Too Much Risk
Chances are, your current retirement plan contains too much risk. Why? Because keeping your money at risk is how banks and brokerages get paid.
Unlike an independent fiduciary firm such as Decker Retirement Planning, banks and brokerages do not have a fiduciary obligation to put your best interests first at all times, because they are not legal fiduciaries. The Series 7 license held by most bankers and brokers means they are actually commissioned salespeople selling the investment products that their firm wants them to sell. How do we know this? I, Brian Decker, spent the beginning of my career working for them, before I knew better. Three decades ago I got out of that racket and started my own firm so that I could sleep better at night. Now I’m on a mission to educate everyone who will pay attention.
Most bankers and brokers will tell you that you need to use the “Rule of 100” when it comes to retirement planning—meaning the move of increasingly more of your money out of stocks and into bonds/bond funds as you get older. (Sixty-five percent when you’re 65, seventy percent when you’re 70, etc.) The trouble is, bonds lose money when interest rates go up. And right now, our near rock-bottom interest rates are poised to go up! This puts people’s retirements at risk, and is simply bad strategy.
Time and time again we see portfolios for people that are over 55 years old where all of their money is at risk, primarily because banks and brokerages are not specialists in retirement planning. They print pie chart ratios of stock market investments and encourage you to “buy and hold.” (This is fine when you’re young, but not when you’re older.) They then claim you can start withdrawing 4% out of your portfolio when you retire and be just fine. Wrong. Read about the debunked and destructive 4% Rule here.
The trouble is, retirees can’t afford to lose money or wait-out a market drop. They need to leverage their investments so that they can access money to live on—they need reliable income.
Fiduciary Retirement Planning
The first thing we do for clients when it comes to retirement planning is a custom distribution spreadsheet, where we list all your different sources of income, including your pensions, Social Security, rental real estate and income from assets. We total that up, minus taxes, which gives you your annual and monthly income with a three percent COLA (cost of living adjustment) up to age 100.
The reason we start with income is so our clients mathematically know how much money they can spend without running out—which is the number one fear of retirees. I don’t care how smart you are, if you haven’t done these calculations, you’re just guessing. You have no idea how much money you can draw from your portfolio. We are a math-based firm and we do that work from the beginning.
The next thing we do is organize approximately 75 percent of your portfolio into buckets which represent chunks of time or age ranges during retirement for the first twenty years, laddering them into principal guaranteed accounts. These are currently averaging around 6.3 to 7 percent. By designing your retirement plan like this, we can help ensure that when the markets crash every seven-eight years—like they do—you won’t be affected at all. The clients we had through the 2008 crash didn’t even have to change their travel plans.
NOTE: We carve your sizable emergency cash out separately so that you always have immediate liquidity in addition to the highest returns we can find. Right now, that’s Goldman-Sachs, CIT, Synchrony and Capital One, each yielding around one-and-a-half percent.
“Risk” Money
For some clients, who either want or need to keep some of their money “at risk”, we recommend that 25% of their portfolio be in the risk bucket which we plan as the last bucket, meaning available to access when you are around 80-85+ years old. That gives you 20 years of market growth before you touch it. (Keep in mind that some people have the last bucket in principal guaranteed accounts instead of managed-risk accounts depending on their personal desire and situation.)
In terms of this last bucket of managed-risk money, we utilize what we personally think are brilliant fiduciary strategies to take advantage of both up and the down markets. (Because if there is one thing we can be certain of, it’s stock market volatility.) We currently use six money managers to implement our two-sided market approach, which we discuss in more detail below.
Roth conversion strategy – we purposely put Roth money in this last bucket, as well as IRA or 401(k) money which we’ve converted into Roth accounts over a period of five to seven years to minimize taxation. This conversion process is very important because it’s typically the biggest tax-saving strategy in your retirement lifetime. We have a conversation every year. We look at your income. We gross it up. We look at your AGI, your adjusted gross income, and we estimate how much money we can convert from an IRA to a Roth without bumping your tax bracket.
