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| A Common-Sense Approach to Retirement Planning |
| by
Christine Benz
| 07-09-10 |
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Today's retirees and pre-retirees face multiple challenges, including still-shrunken principal values following the 2008-09 bear market and rock-bottom interest rates. Here are Harold Evensky's thoughts.
Question: There's a lot of concern about the prospect of higher interest rates and what that could mean for fixed-income portfolios. How are you thinking about that issue?
Answer: With a fair amount of concern. We do expect higher interest rates. Our concern is that they could peak in a very short period of time. In terms of fixed income, we invest in fixed income to preserve principal. We invest in equities to make money.
So we've always had a focus on preservation of principal in the fixed-income portion of our clients' portfolios. Our average standard in a normalized world is a credit quality of A and a duration exposure of about five years. Now, we ladder our portfolios, and even if we use funds we ladder by using funds of different duration exposures.
But for quite a few years we've been more defensive so that our average quality has been AA and our duration exposure has been around four years or so. And we've moved that down to about three and a half years. So that's the primary positioning in fixed income in anticipation of higher rates. Now, there's a cost, and we've been defensive for a fairly long time and given up some extra yield because we've stayed high quality and short term.
The other concern is if rates go a lot higher and they pick up quickly, that's also going to have a negative impact on the equity market, too. There's only so much you can do in terms of trying to predict the future. But that's the reason we're such big believers in diversification and so skeptical about any significant tactical strategies. If you're right with a tactical move, you look brilliant. But there's way too much risk. I would say there's a guarantee that the timing of some these brilliant tactical moves is going to be wrong.
Question: What are your thoughts on bank-loan funds? I've been hearing from a lot of readers who are looking to them as insulation against rising interest rates, but it's hard to forget how badly some of them performed in the bear market.
Answer: It's something that we've looked at, and intellectually, bank-loan funds make sense. But given what's happened in the last few years, our lack of confidence in being able to understand or evaluate the underlying quality has made us very hesitant to go into any investments of that type.
Burned once, shame on you. Burned twice, shame on me. So if there's anything sort of new or special or different or clever, we're extraordinarily skeptical and careful.
Question: So let's segue into annuities. Based on a previous discussion, it sounds like you are very bullish on single premium immediate annuities long term as a part of retiree toolkits. But right now you're saying hold off, because of the interest-rate environment and the relatively low payouts that you'd earn?
Answer: Correct.
Question: So how would you know when is a good time to start looking at a product like this?
Answer: No one's going to ring the bell, per se. But I said when interest rates get back to what would be considered more normal and when the yield curve looks normal, where we're not at historical lows and where we're somewhere around the median of what rates have been for the last couple of decades, it's time to consider [annuities].
We won't necessarily do 100% at one time. One of the suggestions often made, and I think it makes sense, is you ladder into it. We'll do 10% or 20% of whatever the total allocation we're planning on during over a period of a couple of years.
Question: And how about other annuity products and in particular the fixed deferred annuity or longevity insurance? What's your take on that type of product?
Answer: I think the longevity insurance is a brilliant idea, and assuming it's reasonably priced, will probably be the single most important vehicle. You'll get a lot of bang for your buck if you live long enough to see a payout, and it provides a great deal of flexibility in the design of the balance of the portfolio.
And from the behavioral standpoint it's very powerful. To tell someone to take 20% of their portfolio and annuitize it is difficult. Individuals are reluctant; they just don't want to do that.
But to tell someone who's, say, 50 years old or maybe even 60 that they can take a relatively small amount of dollars now and at 80 the deferred annuity will start paying them what seems like a huge amount every month the rest of their life--it sounds like an extraordinarily good deal. Individuals are not good discounters of future values so they're not discounting the fact that the big number 30 years from now it really isn't such a big number. But it feels big so it makes the investment much more palatable.
It also helps from a planning standpoint in doing a capital-needs analysis. If you know you have a good solid income stream kicking in at age 80, it's often possible to significantly increase the probability of success of a plan.
Now, it's not a free lunch, and you're clearly giving up a certain element of corpus. So if you die, you might be leaving less. But our goal is to increase the probability of our clients achieving their goals.
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