Building better retirement_portfolios_client

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  • We have seen an abundance of financial news and industry research on the topic of retirement planning over the last few years in anticipation of the retirement of the baby boomer generation. October 15, 2007 officially kicked off this much anticipated event when the first baby boomers, born on January 1, 1946, filed for Social Security retirement benefits. It’s expected that this marked the start of a wave of boomer retirements. Effective strategies at this stage require significantly more than just withdrawing funds periodically. It may require a different approach to portfolio management, and most certainly more dedicated time and resources to retirement planning and cash flow management.
  • In this presentation, we will review the risks and challenges facing retirees including the unique challenges to consider for the next generation of retirees.We’ll also review the traditional approaches that have been used in the past for structuring retirement portfolios, and why these approaches may not work for the next generation of retirees.Then we’ll present a retirement portfolio structure which focuses on generating a total return for building potential long-term wealth and financial security as opposed to simply generating retirement income.Lastly we’ll present some helpful tips for managing cash flow and emotions
  • All the risks listed here have always been important considerations for retirement planning. But there are some new challenges for those approaching retirement. The good news is that we are living longer and healthier lives. The bad news is that this leads to greater challenges for retirees in planning and funding.
  • Retirees Should Plan for a Long RetirementChances are, people are going to live longer than they think. This is probably good news for most people, but it does pose some challenges for retirement planning. The problem is that many people base their financial planning upon the median life expectancy from mortality tables, which is the average age at which someone is expected to die. In the United States, the median life expectancy of a 65-year-old man is 85 and woman is 88. What they don’t often realize is that this is the median. Half of the population will live longer, often much longer than their life expectancy. And the median life expectancy does not account for the fact that life expectancy increases with age. For example, the graph illustrates, with the bottom set of numbers, the probabilities of a 65-year-old living to various ages. For example, there is 25% chance that a 65-year-old man will live to age 91, a 65-year-old woman to age 93, or at least one spouse of a 65-year-old couple to age 96. Bottom line: Retirees should plan for a long retirement. You would rather be conservative and have money left over than run out of money. Source: Annuity 2000 Mortality Tables—Transactions, Society of Actuaries, 1995–1996 Reports.
  • Another common misperception in retirement planning is that the need for money declines with age. The rule of thumb in the past was to plan for about 70% of pre-retirement expenses. That’s because prior generations planned for more sedentary lifestyles. It was generally assumed that retirees would stay home and do more gardening or play bridge or whatever. Today’s healthy retirees are jet-setters.Again due to advances in medicine, diet, and technology, retirees are not only living longer but are healthier. Those that remain healthy, maintain more active lifestyles. They have more time, and time costs money and healthy living is more expensive. Even for those that do not remain healthy, they may need more money for health care or because they cannot care for themselves and need assistance.
  • Another challenge for the next generation is that Personal Savings is expected to Play a Larger Role in Retirement fundingAs the graph illustrates, there has been general shift in the expected sources to fund retirement when comparing current retirees to current workers/future retirees.Source: Employee Benefit Research Institute, 2006 Retirement Confidence Survey. Data presented in 2006 Retirement Confidence Survey may not total 100 due to rounding and/or missing categories.
  • We all know that inflation takes a nice sized bit out of investment returns. Whether you are retired or not.This graph illustrates the compound annual returns of three asset classes before and after considering the effects of inflation. Looking over the past 81 years, inflation has reduced the returns of stocks, bonds, and cash by an average annual inflation rate of 3%.The first bars for each asset class represent the nominal, or unadjusted, returns of each asset class. The second bars illustrate the real, or inflation-adjusted, returns of each asset class which reflect the real purchasing power that the investor is left with after inflation. Notice that with cash and bonds, after adjusting for inflation, you are left with very meager returns to support long-term growth. Cash real returns were 0.7% and Bond returns were 2.7%.