A Roth account is golden for three reasons. It grows tax-free, it distributes income back to you tax-free and it passes to your beneficiaries tax-free.
“Risk” Money Options
Because we are fiduciaries, we try to cover as many options as possible with you, both the ones that we recommend, and the ones that we don’t recommend. Here’s a brief synopsis of some of them in terms of why we do or do not use them.
- Variable Annuities
In short, no, never. The broker makes eight percent right up front; the insurance company gets paid every year you own it. The broker also gets paid every year you own it and the mutual fund companies get paid every year you own it. Three layers of fees that usually add up to five to seven percent before you make a dime. We don’t like them. We don’t use them. Because of all the fees, they lag the markets when the markets go up, and lose more than the markets when the markets go down.
Variable annuities are sold by bankers and brokers in a very deceptive way—they tell you that they allow you to invest in the stock market and have a principal guarantee to back you. What they don’t tell you is that you have to die to get that guarantee.
- Bond Funds
Absolutely no. Bond funds right now are yielding hardly anything because interest rates are so low. They are not safe. They can lose double digits when interest rates go up—for every one percent of interest-rate rise, you lose around 10 percent on an intermediate duration bond fund.
As an example, in May of last year, the 10-year Treasury was at 1.6 percent. Right now, it’s at 2.6 percent. So people have lost 10 percent on their supposedly “safe (according to bankers and brokers) retirement money held in bond funds. Bond funds are demonstrably not safe, and industry experts like Bill Gross, who worked at PIMCO and now works at Janus, and was interviewed in Barron’s last year about the likely risk of big losses with bond funds, encourages everyone to stay away from them. We concur!
- Real Estate
Real estate has historically made people a lot of money over time, whether through rental property, investment properties and/or commercial real estate. A rental real estate portfolio might make sense for some, but for people to withdraw qualified (like IRAs) or unqualified assets out of their portfolio to purchase commercial or residential property may not make economic sense when the costs of taxes and fees are analyzed, which can typically add up to around five to eight percent.
With the invention of REITs (Real Estate Investment Trusts) and ETFs (Exchange-Traded Funds) focusing on the real estate sector, real estate now can be bought and sold easily and efficiently with low cost. REITs and ETFs can target geographic areas or certain types of properties like hospitals, government buildings, commercial office or retail space.
Speaking of retail, Amazon is destroying the retail sector, so we don’t recommend investing in retail property right now. That’s an example of why we watch trends carefully, because real estate runs in cycles. Remember October 2007–March 2009? REITs were down from 50-70 percent. There is a time to be in real estate, and there is a time to be out of real estate. Trend-following models have been around for about 15 or 20 years, and we use them.
In addition to trends and cycles, we want to warn you about non-traded REITs. Non-traded REITs pay very high commissions to bankers and brokers—they make eight to 12 percent right up front. You’re locked in, you can’t sell them, so when the markets drop on real estate, you’re left guessing what the real price is and you’re given notice later—five to seven years down the road—when you’ll be allowed to sell any shares. We avoid them for retirement planning, and so should you.
- Mutual Funds
Most people understand what these are, they’re in your 401(k). Mutual funds are like a “common portfolio” where you buy shares in a sector fund, an index fund or a human-being-managed mutual fund. You are charged a fee, and your shares in the fund appreciate as the portfolio appreciates and depreciates as the portfolio depreciates.
In terms of retirement planning, it’s safe to say that the majority of mutual funds are buy and hold, and therefore aren’t that appealing in retirement unless they’re sector rotators. But even those come with caveats.
Sector rotator mutual funds own the market sectors that are positive and move out of sectors that aren’t doing well. As an example, in 2001-02, sector rotators avoided tech stocks getting crushed because there were plenty of other sectors that were doing well—like real estate, copper, steel, energy, healthcare, etc.—which the funds had switched into.
We have used sector rotators in the past (as long as they were no-load)—FPA Crescent has a good one. First Eagle has some good ones. What we don’t like about them is that in 2008, sector rotation just plain didn’t work. (That’s one reason we’ve rotated away from them.) The other reason is that even good no-load sector rotation funds are currently not showing higher returns than six percent, which we’re getting elsewhere.
