4% Rule Under Fire- Again


4pctThe often-quoted ‘4% withdrawal rule’ that mainstream investment managers use as a guideline ‘safe’ withdrawal rate for a portfolio has come under fresh fire.

The volatility of the last few years should have already given most conservative investors enough heartburn to not stake their life savings on this faulty rule of thumb.  But new research is showing just how disastrous bad advice can be.  We’ve written about this flawed approach before as well.

The 4% Rule Background

The ‘4% Rule’ isn’t really a rule.  Rather, it’s an asset withdrawal rate promoted initially by a retirement planner named William Bengen.  The theory states that a safe retirement withdrawal rate starts out by drawing down just 4% of your portfolio and adjusting up only for inflation.  Testing against 75 years of historical stock and bond prices shows the probability of failure – meaning, the chance of running out of money in a 30 year retirement, at an acceptably low probability of about 6%.

Where It Falls Apart:

In its day, the “Rule” made sense, but that day was 1994.  The US had strong market performance year over year in the preceding decade, and portfolios grew at a solid rate even with withdrawals.

Well along comes the Tech Bubble, a Black Swan event, and then a Flash Crash, computerized trading, the lost decade of the 2000’s, the banking crisis, international currency crisis, and the real estate crash.  Oh yeah, THAT awful decade….

Retirees looking to their assets for income, and carrying their own longevity risk, saw portfolio values decimated, and at the same time were forced to sell securities while they were down for income.

Welcome to Reverse Dollar Cost Averaging- Getting kicked while you are down.

Well in case you didn’t already know from common sense, you can’t pull money out of a depreciated portfolio and expect it to bounce back and stay on track indefinitely.

The Case for Annuities:

I probably don’t need to belabor the point that annuities are MADE for times like this- quite simply, you buy security and safety of income, and offload major risks like longevity and loss of principal on a strong insurance institution. That’s all there is to it.  How we put together a plan for you depends on your needs and assets, so get started by giving us a call today.

 4% Rule- New Research

New research from a distinguished trio of academic and research economists has driven a new nail in this coffin.  Michael Finke, Wade Phau and David Blanchett have re-run the economic simulations that Bengen initially based his finding on with TODAY’s actual reality of low to negative real (after inflation) bond yields.

Instead of a 6% probability of failure, today’s rate environment produces an astounding 57% probability of portfolio ruin.  Remember, ruin means running out of money- kaput, no groceries, no roof over your head.  Does that sound a like a good way to spend your final years?  At 57%, this is almost a certainty of failure!

Here are several quotes from the Author’s excellent new study (Available Here):

The safety of a 4% initial withdrawal strategy depends on asset return assumptions.  Using historical averages to guide simulations for failure rates for retirees spending an inflation-adjusted 4% of retirement date assets over 30 years results in an estimated failure rate of about 6%. This modest projected failure rate rises sharply if real returns decline.

As of January 2013, intermediate-term real interest rates are about 4% less than their historical average. Calibrating bond returns to the January 2013 real yields offered on 5-year TIPS, while maintaining the historical equity premium, causes the projected failure rate for retirement account withdrawals to jump to 57%. The 4% rule cannot be treated as a safe initial withdrawal rate in today’s low interest rate environment.

Some planners may wish to assume that today’s low interest rates are an aberration and that higher real interest rates will return in the medium-term horizon. Although there is little evidence to support this assumption, we estimate how a reversion to historical real yields will impact failure rates.

Because of sequence of returns risk, portfolio withdrawals can cause the events in early retirement to have a disproportionate effect on the sustainability of an income strategy. We simulate failure rates if today’s bond rates return to their historical average after either 5 or 10 years and find that failure rates are much higher (18% and 32%, respectively for a 50% stock allocation) than many retirees may be willing to accept.

The success of the 4% rule in the U.S. may be an historical anomaly, and clients may wish to consider their retirement income strategies more broadly than relying solely on systematic withdrawals from a volatile portfolio.

As Pfau (2010) showed, the success of the 4% rule is partly an anomaly of the US historical data. In most other countries sustainable initial withdrawal rates fell below 4%. We find there is nothing inherently safe about the 4% rule. When withdrawing from a portfolio of volatile assets, surprises may happen. This study demonstrates that when we recalibrate our assumptions for Monte Carlo simulations to the current market conditions facing retirees, the 4% rule is anything but safe.