  • One Traditional portfolio Approach for the prior generation was to construct an income portfolio through a laddered bond portfolio or some other type of fixed income or stable value vehicle.The problem with this approach is that Inflation Significantly Erodes Purchasing Power Over Time of both the income and the principal.The graph demonstrates that $100,000 of income today will only be worth $85,873 of value in as little as five years, or roughly 14% less than today. Over the course of a typical 30-year retirement (based on a 4% inflation rate assumption), the income will be reduced by nearly 60% to $40,101.And this example only demonstrates the declining purchasing power of the income, not principal. ---not likely to have a constant income value unless you use an annuity or stable income vehicle.More realistically, when fixed income investments are used, the value of those bonds also tend to decline in periods of unexpected inflation, along with investor’s spending power.
  • Probability of Meeting Income NeedsThere are a number of factors that can impact whether a portfolio will last through retirement. The table shows how the amount of withdrawal and various portfolio allocations can affect the chance of meeting income needs over a 25-year retirement. It is assumed that a person retires at year zero and withdraws an inflation-adjusted percentage of the initial portfolio wealth each year beginning in year 1. Annual investment expenses were assumed to be 0.83% for stock mutual funds and 0.64% for bond mutual funds. A high probability indicates that an investor is more likely to meet income needs in retirement, while a low probability indicates that an investor is less likely to do so and may face shortfall. The chance of a portfolio running out over a long retirement is less likely as the amount withdrawn decreases and as equities are added. Keep in mind that returns and principal invested in stocks are not guaranteed and they have been more volatile (risky) than bonds.The image was created using Monte Carlo parametric simulation that estimates the range of possible outcomes based on a set of assumptions including arithmetic mean (return), standard deviation (risk), and correlation for a set of asset classes. The inputs used are historical 1926–2010 figures. The risk and return of each asset class, cross-correlation, and annual average inflation over this time period follow. Stocks: risk 20.4%, return 11.9%; Bonds: risk 5.7%, return 5.5%; Correlation –0.01; Inflation: return 3.1%. Other investments not considered may have characteristics similar or superior to those being analyzed. The simulation is run 5,000 times, to give 5,000 possible 25-year scenarios. A limitation of this simulation model is that it assumes a constant inflation-adjusted rate of withdrawal, which may not be representative of actual retirement income needs. This type of simulation also assumes that the distribution of returns is normal. Should actual returns not follow this pattern, results may vary.Government bonds are guaranteed by the full faith and credit of the United States government as to the timely payment of principal and interest, while returns and principal invested in stocks are not guaranteed. About the dataStocks in this example are represented by the Standard & Poor’s 500®, which is an unmanaged group of securities and considered to be representative of the stock market in general. Bonds are represented by the five-year U.S. government bond, inflation by the Consumer Price Index and mutual fund expenses from Morningstar. An investment cannot be made directly in an index. The data assumes reinvestment of income and does not account for taxes.
  • We believe a total return portfolio is a portfolio constructed to provide maximum total return for any given level of acceptable risk.The structure of a balanced portfolio with equity allocations ranging from 50% to 75% may have the greatest probability of success in a variety of potential scenarios (varying sequence of returns, inflation, etc.). This is a fact supported by numerous studies, Milevsky, Bengen, Guyton and Klinger) Using a total return approach, the role of fixed income is primarily to reduce the volatility associated with the equity investments for long-term growth. Not primarily to provide income.Income is provided through what we refer to as a synthetic dividend, which I will address in a few minutes.Global diversification will be used in an effort to reduce volatility further and the addition of value and small cap asset classes will be used in an effort to increase long-term returns. Although remember that diversification cannot guarantee a gain or protect against a loss.
  • The confusion between income and cash flow is the root of many emotional issues in the retirement planning process. Read slide.
  • An example of a cash flow strategy to mitigate the “paycheck syndrome”.Cash flow reserve is maintained with at least one year of retirement spending needsAvoids perception of “dipping into capital” or taking losses from investment portfolioIntention is to mitigate losses from equities as much as possible.Fixed income is sold in years of negative equity returns.
  • Cash reserve funded through annual rebalancingPositive return of equities (excess over target allocation) is sold and proceeds invested in cash to meet future withdrawal requirementsNo withdrawals taken from equity following year with negative returnReplenish cash reserve annually via annual rebalancing
  • In conclusion, Read Slide.Are there any questions?
