As I continue to write the book that is accompanying this site, I can’t help but marvel at the impact we are having on our retirements. Consider of sudden switch to conservative investing. Is this because we fear the worst could happen again? Are we simply trying to protect what we have?
To answer those questions, a paradox presents itself. If retirement is the goal, why would you handicap your chances of arriving when you imagined? Evidence of this shift has challenged those imaginations: Year-to-date (third quarter 2009), the US household sector is shown to have purchased $529 billion of US treasuries. Granted, a great deal of this was due to money flowing into more conservative 401(k) investments via mutual funds. This pace, the purchase of approximately 45% of what the Treasury was selling, is four times that of the previous year.
This sort of immunization has not gone unnoticed. The problem with many of these commitments to a more conservative approach may be creating a bubble of their own. These types of debt instruments are based on price and yield. As one goes up, the other goes down. The more someone is likely to pay for a bond, the lower the yield that is offered. If this sort of pace continues, and it looks as if it may as the temptation to be able to even consider retirement strengthens as the economy gradually improves.
But with more people flocking towards these fixed income investments, the price paid will begin to become unattractive, in large part because inflation remains benign. That won’t last forever. And when those conservative investors begin to realize that the yield is now negative to inflation, the selling will begin.
The real paradox will then kick in. Now what? Nothing seems to be working in the long-term, even if you are still looking at it in terms of six-months, one year of slightly longer. Long-term needs time to work its magic on a portfolio. I recently reported on the gains of actively managed funds over their index fund counterparts. This was part of a great machination referred to as “a cycle”. Up and down are realities of investing and offer something great for the investor the longer they are in place: the ability to buy low (in greater quantities) and not buy so much (when equities are priced high).
But this needs time. Too often, the siren call to rebalance is noticed at exactly the wrong time. You may not be able to time the markets, but rebalancing requires more than the simple approach of moving percentages around. If cycles occur regularly, won’t your investments find the rebalance on their own?
We often forget how a 401(k) works. You designate a certain percentage of your pre-tax income to the retirement plan at work. You diversify with what the smallest, least efficient plans offer and allocate one-fourth of your investment dollars to a small-cap index, a mid-cap index, a large-cap index and an international index.
You are set until forty. At that point, you begin to add another bond index fund or a balanced fund. (Keep in mind, I am thinking that the investor in question has only the most basic of choices in their fund. And keep in mind that bigger is not always better. Many plans offer too much and create investor confusion, a problem that forces them into making a single choice or none at all.) The key here is to keep increasing your percentage contribution, which should have begun with at least 5% and added each raise you received over the years – okay, perhaps a portion of it.
But huge shifts in how your invest lead to sales that shouldn’t happen, particularly if your investment has dropped off considerably. You may be buying in at the top of yet another bubble.
What to do if you already have made the shift, stung by huge losses? Stop sending money in the direction of those investments and get back to a little bit of risk. Let the cycle take its course.
The paradox continues in our heads. We want to retire but often fail to ask ourselves why. The vast majority of us love the concept of work. We could, conceivably find a way to continue to do so well into our seventies. And this may be the healthiest of antidotes for outliving your money.
For those of who have found the idea of extending a long work career one more minute than is necessary, should be more concerned about this cycle. The cycle will continue on its relentless shift with our without you, putting more pressure on some your investments at one time than they might on other investments in your portfolio. But the problem still remians, you ned to keep a steady flow of cash headed towards those retirement accounts even after you retire or you will need to lower your distribution from those accumulated assets. A popularly suggested (offered by me more than once and by others) distribution rate is 4%. Can you live on less? Or can you continue to produce an income?
Many of us will be able to retire when we want. Yet, long before we do so, we will wonder what it will be like, how viable we will be and whether work makes us who we are.
Or you can increase your contribution now, stay invested across many funds (at least four) and add conservative funds as you age. Believe it or not, the only other way to not outlive your money may be to wait to take your distribution. Which means, plan on working, a paradox that achieves the same thing.
Paul Petillo is the Managing Editor of Target2025.com
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Dear Paul,
FIrst let me say that I write as a fellow baby boomer, an entrepreneur of ten businesses, and a husband and father of six (from 4 to 18). While I recently ventured into the “fixed annuity” business, it was only because of the many issues addressed in your article. My business, AnnuitySpeak, provides independent analysis, in laymen’s terms, of fixed annuities and specific annuity products via AnnuitySpeak TV because there is such overhwhelming confusion enveloping this industry. Anyway, I digress.
I understand that no one has a crystal ball, and the financial future of this country, and globally, is one huge question mark. And even the most brilliant economists rarely agree on future predictions. But common sense provides me with a constant “gut” feeling that we’re in this thing for the long haul. (Whether that is 3 years, 5, 8? Once again, who knows?) It has taken our country a long time to accumulate $53 trillion in debt (when including monies unfunded for Social Security and Medicare) and to reach a pace of $2 trillion ANNUAL deficitis. The US government appears intoxicated with spending and there are no signs of abating. Unemployment continues its upward march. You only have to talk to friends and strangers about work, money, the cost of living and the myriad ways they are finding to “cut back” to understand that things are very, very different than any time in our lifetimes. So, for us baby boomers, what to do?
You said it best when you noted that the best antecdote to retirement woes are to continuing working as long as possible. That is ABSOLUTELY the best plan, providing your health holds up. But you also mention risk, diversifying risk, yet you failed to mention that fixed annuities offer tremendous diversity in that they eliminate the market risk of losing principal and index annuities even provide a fighting chance of a healthy, passive income. If the market “yo-yos” for a decade and ends where it began, a fixed indexed annuity might have a had a pretty good ten year income stream. That’s a very diversification to have. I don’t suggest placing all eggs in any basket, but, if you deal with an A+ insurance carrier (historically, much safer than banks) youy only risk is the carrier going bankrupt. With all the fear surrounding AIG’s near fall, it’s annuitants would have gone unaffected had AIG gone bust. Further, no index annuity holder has ever lost a dime of principal. While carriers have gone under, other insurance carriers have come alongside and made good on their claims and obligatons. (Research this, if you like, but I’ve never found evidence to the contrary.)
I’m not an “insurance saleman” and I don’t consider myself an annuity promoter either. I’m simply looking for ways to mitigate the impact of the worst financial markets in my lifetime stealing away a lifetime of savings (from me and others). Show me a “better” solution or one with less risk than fixed annuities with a strong insurance carrier, and I’ll shift my focus and analysis to that product. But, for those baby boomers still riding the financial market roller coaster and counting on stock returns to beat inflation and provide for a nice retirement – God help them.
Dean C. Lovett – President/AnnuitySpeak