(Hint: Use Math and Logic Instead)
Decker Retirement Planning is a true fiduciary firm, which has been helping people with retirement for years. When clients first come in to talk with us, a small percentage of them have been putting money away for years in their investments without really caring much about them at all. They’re not attached; they just want a plan that will work for them.
But, other clients, instead of focusing on their future and planning for future retirement income, begin explaining and getting excited about all their existing assets they’ve accumulated over their lifetime. As a result, and as fiduciaries, we can’t always implement what we feel is the best retirement plan for these passionate people—at least not right away. Why? Because they’re holding on tightly to certain investments that may not make sense in retirement. They’re so attached that it hinders their decision-making process.
These people have made personal choices; they’ve had a big hand in what they were investing in over the years. They’ve made decisions based on companies they liked, products they liked, or the social aspect of how these companies operated. Some examples of this that we see in our Seattle office are people holding Starbucks, Microsoft, or Boeing stocks. These companies have been around a long time, and a lot of these people have actually worked for these companies at some point in their life. They have an emotional attachment to these stocks.
This was fine while they were working—when they had time on their side for riding waves of market crashes. In retirement, of course, this changes. In the retirement plan, a different approach needs to be taken when it comes to your assets.
The Market Roller Coaster Between Fear and Greed
In general, the two biggest emotions people act on when they invest in the stock market are fear and greed. Fear will keep you out of the market when you should be in. Greed will put you in the market when you should be out. It’s hard to buy low and sell high when you’re operating strictly on instinct with no strategy.
An emotion-driven investing style has no place in retirement because you have no more working years to replace bad investment decisions. For instance, we see a lot of interest in Bitcoin, an extremely risky investment. We see a lot of dollar signs in peoples’ eyes when it comes to these non-dollars, backed by no government, and issued by an anonymous group somewhere in the world.
We’re not saying you shouldn’t have any stocks or risky investments in your portfolio. You absolutely can. You just have to make sur you’re okay with that money dropping by 40 or 50% every seven or eight years. You have to be prepared to lose it.
Since the number one fear of retirees is running out of money, emotional investing in retirement doesn’t make sense.
The Truth About Bond Funds
Sometimes, people have been sold on certain investments by non-fiduciary financial professionals who do not specialize in retirement. Unfortunately, we see this a lot in our office when we first start working with new clients. Clients may believe they are getting incredible returns because that’s what they’ve been told; therefore, they are emotionally attached to these investments as “winners.” But, sometimes this belief doesn’t match reality when we do the math and actually check the returns.
You need to be able to check the validity of the financial advice you’ve been receiving. For instance, new clients who have been working with stockbrokers or bankers often come in saying their investment choice of bond funds—which they’ve been advised to increase as a percentage of their portfolio holdings versus stocks as they get older—have averaged a return of 5-6% per year.
We know for a fact that’s not true. Bond funds right now are one of the worst investment choices because of the extraordinarily low interest rates we’ve experienced in the US since 2008. As interest rates continue to go up, as they have been recently, bond funds will actually lose money.
One of the easiest ways you can check the validity of what you’re being told about bond funds is to take a look at the specific fund yourself. Go online; there are dozens of sites where you can check how a stock or a mutual fund or an ETF (Exchange-Traded Fund) has been performing. Take a look, and verify it for yourself. We had one person in our offices who specifically said that their bond fund, a PIMCO bond fund, was averaging 4-5% for the past three years. It was a very eye-opening experience when we went to our computer and took a look at the specific fund that he was touting to see that it was only up an average of 0.5% for the past three years.
The Toxic Variable Annuity
The most common investment where we see inaccurate information being reported and people not being told the truth about how their returns are calculated is with variable annuities.
Insurance salesman may come right out and say they will guarantee a return of 5-7% per year. That’s not accurate, because they’re giving you a return on the accumulation value of the annuity’s income account, not the value on the cash account. This income account accumulation value is a made-up number that the variable annuity holder will end up drawing for a lifetime income stream. It’s not obtainable cash. And so, it’s very misleading for individual investors when they are told that you get a 7% guaranteed return, but it is not on the cash account.
When you actually calculate the return on a lot of these variable annuities, because of the very high fee structure that’s in them—up to 5 or 7% just in fees—you’re not seeing much of any return at all on the cash value side.
Bottom line, if this accumulation has been growing at 5-7%, you will actually only get 3% of that per year for the rest of your life. When you run that actual calculation against your life expectancy—or up to age 100—you’re seeing a return very close to a savings account.
Variable annuities are a horribly toxic investment choice, and a lot of people misunderstand how the return works.
If You Don’t Understand It, Don’t Invest in It
The blame for misunderstanding unfortunately often rests squarely on the shoulders of the non-fiduciary financial professional. They need to be more thorough in how they explain these investment products, and more forthcoming about how they actually work.
But, additionally, you as an individual investor need to know the specifics of how your investments work. Understand the difference between accumulation value versus cash value. Make sure you understand investments before you jump in and get excited by the hype.
Disadvantages of Emotional Investing in Retirement: Potential Loss
If you’re invested emotionally into a position, it’s more difficult for you to see it objectively. It’s easier for you to justify staying in it longer than you should because you feel that, “Oh, they have such a great product. They’re such a great company. There’s no way that they’re going to lose long-term. There’s no way they’re a bad investment decision for me.”
