How a Retirement Financial Planner Looks at Risk

A Retirement Financial Planner Is Focused On Preserving Your Nest Egg

At Decker Retirement Planning, Inc., we know how important it is for retirees to have a plan in place to help ensure their money will last–even if they live to be 100 years old. In fact, since 2008 the number one fear of people in retirement has been running out of money. That’s why it’s so important for our readers and clients to understand interest rate risk, credit risk, and market risk.

Let’s start with interest rate risk.

Interest Rate Risk Is Very High Right Now, Because Interest Rates Are Artificially Low

Bill Gross, a brilliant man who used to work for PIMCO and now works for Janus, said something very important in an interview with Barron’s last year in April. He basically said that, number one, central banks around the world and the Federal Reserve are keeping interest rates artificially low. And number two, “It’s unsustainable.”

And here’s the thing. Bill Gross also said, “When interest rates go back up, people will lose a lot of money.” He’s right. Bond funds are in a bubble right now, as much as the stock markets are. And yet, retirees are still being told that bonds are where you put your “safe” money.

The “Rule of 100”—still being used by big banks and brokers to this day—says that as you get older, you should put increasingly larger percentages of your portfolio (corresponding exactly with your age) into bonds/bond funds. For instance, at age 60, 60% of your portfolio should move to bonds/bond funds; at age 70, 70% should move, etc. This is recommended for your “safety.”

No reputable retirement financial planner would tell you to put the majority of your money in bonds right now, especially not a fiduciary.

Bonds are not “safe” in a low-interest environment, because of the risk that interest rates will go up.

When we take a look at historical performance when it comes to bond funds, we find that in 1994, the 10-year Treasury went from 6% to 8% which resulted, according to Morningstar, in people losing around 20%. In 1999, the 10-year Treasury spiked up from 4% to 6%–and people lost about 17% of their money.

If interest rates go from where we are right now at around 2.1% back up to let’s say, 4%, it will be a hit to your principal of around 20% on what bankers and brokers are telling you is your safe money invested in “bonds!”

NOTE: Bonds are not synonymous with bond funds, although most bankers and brokers, who are not financial fiduciaries (or retirement financial planners) use the two words interchangeably. Some bond funds actually invest in the stock market, and are subject to market risk. Call Decker Retirement Planning, Inc. to discuss.

How Credit Risk Affects Retirement

Credit risk is basically the risk of default on a debt if a borrower fails to make required repayments. The reason a retirement financial planner like Decker Retirement Planning, Inc. sees credit risk being a big problem for retirees is due to their holdings in municipal bonds.

Municipal bonds are often touted as a great “safe” investment for retirees because they can collect tax-free interest on them, providing them with a source of passive retirement income not subject to federal or state income taxes.

The thing is, you’re betting on the ability of the municipalities to pay back your principal on maturity. Credit risk is the risk that your municipal bond portfolio doesn’t mature with all its principal. And right now, 49 out of 50 states have taken on pension obligations they can’t possibly pay back. There’s only one state that’s in the black right now and that’s South Dakota. Fracking put them in the black.

At Decker Retirement Planning, Inc., we’re not saying that all municipal bonds are risky or all municipalities are going broke. But we are saying that since 2008, the nature of credit risk has changed when it comes to your municipal bonds. We believe that when interest rates are this low, if you’ve got a 3% to 5% coupon municipal bond, those bonds should be trading at around 109 to 112, depending on maturity. If they are trading at 100, we think they are below par and you should sell them. Remember this is supposed to be your safe money in retirement. Bonds are supposed to be your safe money.

Market Risk

You’ve heard us in our role as a retirement financial planner talk over and over again about the dangers of market risk. But we really can’t be too redundant, especially since so many bankers and brokers are still muddying up the financial waters with what we think is terrible advice.

Creating a pie chart of stocks and bonds, then using a “buy and hold” strategy when you are in your 20s, 30s and 40s (and still have employment income coming in) may make sense for you, because the markets are cyclical, they go up and down. Historically, every seven or eight years or so, stock markets take a hit, and at a younger age you have the time horizon to wait-out a market downturn. You are in the accumulation phase of your financial life.

But when you get to your 50s and are edging closer to retirement, things change. It’s absolutely not okay to start moving half, and then increasingly greater percentages of your portfolio into bond funds, subjecting the majority of your retirement money to all kinds of risk, including interest rate risk and market risk.

It’s not okay to plan on using the 4% Rule in your retirement either, a rule completely rejected in 2009 by its creator, William Bengen.

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BRIEF, RECENT HISTORY OF THE STOCK MARKET

• Working backwards from the Great Recession of 2008, the stock market experienced a ~50% drop from October of ‘07 to March of ‘09.
• Seven years before that was 2001, the year the Twin Towers went down, when we were already in the middle of a three-year bear market from January of 2000 to March of ’03 resulting in a ~50% decline.
• Seven years before that was 1994. Iraq had invaded Kuwait, interest rates spiked up, the economy stalled, and we went into recession as the stock market struggled.
• Seven years before that was 1987; Black Monday was on October 19th, with a ~30% drop in one day.
• Seven years before that was 1980 with another ~46% drop during the ’80 to ’82 bear market. Interest rates were sky-high and the economy was in recession.
• Seven years before that was 1973; from ’73 to ’74 there was a ~42% drop.
• Seven years before that was the ’66 to ‘67 bear market with more than a 40% drop.
• And it keeps going.
  