Our two biggest warnings about mutual funds are this. Bankers and brokers recommend the ones that their employers want them to sell, usually with their brand name on them. Secondly, you may be paying fees you’re unaware of, or actually lied to about, like front-end or back-end loads. Case in point the biggest no—the C share mutual fund. These mutual funds are so toxic we can’t even believe they exist anymore, but they do. Schwab, Fidelity, Vanguard, they won’t allow them to be transferred in, they have to be sold off before you can use their services.
C-share mutual funds are very deceptively sold by bankers and brokers as having no front-end or back-end loads. What they don’t tell you is that there’s a 12-B1 fee that’s attached where, along with the one percent that goes to the mutual fund manager, the broker has attached another one percent to pay himself.
- ETFs (Exchange-Traded Funds)
ETFs were created in 1993, but really started to come into their own around 2000. In the last 17 years, there has been a huge revolution in them and they are a very efficient, effective way to track indexes or sectors. For instance, there is an ETF that allows you to track an index of all 500 stocks on the S&P 500—(SPY) is its ticker symbol. Or you can track the S&P 400 MidCap index, (MDY), S&P SmallCap 600 index, (IJR) or Nasdaq 100 index, (QQQ). There are all kinds of indexes.
Why would you buy the S&P 500 index ETF? Three reasons: 1) Performance. For example, 85 percent of mutual fund money managers don’t even manage to track with the S&P every year. 2) Diversification. The various firms on the S&P 500 are arguably some of the best companies, both domestic and international. 3) Cost. For instance the cost of buying the ETF (SPY) is very, very low, maybe 0.4 percent, or what we call basis points. A far cry from the 100 basis points that bankers and brokers will charge you on your management fees. The problem with this strategy is….NO downside protection when the markets get creamed.
Emerging markets and international indexes all are represented through ETFs, in addition to market sectors. You’re able to track the entire sector, for instance, the ETF ticker (OIL) allows you to track all the major oil companies in the world. This is a lot less risky than owning one or two stocks in that sector. Or you can track (TAN) for the solar sector, (GLD) for gold, (SLV) for silver or (SOCL) for social media.
There are all kinds of different sectors that you can own and your risk goes down because you own that sector, not just one stock. We like ETFs. In fact, of the six managers we use, three of them are trading the stock indexes. The other three are trading the commodity indexes, like oil, silver, gold and Treasury bonds.
- Commodities
The commodity sector is the largest sector to invest in, and it includes “hard” commodities that have to be mined or processed like gold, rubber and oil, as well as “soft” commodities like agriculture products or livestock. It’s a vast sector, and about 97 percent of it is bought and sold by hedgers.
Do we recommend commodities for the risk bucket in the retirement portfolio? Yes, by using ETFs to purchase sectors, because every seven or eight years, when the stock market tanks as it has historically done, you can take commodities to the bank. Three different asset classes go up when the markets get hammered—Treasury bonds, oil, and precious metals like gold and silver.
- Managed Futures
Futures are to commodities what options are to stocks, and about 95 percent or more of the futures markets are hedging versus speculating. So what are futures? Here is a made-up example to illustrate:
Let’s say you’re a farmer, and you know that you can put in a crop of August red wheat and sell it for $1.20 a bushel while your expense is $0.60 a bushel. Let’s say you’ve seen that selling price drop every time you deliver your crop, but your expenses have stayed the same. You can use insurance to hedge risk. If your crop is 10,000 bushels and you plant in April, you can sell 10,000 contracts of the wheat for August delivery.
What happens? There are three possibilities: the price of wheat either goes up, down or flat when it comes to delivering our crop. If the price goes up, and sells at $1.30, you make an extra 10 cents, but you lose 10 cents because of the hedge. If the price if it goes down to $1.00, you make 20 cents on the hedge. And obviously, if the price doesn’t move, there’s no change. You are able to lock in the price using the commodity futures markets as a hedge.
