Tag Archives: Planning

Do You Have Too Much Stock Exposure?

If you’re retiree trying to use your saved capital to generate income, you’re basically trying to construct a pension for yourself. And that means you should think about how Jeremy Gold understood pensions.

Gold, who died recently (here are his obituaries in in the New York Times and the Wall Street Journal), made the first arguments that public employee pensions were more radically underfunded than most people thought. One of the questions he raised was why the payments pensions make, which are obligations, are funded with securities that are not obligations (stocks). Shouldn’t payment obligations be funded with investment obligations (bonds)? People complain that pension return estimates (or discount rates) are too high, which lowers the amount that needs to be saved today to fund future payouts. But why, Gold asked in articles like this one with his frequent collaborator Ed Bartholomew, pick securities whose returns need to be estimated in the first place?

“Risky assets (like stocks) are of course expected to return more than default-free bonds. If that weren’t true, no investor would hold risky assets. But expected to return more doesn’t mean will returns more,” Gold wrote. Indeed “[r]isky assets might well earn less than default-free bonds, perhaps much less, even over the long term – that’s what makes the risky. And if that weren’t true, no investor would hold default-free bonds.”

These are all questions for retirees trying to generate income to ponder. It’s hard for most people to estimate how much equity exposure they should have in an income-generating portfolio. Perhaps Gold’s suggestion of 0% for pension funds is too severe. What retirees should understand for their own accounts, however, is that they might not be able to take as much risk as they think they can.

Moreover, as Gold says, risky assets might earn less than risk-free assets even over the long term. That’s especially a possibility now with stock valuations so high. It shouldn’t shock anyone if bonds outperform stocks over the next decade given the starting valuations of stocks (current Shiller PE of 32).

Gold also tacitly seems to deny that risk is volatility. He speaks simply of stocks not performing as well as government bonds, not about whether stocks might be justified or not on a volatility-adjusted return basis. Retirees need to think about both definitions of risk – simple underperformance, even over a long period of time, and volatility. I’ve shown in a previous post that an asset class that has a slightly higher compounded average annual return can also inflict greater damage to a portfolio in distribution phase than an asset class with a slightly lower compounded annual rate of return, but lower volatility.

Should retirees trying to convert their assets into income lasting the rest of their lives own any stocks at all? Maybe they should own some. After all, even Gold says if stocks weren’t expected to return more than bonds, nobody would own stocks. But Gold’s arguments should make someone asserting confidently that longevity demands a lot of equity exposure blanch. Gold once had a discussion with finance professor Zvi Bodie, where Bodie repeated his famous thesis that stocks don’t get less risky over the long run if you try to insure against their delivering a loss with a put option. The option gets more expensive as you try to insure over a longer period of time. Bodie didn’t deny that the longer you go out in time, the lower the probability of a shortfall from stocks relative to a government bond. But he asserted that this lower probability of underperforming a government bond is offset by the fact that the worst possible outcome becomes worse. What Bodie calls “severity” increases over time.

Investors using their assets, saved over a lifetime of hard work, should think harder about how much stock exposure is enough.

If you need help understanding your risk tolerance and constructing an appropriate asset allocation in or before retirement, please click this link.

The Psychological Side Of Retirement

16-mental and financial tips for a “successful” retirement. 

Retirement is easy, right? Said the newly minted retiree

You stroll out of your cushy, corporate job for the last time passing all the desperate souls who are stuck in their cubicles and think to yourself, “life is good”. You have dreams of laying by the pool, lavish vacations, time with family and friends, and maybe you’ll even pick up an old hobby or two.

Then you get home and reality sets in.

And you realize, “what in the world am I going to do”?

The problem is we have these grand ideas of what retirement is supposed to look like, but typically, it’s far from reality. When possible, we plan for the financial side of things, yet we disregard the emotional challenges retirement poses.

Retirement is hard, right? 6 months into retirement

It may start out like a dream: no alarm, no one micro-managing you, no one to answer to (except maybe your spouse). But ask almost any recent retiree – I mean really ask them how they are doing and more than likely, they’re having some trouble adjusting. Everyone will tell you they love it — they’re enjoying the slower pace of life, but if you dig a little deeper, you’ll reveal that many are experiencing a bit of an identity crisis.