This type of thinking can cause you a lot of issues in retirement. It can cost you real income. It can cost your beneficiaries their inheritance.
Overall, emotionally investing is a very dangerous, dangerous place to be once you’ve taken your last paycheck. Your risk needs to be managed more effectively in retirement. It needs to be managed more mathematically.
The Advantages of Logical Investing: Maximizing Gain
If you invest mathematically as opposed to emotionally, the end result is the potential for maximizing your gains. A mathematical approach means you are strictly looking at investing based on the best earning potential that could maximize your retirement income.
But there’s another big advantage to logical investing versus emotional investing in retirement that people rarely talk about. And that is that it could preserve your sanity.
There are many people with an unhealthy attachment to their stocks, and to their portfolio. They’re checking it daily, hourly, every couple of minutes to see how the market has responded, how it’s turned your assets up or down.
When you’re in retirement, this is not what you should be worrying about. You should be out there going on trips, playing with the grandkids, and developing the newfound hobbies that you love in retirement—like gardening or whatever you enjoy. A mathematical approach to your assets in retirement can give you the freedom and ability to no longer worry about the day-to-day of how your assets are doing.
A mathematical approach can also preserve the financial safety of your loved ones when you pass away. Or if, heaven forbid, something happens to your mental ability to process information.
Yes, you will be slow and steady in the race. You’re not going to have those huge gains or windfalls (but people rarely do anyway). Instead, you could have more consistency in your returns over time. It will be more like driving a sensible sedan versus racing a red convertible.
It’s Your Choice
The first step for you is to understand the environment that you’re operating in. The stock market goes through periods of market correction every seven or eight years, when the market will drop 30-50% percent—it’s been almost like clockwork every seven or eight years. Right now, we are at year 10 of the seven-eight year market cycle; the last crash was in 2008. So, that puts us in a relatively dangerous spot when it comes to where the market is based on the history. Understanding that aspect alone will help from a mathematical standpoint with investing.
Now, those market crashes aren’t such a big deal when you’re working. When you have a paycheck coming in to you, then a market crash, you can just hold on and ride the wave. After the market crashes it could go higher afterwards and then you will be just fine.
The problem is when the market crashes and you’re retired. Time is not on your side any more. Returns on invested money relate directly to your short-term needs. It’s money you need to live on now—it’s your retirement income. Understanding the market and its history of crashes could help you to have a better approach when it comes to how to invest these assets.
A good rule of thumb to use in the stock market is diversifying into non-correlated sectors, meaning don’t put all of your money in the S&P 500 or the NASDAQ 100 because these sectors typically fall together. Instead, consider moving to commodities when markets fall. Traditionally if the stock market crashes, depending on the global economic environment, commodities tend to go up—that’s how it was for gold in 2008 and in 2000. Investing in these non-correlated sectors gives you a more mathematical approach to limiting your potential portfolio losses.
(Most importantly, in retirement, have very little money in the market in the first place.)
The Decker Approach to Retirement
Our approach is different, and we caution our clients against emotional investing in retirement. We simply use math.
We have seen a lot of stock market volatility pass us—and our clients—right on by. We don’t like market risk, and we seek to avoid it through our math-based retirement planning methodology, which spells out income, cost of living increases, taxes, RMDs and more up until age 100.
We believe the best-earning, guaranteed investments are the ones that should be in the largest portion of your retirement portfolio. For most of our clients, we put about 75% of their investable assets into laddered, principal-guaranteed accounts. (A principal-guaranteed account is any type of investment that is guaranteed by either a bank, an insurance company, a municipality or the federal government.)
By using this strategy, our clients are in a situation where their income is coming from principal-guaranteed accounts every month throughout the rest of their life. Our goal is to put them in a position where they don’t have to worry about stock market crashes, interest rate hikes or interest rate risk.
With some clients, we may have 25% of their money at risk, because by having this little bit of risk in their plan, it could significantly increase the amount of net annual income or money they have to leave to their heirs.
To shrink the amount of stock market risk that they are exposed to with this portion of their money, we use something called a “two-sided risk model.” A two-sided risk model is a computer driven, quantitative model that is designed to make money as the markets are going up, while also offering downside protection when the markets are going down.
The Upside of the Upside…and the Downside
As a math-based firm, we approach investments more as statisticians. We look at the two largest databases as well as a couple of the smaller ones (like the Wilshire database and Morningstar database), looking for money managers and mutual funds returning the highest performance.
The highest earning of these managers and mutual funds for many years has been what’s called two-sided trend-following algorithms. That sounds like jargon, but essentially it stands for computer algorithms that are designed to make money in both up and down markets. They’ve been around for a handful of years. We didn’t invent them, but that’s what we’re using because they are the highest earning—period.
These managers (algorithm or computer programs) were reading the trends in the marketplace and trading out of tech stocks as they were crossing down their averages. They moved into sectors that were still going up, like biotech and commodities. Therefore, they made money when the market was down overall.
These models have been mathematically the highest performing out there, and that’s who we use.
The result has been that since 2000, we have seen a 16-1/2% per year gain with the managers that we are currently using for risk money. The market during that same timeframe has been right around 5.6% per year. The reason for the gains has to do with preservation of capital in the down years. When you don’t lose money when the markets go down, compounding makes a huge difference, and that’s where that 16-1/2% comes in.