  • In conclusion, Read Slide.Are there any questions?

Transcript

  • 1. Building Better Retirement PortfoliosLWI Financial Inc. (“Loring Ward”) is an investment adviser registered with the Securities and Exchange Commission. Securities transactions may be offered through Loring Ward Securities Inc., an affiliate, member FINRA/SIPC. B 12-006 (02/12) Implementing a Distribution Portfolio Series does not guarantee a profit or protect against a loss.
  • 2. Agenda• Retirement Risks & Challenges• Traditional Approaches• Total Return Portfolio Strategy• Managing Cash Flow and Emotions
  • 3. Risks & Challenges for the Next Generation of Retirees• Inflation… rising health care costs• Longevity… increasing life expectancy• Lifestyle… higher income replacement needs• Funding… more personal responsibility• Investment… volatility & uncertainty
  • 4. Longevity Risk: Plan for a Long Retirement 100% 78 81 86 75 • Male 85 88 91 50 • Female • At least one spouse 91 93 96 25 0 65 years old 70 75 80 85 90 95 100 105Source: Annuity 2000 Mortality Tables. © 2010 Morningstar, Inc.All rights reserved. 3/1/2011
  • 5. Lifestyle Risk: Higher Income Replacement Needs• Retirees should generally plan for 100% income replacement vs. 70% rule of thumb used in the past• Retirees are remaining healthier longer — healthy living is more expensive• Retirees have more time — time costs money
  • 6. Finding Risk: More Personal Savings Responsibility Next Generation Retirees Today’s Retirees (Expected sources of (Actual sources of retirement income) income in 2006) 20% 36% 43% 14% 66% • Social Security 20% • Pension plans • Personal savings/otherSource: Employee Benefit Research Institute, 2006 Retirement Confidence Survey. Datapresented in 2006 Retirement Confidence Survey may not total 100 due to rounding and/ormissing categories. © 2007 Morningstar, Inc. All rights reserved. 3/1/2007
  • 7. Inflation Risk: Will Returns Keep Pace with Inflation? Annualized Returns 1926 to 201012% 10 9.9% 8 6 6.6% 5.5% 4 3.7% 2 2.4% 0 0.6% Stocks Bonds Cash Before inflation After inflation Before inflation After inflation Before inflation After inflation Past performance is no guarantee of future results. Assumes reinvestment of income and no transaction costs or taxes. This is for illustrative purposes only and not indicative of any investment. Stocks are represented by the Standard & Poor’s (S&P) 500 Index; Bonds are represented by the Ibbotson/SBBI Long-Term Government Bonds Index; Cash represented by one-month Treasury Bills. An investment cannot be made directly in an index. © 2010 Morningstar, Inc. All rights reserved. 3/1/2011
  • 8. Traditional Approach: Impact of 4% Annual Inflation on an Income Portfolio$100k $85,873 80 $73,742 $63,325 $54,379 60 $46,697 40 • Purchasing power of today’s income and principal $40,101 will decline over time 20 • Fixed income is generally not good hedge against inflation because values tend to decline in periods of unexpected inflation, along with investors’ spending power 0 0 Years 5 10 15 20 25 30 This is for illustrative purposes only and not indicative of any investment. Assumes an inflation rate of 4.0%. © 2007 Morningstar, Inc. All rights reserved. 3/1/2007. Past performance is not indicative of future results.
