk) tolerance may be forcing you to look for investments in your retirement accounts that take more risk than is desirable. Before we look at those types of investments, it is important to note that the reason you invest in your 401(k) is to provide income for a time when you no longer want to work (or work doing what you are doing).

For many of you, this has meant turning to the ever-present and often innocuous retirement calculator online. You enter into these tools, your current balance, which according to the latest Employee Benefits Research Institute report, is about $74,148 for the average 40 year-old. (The study reports data as of the year ending 2008.) While this down over 25% from the close of 2007, that figure represents a 35% increase for the investor in this age group since 2003.

The report also indicates that this was in-line with the stock markets performance over the same period. If you suffered less, it was due to diversification and the ability of the 401(k) to supply ongoing and consistent investment. This diversification was found using equity investments as the primary driver for the growth in these portfolios. In terms of asset allocation, 40% of this group allocated 80% or more of their assets to the equity markets, down only slightly from their years as a twenty-year old. (This group also owned about 11% of the remaining portion of their portfolios in their own company’s stock.

These contributions are, as one might expect, greater in your investment youth. Or they should be. Investment returns (and sometimes losses) are the result of many of the changes in portfolio valuations. Even after the losses experienced in this age group’s portfolios (28.5% in 2007-2008 and 5.8% in 2001-2002) the average account over a ten year period had increased 94%.

I have suggested that you should contribute at least 5%, company match or not. If you begin with that average balance of $74k, in 25 years you will have breached the $250,000 mark using a conservative approach which has about 50% of your portfolio invested in equities. Reduce your exposure to bonds in that portfolio to 15% or less, and the same time span could leave you with a balance of four times as much.

In terms of risk, 2008 was a game-changer. While 64.5% of those with plans in 1998 found equities the most desirable of investments, by 2008 this sentiment had shifted to 41.9% with the shift to a more balanced approach such as lifecycle funds (an increase of over 300% and to bond funds, which posted a 100% increase from a decade ago. Although we are looking at the forty year-olds, the sixty year olds made essentially the same moves as their counterparts twenty years their junior.

Using a retirement calculator, based on a generous 5% withdrawal when you retire, at age 40 or younger, will not produce the retirement income (based on a growth rate of 8% after you retire, beginning with zero and ending with a balance of $250,000 and an inflation rate of a modest 3.5%) you might imagine. If you can live on $14,446 in the first year (excluding Social Security and if you are fortunate enough, pension payments) then you are on track. This will however, draw your balance to zero in thirty years or less, if your investments fail to meet the 8% mark, year over year.

2008 also brought a dramatic increase in the number of loans on these plans (90% offer some sort of loan available). Eighteen percent of you tapped these provisions with, the report cites, an average outstanding balance of $7100. This may have been money you thought you needed at the time. But what it represents has a far greater impact in the future.

So why are so many individuals shifting to a less riskier (less anxiety inducing) form of investment? Perhaps they simply do not know what they are setting themselves up for in twenty or more years.

There is the argument that these more conservative investments utilized by retirement investors are not as risk free as previously imagined. This could put an additional drag on perceived outcomes you and your calculator have projected.

All bonds, essentially an extension of credit are compared to what the US Treasury issues. The difference between what a bond yields against this measure suggests the creditworthiness of the bond. In other words, the closer the bond to the US Treasury, the safer it is.

And as we say safe, we also remind you what we have previously discussed about safety. Without some risk, the chances that your money will grow are greatly diminished.

While this complicates the purchase of a bond individually, it makes bond funds much more attractive and some respects, slightly more risky. And in lifecycle funds, the employment of bonds lowers the risk of too much equity while possibly increasing risk where safety is sought.

What if, as Eric Fry of the Daily Reckoning suggests, the creditworthiness of the US Treasury comes under pressure? It is extremely important to bonds that it have a good benchmark to use. He writes: “Are foreign sovereign issuers becoming MORE credit-worthy or is the US government becoming LESS credit-worthy? Or is it a little bit of both?”

This type of risk may undermine the best intentions of the retirement investor and those who invest for them from a direction they will be mostly unprepared to handle. Not only will the return they are seeking be less than than they need to get to where they are going, there is a possible risk that they will receive far less than they anticipated. Fixed income may not be so fixed.

There is a risk to the equity markets because of this possibility. Yet it is still one worth taking. Even if your anxiety tolerance will not let you go beyond the simplicity of an index fund, you will fair better over the long run that those who shift gradually to a more balanced approach with an increasing amount of bond type investments. I’m not adverse to adding to your portfolio a fund that offers even more diversity (even a conservative choice) but in many instances, investors simply reallocate existing contributions when they should, for the best possible balance, increase their contribution and direct these increases to the more conservative product.

There is a distinct possibility that too little risk will not perform as planned.

Paul Petillo is the Managing Editor of BlueCollarDollar.com