Commercials, magazines, movies all portray the good life, but that is not the reality of most people.

We like to call the first year of retirement the black hole.

Most retirees go in, stumble around, tinker with some things but can’t quite seem to find their way. Unfortunately for retirees, there is typically no practice prior to retirement. Think about it, we practice EVERYTHING before we retire, but not the not-so-simple act of retirement?

My 5-year-old daughter just practiced 6 months for a dance recital, a 5-minute dance recital!

We practice sports several days a week prior to a ball game. We go to school for years prior to

our first real job, and we progress step by step.

Until we don’t…we retire.

Yet we never give the idea of a trial run or even writing a plan of what we want to accomplish during retirement, outside of “do we have the money.” If we do write down what we expect, often we don’t include our significant other. Trust me, that’s a big adjustment and a big no-no. My wife quit her job a year and a half ago to stay home with the kids, and we’re finally use to each other being home at the same time, but retirees are expected to rip the band aid off and act like we were made for this next stage in life.

Does this not seem broken to you? So not only are you supposed to begin drawing down your funds on which to live, which goes against everything you’ve ever done over the last 30, 40 or 50 years, but now you’re supposed to go blindfolded into retirement with no trial run and no real plan? What will give you purpose?

“Ah, screw it. We’ll just wing it, after all I am retired. I’ve got all the time in the world.”

PURPOSE– the reason for which something is done or created or for which something exists.

I know I’ve been a tad bit redundant, but I’d like to drive home the point. Your retirement preparation and plan should be way more than just money.

Here is your pre-retirement quick-list:

  1. Jot down what you envision for retirement
  2. Now be realistic and do it again (If you’re married do this independently and compare notes, then discuss)
  3. Track your expenses monthly (You can’t make improvements if you don’t know where you need to improve)
  4. Plan a dry run, now take time off work and do it
  5. Exercise or start a fitness regimen (there are thousands of millionaires who would trade every dollar for your health and thousands more who did)
  6. Find ways to stay social and vital
  7. Prior to retirement check your plan for appropriate baselines. If you have questions, look here for Richard Rosso’s Pre-Retirement Preparation Checklist
  8. Take a life expectancy quiz, we like livingto100.com (This will be used to help make social security and pension decisions, health care, using an appropriate timeline in your financial plan and long-term care)
  9. Hopefully long-term care has been addressed. If not, your plan should dictate if it’s a) needed, and b) affordable
  10. Do you have diversification of assets? Not positions, but registrations or flexibility for taxes
  11. Find an advocate, an advisor to keep you grounded. Emotion, laziness and lack of understanding are the biggest killers of a financial plan. Yes, I’m not just talking about you, but your advisor too. Buying low and selling high is easier said than done.
  12. Know your risk aptitude, not appetite. Aptitude. That’s what you’re more likely to follow
  13. Set guidelines, guardrails or parameters. Your advisor should live by some, if they don’t or you don’t, use these rules. 
  14. Get a good understanding of Medicare and your health care options
  15. What will you do that gives purpose, for you, for others? Not your family? You need your own “thing.”
  16. Volunteer; it will make you feel good, but it will help others much more.

“The greatest gift you can give someone is your time,” Rick Warren, author of the Purpose Driven Life.

“A man’s life may stagnate as literally as water may stagnate, and just as motion and direction are the remedy for one, so purpose and activity are the remedy for the other,” – John Burroughs.

“The man without purpose is like a ship without a rudder- a wait, a nothing, a no man,” – Thomas Carlyle.

We typically find that it takes at least the full first year to get out of the “black hole” and find your retirement groove, but if you heed this advice, our hope is you can hit the ground running and never look back.

I’ve been in the retirement business for almost 15 years, my partners more than twice that time. We’ve helped a lot of people retire but have also learned a lot from people with their feet in the fire.

I think we will all tell you the same thing.