Do we own managed futures in our clients’ retirement portfolios? No, but we are aware of who the best managers are. There’s a lot of volatility with two-sided managed futures models. They aren’t producing gains good enough to use them right now. We’re watching them, though.
- Foreign Exchange (FOREX)
The foreign exchange market includes the different world currencies, like the Canadian loonie, the Mexican peso, the Brazilian real, the European euro, the Japanese yen, the US dollar. They’re all represented through ETFs, and we’re not averse to using them, it’s just that right now the two-sided strategies with ETFs aren’t in place and aren’t producing returns that track when the markets go up and protect principal when the markets go down.
- Stocks
We want to warn you that all individual stocks, like all companies, have what you can think of as a bell curve—a growth phase, a maturation phase and a phase of decline. Let’s use an example of what’s happening right now in retail. JC Penney’s and Sears were in a growth phase for many decades. Then they hit a maturation phase about 16 years ago with the start of online retail. And now, in the last two or three years, they’ve lost 60-70 percent of their value because people now are purchasing things online through Amazon and other retailers.
Another stock decline example is the cell phone hitting AT&T, known as “Ma Bell” back in the days when telephone land lines were the only option. AT&T has lost 70 percent of its market value in the last 17 years, surviving primarily by becoming a wireless carrier for Apple cellphones. Cell phone photography hit Kodak and Polaroid. Kodak went bankrupt and now focuses exclusively on printing; Polaroid went bankrupt twice and has completely new ownership.
Do we recommend owning stocks in your portfolio? Yes, through ETFs. You can track the indexes, have more diversification, and efficiently, effectively trade in and out—holding while the trend is up, and getting out, going to cash or going short when the markets are going down by utilizing trend-following algorithms.
How Do We Decide On “Risk” Money Options?
As fiduciaries, not only do we try to completely explain your options to you, but we also work hard to educate ourselves on an ongoing basis. Because even though the “risk” money portion of our average client’s retirement portfolio is around 25% or less of their total portfolio with the rest in cash and principal guaranteed accounts, we simply do not like losing money at all, we like making it. We are conservative that way. And we’re fiduciaries, a status we take very seriously. We use the Morningstar database for mutual funds. We go through the Wilshire database for money managers. We monitor and want to know who is giving the highest net-of-fee returns and providing downside protection.
And by the way, what are we looking for when it comes to options to use in our risk managers? We’re looking for two things. One, we want to track with the S&P when the markets go up. Number two, we want to protect principal when the markets go down. This is a high bar, because around 85 percent of money managers aren’t doing it. We only work with six money managers right now. Five of the six managers we use for our clients made money in 2008. So, this is a high bar, but it’s an achievable bar.
In our risk-money strategy, we’ve crossed out variable annuities and bond funds as options. We use our six managers to implement a two-sided strategy on gold and silver, a two-sided strategy on oil, a two-sided strategy on Treasury bonds, a two-sided strategy on the Nasdaq 100 index and a two-sided strategy on the S&P 500. Just as an example, the average annual returns net of fees for our one manager that trades the S&P is 18.3 percent net of fees and his model has been in use since 2006. Gold, with a two-sided model in place, net of fees is now 29 percent. And it goes on.
The thing is, three of our six managers will have huge up-years when it comes to the next market crash. We think that’s very, very important, because it’s critical to have a two-sided strategy so that your portfolio can continue to see gains in both up and down markets. Since January 1, 2000, the six managers that we’re currently using have always collectively beat the S&P 500.
One final point about “risk” money. As fiduciaries, most of our clients see a drop in management fees when they move over to us and away from their banker or brokerage firm. A huge drop—from 70-75 percent in fees. Why? Because we don’t charge a management fee on your emergency cash or principal guaranteed accounts.
Talk to Us
Decker Retirement Planning has offices in Seattle, Kirkland and Salt Lake City. You can reach us to discuss your personal retirement planning situation at 855-425-4566.
