Retirement investing can be very challenging because you want to make sure your investments are generating enough money to live on, and you want to make sure your money doesn’t run out. Avoiding unnecessary risk and protecting your money is a necessity because you can’t wait out a market downturn. But, investments with more risk do offer higher returns. So, what should you do?
Risk in the Retirement Portfolio
How much risk is too much? That’s the question we covered in one of our recent radio shows, “How Much Risk Are You Really Taking.” (Listen here.)
“We define risk as principal that’s not guaranteed. It can go up or down, it’s got exposure to the stock market.”
-Brian Decker, Decker Retirement Planning, Inc.
At Decker Retirement Planning, Inc., assessing the amount of risk that might be needed in your retirement portfolio is all about math, and each client’s situation is unique.
The first thing we do for each client is create a retirement distribution spreadsheet showing all sources of income and help calculate exactly how much may need to be drawn out of investment accounts yearly to age 100. Of course, RMDs (Required Minimum Distributions) for qualified money like 401(k)s and traditional IRAs will be taken into account with the goal of minimizing taxation. We even factor in a yearly inflation amount of 3% to be extra-conservative about the amount of income you will need.
Some People Don’t Need Market Risk at all in Retirement
Depending on your monthly income sources and your individual situation, part of your portfolio might need to have more exposure to risk compared to another person in a different situation. For instance:
A 65-year-old couple who needs $6,000 per month to live on will have two Social Security checks, a pension coming in monthly, plus $800,000 saved for retirement. This couple has their monthly living expenses covered without withdrawing money from their nest egg, so they don’t need to take any market risk but, instead, could place all their money in conservative principal-protected investments, if they’d like.
A single 65-year-old who needs $4,000 per month to live on will have only $2,500 coming in monthly from Social Security plus $800,000 saved. This person may need to have some market exposure or take some risk with a portion of their nest egg (maybe 25%-30% of their total portfolio) in order to meet their monthly income goals throughout retirement.
“The stock market offers the highest potential return rate as well as the most risk. Some clients don’t need it. Others without enough monthly retirement income streams may need to get higher returns on a portion of their money. We do the math.”
-Brian Decker, Decker Retirement Planning, Inc.
By the way, you’ll never find a banker or broker doing detailed retirement distribution planning. With them, you’re just guessing. Some still advocate the 4% rule (discredited by its creator, by the way), which refers to the theory that you should take 4% of your retirement money out of your savings every year. That’s it. That’s their plan. Our rule is to never take advice from a financial person who isn’t a fiduciary, who is required by law to give you advice that’s in your best interest!
Once we determine if part of your portfolio should have some exposure to the market, we start looking at which investments are best for you. There are investments that have exposure to the stock market that we do recommend when it’s mathematically determined based on an individual’s situation—for example: certain stocks, mutual funds, real estate, and ETFs that we’ve vetted through the decades.
We use a two-sided strategy that is designed to help you make money when the markets are up and that protects your principal when markets are down. We use models that are designed to make money in both up and down markets. That’s the standard we place against riskier investments.
Five Risky Investments to Avoid
For this article, we want to point out five investments with too much risk or, in other words, investments that we avoid.
Variable Annuities
Let’s start with the worst. As financial fiduciaries at Decker Retirement Planning, Inc., we consider variable annuities the worst investment option out there. When variable annuities fail, there’s no downside protection. And, when you start looking at the fees involved with these products, the returns don’t even keep up with the S&P.
The sales pitch associated with variable annuities is that they offer a way to invest in the stock market and have a guarantee. But, they don’t tell you that you have to die to get that guarantee. It doesn’t benefit you in your life, especially as variable annuities have exorbitant fees taken out every year, typically starting with 8% taken out of your principal up front to pay the banker or broker. The banker-broker, insurance company, and mutual fund companies get paid every single year you own a variable annuity—three layers of fees that typically add up to 5% – 7% before you even make a dime. As a result of all these fees, variable annuities lag the market and go down even more when markets are down.
“Bankers and brokers don’t disclose the exorbitant fees charged on variable annuities—they don’t have to, because they’re not fiduciaries, they are salespeople.”
-Brian Decker, Decker Retirement Planning, Inc
There is a saying in the business that variable annuities aren’t bought, they’re sold. Meaning that if you knew all of the expenses involved with them, you would never buy them.