NOW

• It is more than eight years since March of ’09 when the markets bottomed. About now is the time that historically the markets roll over for a 30% to 40% drop.

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The 4% Rule as a Retirement Distribution Strategy

People ask us all the time, “How much money can I draw out of my portfolio so that I don’t run out of money before I die?” The answer is resoundingly not 4% per year of a pie-chart portfolio that’s 100% subject to market risk. Incredibly, bankers and brokers are still using a distribution strategy called the 4% Rule, in our opinion the most toxic investment strategy out there, responsible for singlehandedly destroying more people’s retirement in this country than any other piece of financial advice out there.

Here’s how it works. The 4% Rule says stocks have averaged around 8-1/2% for the last 100 years.  That’s true. Bonds have averaged around 4-1/2% for the last 37 years; that’s also true. So, by logic not based on any other factors like inflation, taxation or sequence of returns, if you draw 4% from your assets for the rest of your life, you should be just “fine.”

The problem is that the 4% Rule fails retirees during down-market cycles.

How the 4% Rule Destroyed Retirements in 2008

Hypothetically, let’s say Jane and John retired on January 1, 2000 with $4 million. The good news is that they had amassed that much money. The bad news is that the market started an immediate downward spiral right when they retired. It was down in 2000, ’01 and ’02–by 50%. And because they had to draw 4% income out each year to live on, their loss was even greater. Their portfolio was down 62% heading into ‘03.

Good news–markets doubled from March of ’03 to October of ’07. Bad news, Jane and John didn’t get all that because in ’03, ’04, ’05, ’06, ’07; each year they were still drawing 4%.

Worst news—Jane and John took the 2008 hit of 37% plus 4% draw and they were finished. They were done and out of money—they could no longer stay retired.

Millions of people across the country witnessed this in 2008. The gray-haired people had to go back to work. They had to go back to fast food, they had to go to banks, they had to go to Walmart as greeters. They had to move in with their kids, sell their homes. They had to go to various “plan B’s” because the 4% Rule destroyed their retirement.

Brian Decker: “Right now, we are living the perfect storm for retirees. You have the combination of uncertain market cycles, along with historically-low interest rates. So as retirement financial planners, we highly recommend that you switch from a pie chart accumulation plan with all your money in stocks and bonds, to a retirement distribution plan—a plan that doesn’t have all of your money at risk in the market.”

Elements of a Retirement Distribution Plan

A qualified retirement financial planner like Decker Retirement Planning, Inc., doesn’t follow the 4% Rule. We build individualized retirement distribution plans designed to minimize taxation and to help maximize your retirement income, while focusing on principal-guaranteed accounts for the first 20 years.

Brian Decker:  “As soon as we say ‘principal guaranteed,’ that limits us to four different types of investments: guaranteed by a bank, a municipality, an insurance company or the federal government. We don’t care who guarantees it, just that that money is guaranteed by a highly-rated entity and we’re getting the best possible rate of return.”

We create a spreadsheet, which shows all of your sources of income, including income you will take using tax-advantaged, qualified and non-qualified account withdrawals. Everything is spelled out. We also include pensions, real estate rental investment money, Social Security, and all your income from assets. We total it up into gross income plus a yearly COLA (cost of living adjustment)—minus projected income taxes. That helps gives you a true idea of your annual and monthly income. Then we match this against your other household expenses and run all the numbers out to the age of 100 so we can help you feel as confident as possible.

A Retirement Distribution Plan for Bill and Betty

Here’s another example based on some of the work we do on a daily basis for our clients. Bill and Betty came to us in their early 70s and wanted to know when (or if) they could retire. They had saved up $1.4 million, but their broker was telling them they needed at least $4 million in order to cover the yearly income of $80,000 needed to maintain their current lifestyle. They weren’t very hopeful, but thought they would get a second opinion from us.

The first thing we did was create a retirement distribution plan, with their first 20 years of retirement covered by various “buckets,” all comprised of guaranteed-principal investments. We also created a bucket for emergency funds, and buckets for the long-term, when they would be in their 90s.

From doing the actual math and running all of the numbers, Bill and Betty absolutely could retire, and they could retire right away.

Not only that, but because we are a fee-only fiduciary (unlike their broker, or most bankers and brokers, who charge security commissions on everything), Bill and Betty realized a 75% savings on their management fees because Decker Retirement Planning, Inc. does not charge them on emergency funds or guaranteed-principal accounts.

Find Out For Yourself

Decker Retirement Planning, Inc. would welcome the opportunity to meet with you about your individual situation, on a complimentary basis. We have offices in the Greater Seattle and Greater Salt Lake areas. Call us at 855-425-4566 to schedule an appointment.