  • 9. Probability of Meeting Income Needs Various withdrawal rates 87% 98% 96% 93% 90% 4% and portfolio allocations over a 25-year retirement 38% 75% 82% 81% 79% 5% IMPORTANT: Projections generated by Morningstar regarding the likelihood of various investment outcomes are hypothetical Withdrawal Rate in nature, do not reflect actual investment results, and are not guarantees of future results. Results may vary over time and 6% with each simulation. This is for illustrative purposes only and not 5% 31% 56% 64% 65% indicative of any investment. An investment cannot be made directly in an index. “A limitation of this simulation model is that it assumes a constant inflation-adjusted rate of withdrawal, which may not be representative of actual retirement income needs. This type of 0% 6% 30% 45% 51% 7% simulation also assumes that the distribution of returns is normal. Should actual returns not follow this pattern, results may vary. Stocks in this example are represented by the Standard & Poor’s 500®, which is an unmanaged group of securities and considered to 0% 0% 13% 29% 39% 8% be representative of the stock market in general. Bonds are represented by the five-year U.S. government bond, inflation by the Consumer Price Index and mutual fund expenses from Morningstar. An investment cannot be made directly in an index. The data 100% 75% B 50% B 25% B 100% assumes reinvestment of income and does not account for taxes Bonds 25% S 50% S 75% S Stocks Government bonds are guaranteed by the full faith and credit of the United States government as to the timely payment of principal and interest, while returns and principal invested in stocks are not guaranteed.The stocks in this example are represented by the Standard & Poor’s500 Index. The bonds in this example are represented by the FiveYear U.S. Government Bond.
  • 10. Total Returns vs. Income Portfolio Strategy• Short-term bonds seeking to reduce portfolio volatility, not primarily to provide income• Equity allocations to help support long-term growth• Global diversification seeking to reduce volatility• Potentially increase expected returns with small cap and value stocks• Synthetic dividend for paycheckRisks associated with investing in stocks potentially include increased volatility and loss of principal.Small company stocks may be less liquid than large company stocks. Bonds are subject to certainrisks, including interest rate risk which can decrease the value of a bond as interest rates rise.Principal value, bond prices and investment returns fluctuate with changes in market conditions, sothat bonds, when redeemed or sold, may be worth more or less than their original cost. Diversificationdoes not guarantee a profit or protect against a loss in a declining market.
  • 11. Managing Cash Flow & ConfidenceA “Synthetic Dividend”• Total return portfolio designed to deliver a “synthetic dividend” or total portfolio earnings vs. only dividends and interest income to fund retirement cash flow needs• Money is money, whether it comes from income or capital gains• May be more tax efficient to generate and spend long-term capital gains than dividends and interest
  • 12. Managing Cash Flow & Confidence• Cash flow reserve is maintained with at least 1 year of retirement Cash Flow spending needs Reserve• Additional 2 years of spending in short-term The Total fixed income to Portfolio The potentially insulate from Investment market Portfolio• Avoids perception of “dipping into capital” or taking losses from investment portfolio
  • 13. Managing Cash Flow & Confidence• Cash reserve funded with cash dividends Cash Flow Rebalance• Difference between Refill Reserve spending and dividends funding through annual The Total rebalancing mid year Regular Portfolio Monthly• Any positive return of Payments equities (excess over target allocation) is sold and proceeds invested in cash to meet future withdrawal requirementsThe buying and selling of securities for the purpose of rebalancing may have adversetax consequences.
  • 14. Advantages of the Distribution Portfolio SeriesDesigned to Provide:• Addresses potential short-term emotional responses• Better management of inflation risk• Improved sustainability of withdrawals
  • 15. Different types of investments and/or investment strategies involve varyinglevels of risk, and there can be no assurance that any specific investment orinvestment strategy will be either suitable or profitable for your portfolio. Youand your advisor should carefully consider your suitability depending on yourfinancial situation.Higher potential return generally involves greater risk, short term volatility is notuncommon when investing in various types of funds including but not limited to:sector, emerging markets, small and mid-cap funds. International investinginvolves special risks such as currency fluctuation, lower liquidity, political andeconomic uncertainties, and differences in accounting standards. Risks of foreigninvesting are generally intensified for investments in emerging markets. Risks foremerging markets include risks relating to the relatively smaller size and lesserliquidity of these markets, high inflation rates and adverse politicaldevelopments. Risks for investing in international equity include foreign currencyrisk, as well as, fluctuation due to economic or political actions of foreigngovernments and/or less regulated or liquid markets. Risks for smallercompanies include business risks, significant stock price fluctuation andilliquidity. Treasuries and government securities are guaranteed by thegovernment for repayment of principal and interest if held to maturity.