Bond Funds
We believe that bond funds are the second worst investment you can make. In addition to the 4% rule discussed earlier, bankers and brokers often talk about the rule of 100. That rule states that you should have 60% of your assets in bonds and bond funds at age 60, 70% at age 70, and so on as you get older.
The terms “bonds” and “bond funds” are used synonymously, and they’re supposed to be your “safe money.” Safe money, by definition, implies that the value won’t go down. But, bond funds do go down! When interest rates go down, bond funds make money. Right now, interest rates are at historic, record lows. Last May, the 10-year treasury was at 1.4%! Now, it’s around 2.3%.
The rule of 100 makes absolutely no sense right now. Why would you place the majority of your retirement money in assets that are paying next to nothing? But, an even greater problem when it comes to bond funds is interest rate risk. Remember, when interest rates go up, the value of bond funds goes down. For example, like in 1999, when the treasury rose from 4% to 6%. The average bond fund that year lost around 17%.
“If we go from our current low interest rate of around 2% back up to around 4%, that’s a hit to principal of around 15%-20% on what bankers and brokers are telling you is your ‘safe money’ in bond funds. In our opinion, that’s financial malpractice.”
-Brian Decker, Decker Retirement Planning, Inc.
We absolutely do not recommend bond funds. Instead, we offer principal-guaranteed products that have averaged 6.5% for the last 15 years. Bankers and brokers don’t get paid security commissions on these sorts of products, and that’s why you don’t know about them.
Oil and Gas Partnerships
With these investments, known as Master Limited Partnerships or LPs, you become a “partner” with a lot of other investors in the pursuit of one limited endeavor. Let’s say you invest in an oil and gas partnership, and you go exploring and looking for oil and gas reserves in Texas. But, let’s say that after awhile, you don’t find any. Sorry, bye. You get an apology letter, and there goes all your money.
Even if you do strike oil, this investment is sector-specific; therefore, if the overall price of oil drops, so does the value of your investment. There’s really no type of industry or sector not subject to market cycles (growth, maturation, and decline) and other ups and downs, which puts your retirement money at risk. Consider technology and what happened to the tech bubble, utilities, and what the cell phone did to AT&T.
Master Limited Partnerships (LPs) aren’t limited to the oil and gas industry. The biggest problem with them is that the terms of partnership are such that salaries and compensation are set aside before any net profits are paid back to investors.
The biggest grossing animated film in history, Disney’s “Frozen,” was set up as a master limited partnership. Huge amounts of money were spent internally before they decided what they would pay out to the investors. There’s no reason for internal employees and owners not to spend through the bulk of the gains on luxury items like cars and houses for themselves first, if they hit the jackpot.
Even if you purchase these sorts of partnerships because they pay dividends, you could run into trouble.
“Often oil and gas partnerships are purchased by retirees for the dividend, and naturally everyone chooses the company paying the highest dividend. What’s often missed is analyzing the underlying EBITDA (earnings before interest, tax, depreciation, and amortization) and cash flow to spot problems before they happen—before a company might suddenly stop paying out dividends because they’ve been borrowing to pay them in the first place.”
-Brian Decker, Decker Retirement Planning
Stock Options and Futures
Stock options are a leveraged way to invest in a company. Why pay $160 per share for 100 shares of Boeing for $16,000 when you can control 100 shares for $1,000 using stock options? You have “puts” that make money as the stock falls and “calls” that make money as the stock goes up. Trouble is, it is essentially gambling. It’s not investing—it’s speculation. You might make money once or twice, but then you’ll lose that and more later.
“There was a guy advertising on radio and TV about how easy stock options are. He’s gone…in prison. The people who push these are deceptive, and they damage investors. I’ve been in business for 32 years and I’ve never once run across anyone who made money in the stock option market over a 12-month period, ever.”
-Brian Decker, Decker Retirement Planning, Inc.
Futures are to commodities what options are to stocks. Avoid them.
Foreign Exchange
Foreign exchange (sometimes called forex or FX) is the global trading of all the different world currencies. At Decker Retirement Planning, Inc., we are watching the volatility in foreign exchange and in managed futures, and they aren’t producing competitive returns yet. We can’t recommend them for retirement at this point in time.