Get out and move, find your purpose and enjoy this next stage. Life happens fast, so does retirement. Let’s make the most of it.

The “Nastiest, Hardest Problem in Finance”

Should retirees own any stocks? It seems ridiculous to ask that question. Of course, they should. People are living longer than ever before and need higher returns on their assets to see them through an extended retirement. And many target date funds are responding by maintaining elevated amounts of stocks through at least the early years of retirement.

How else to get those returns than from stocks?

Not so fast, says economist Allison Schrager who wrote a recent article for Quartz asking the provocative question:

“If you’re about to retire, should you pull out of the stock market?”

After all, weeks such as the last one remind investors that stocks are far from a sure thing, and can vaporize wealth quickly.

It’s true that most people haven’t saved enough to retire easily, and stocks – or the returns they’ve historically provided — may be a way to overcome savings shortfalls. But there are two problems with this argument. First, stocks may not deliver the returns we have grown accustomed to receiving from them. The best indicator of long term – say, future ten-year – returns is the Shiller PE, which is the current price of the market relative to the past decade’s worth of inflation-adjusted average earnings. That metric is over 30, despite last week’s correction. It’s two highest readings previously have been 34 in 1929 and 44 in 2000. And stocks did poorly from those two peaks over the next decade. Basically, it’s very hard for stocks to perform well for the next decade starting from this valuation.



Because of their high valuations, stocks may not outpace bonds. The 10-Year US Treasury is now yielding around 2.8%, and investors can own an index of investment grade corporate bonds that pays nearly 3.6% in the form of the iShares Investment Grade Corporate ETF (LQD). And if investors can get a highly probable return of over 3% from bonds, it’s not clear that domestic stocks will outstrip that by a lot or even at all.

Moreover, the volatility stocks often deliver can destroy retirement plans, even if stocks eke out higher average annual returns than bonds. This is because of something called “sequence of return risk.” That basically means that ,during distribution phase, when and how returns are delivered matters at least as much as the average annual return itself. I did a study of two portfolios – one all domestic stocks, and one balanced – starting in 2000 using the famous “4% retirement rule.” That means the retiree is taking 4% of the portfolio as income in the first year and boosting the first year’s dollar payment by 4% every year thereafter.

Retirement Allocation Chart 4% Retirement Rule

Source: Morningstar, Yahoo!Finance

The results are ugly for the all-stock portfolio, which reduced the account by nearly 80% after 18 years at the end of 2017. The balanced portfolio, by contrast, was reduced by only 20% of the original balance after 18 years of applying the 4% rule. The starting point for the test is admittedly random, and it includes two big stock market drawdowns. But it shows how an unfortunate starting date combined with a lot of stock exposure can hurt a retiree.

None of this is to argue that retirees should eliminate their domestic stock exposure altogether. Stocks may outpace bonds over the next decade, after all; we’re just saying the chances of that happening are low. Also, foreign stocks, especially emerging markets stocks, present better valuations, and their likely future returns are at least somewhat higher than what their domestic counterparts are offering.

Although many mutual fund families have target date funds that contain more than 50% stock exposure at the time of retirement, Schrager says the average target date fund in Morningstar’s database has 40% of its assets in stocks. That’s meaningfully lower than the classic balanced portfolio, which has 60% in stocks.

There’s a big difference between having 60% stock exposure and 40% stock exposure. In 2008, for example, a portfolio that had 60% in the S&P 500 and 40% in the BloombergBarclays U.S. Aggregate Bond Index lost around 20%, but a portfolio that had the reverse exposure – 40% stocks and 60% bonds – lost around 13%. That’s a big difference for retirees taking 4% or more from accounts in income. There are limits to how much stocks can help savings shortfalls in retirement. Don’t put a burden on them they’re not equipped to handle.

As always, your stock exposure depends on your personal risk tolerance (which is much harder to estimate than you might think), your spending needs, and how well funded you are. But Schrager is correct to note that things are different in retirement than they are when investors are saving or accumulating assets. As Bill Sharpe, whom she quotes, says, investing in retirement is the nastiest, hardest problem in finance.