We also show that a 2.5% real withdrawal rate will result in an estimated 30 year failure rate of 10 percent.  Few clients will be satisfied spending such a small amount in retirement.  It is possible to boost optimal withdrawal rates by incorporating assets that provide a mortality credit and longevity protection.  Pfau (2013), for example, estimates that combining stocks with single premium immediate annuities, rather than bonds, provides an opportunity for clients to jointly achieve goals related both to meeting desired lifestyle spending, and to preserving a larger reserve of financial assets. In the absence of some added income protection, there is a high likelihood that low yields will require planners to rethink the safety of a traditional investment-based retirement income plan.

For Many Financial Advisers, Stocks Become A Hard Sell

Life On An Equities Roller Coaster

Life On An Equities Roller Coaster

This post’s title is taken directly from a Wall Street Journal cover story that left me smiling today.

Stocks hold no allure for me anymore… Since the first day I worked with annuities, I’ve been free of the roller coaster ride of stocks- the gut-wrenching drops in value, the sleepless nights, and the fear of simply not knowing what some rogue computer program run by a kid playing with some institution’s account can do to my real dollars….

All that’s gone now… And not missed for one moment!

I take real pride in helping others find the same security.  And in case you haven’t studied real, long term yields, the rates offered on our Secondary Market Annuities are quite competitive given the safety and security of the assets.

You’re hardly giving up anything in terms of yield, and yet you give up all the uncertainty, fluctuation  risk, and worry.

You may just gain years on your life in the trade!  (It’s a fact that annuity owners live longer on average- but more on that in another post)

Here’s the story of a few poor souls who haven’t yet found the security of a good baseline GUARANTEED income… the kind of income only an annuity can provide.

Financial adviser Jeffrey Smith recently watched a once-confident client scrawl his fears across a legal pad during a discussion of stock investments: “Congressional stalemate,” “unemployment,” “European crisis,” “corruption.”

The client, retiree Nicholas Zerebny, later recalled how his thoughts strayed to Edvard Munch’s “Scream” paintings. In the middle of the page, Mr. Zerebny drew a crude version of the iconic screaming face.

“That’s how I feel right now,” he told Mr. Smith.

For Mr. Smith and other U.S. financial advisers, that anguished cry—real and metaphoric—has become a familiar part of the job.

Since hitting a recession-driven low in March 2009, the Dow Jones Industrial Average has doubled in value. But many ordinary investors remain too fearful to join in the gains.

After two stock collapses in one decade—2000-2002 and 2007-2009—along with scandals, the rise of high-frequency trading and worries over Washington’s ability to rein in debt, Americans are pulling out of the market. Individual investors yanked a net $900 billion from U.S. equity funds since January 2000, according to fund flow tracker EPFR Global. Penny Stocks and stock mutual funds now make up 37.9% of the average U.S. household’s financial assets, down from 50.5% during the height of the tech-stock boom in 2000, according to the U.S. Federal Reserve.


Here’s the Source:

Prospects For Stocks Are Dim Says WS Journal


The title really does say it all- “Prospects For Stocks Are Dim” says Tom Lauricella of the Wall Street Journal.  It’s hard to chart a course in this turbulent market and the risks are just too high for most investors.  Individuals can not afford to take the risk of losing principal, and it seems those risks have never been higher.

With record low interest rates, bonds  carry immense risk to principal if interest rates rise.  As value moves opposite to yield, a rise in yield will vaporize principal faster than a stock market crash.

And stock market crashes seem to be more the norm than the exception anymore.  Respected money manager Ben Inker of GMO in Boston is quoted in the article below saying:

“Corporate profits are at all-time highs and we don’t think that is sustainable,” Mr. Inker says. That, he adds, suggests stocks are more expensive than investors realize.

As a result, over the next seven years “we don’t think the stock market is priced to deliver a lot of returns,” says Mr. Inker. “Maybe you will keep up with inflation.”

Faced with such high risk times, volatile options, and low expectations from even the best managers, why not make a smart, safe, insured bet on quality annuities, especially our Secondary Market Annuities which can routinely yield high 5% to 6% range.

What’s not to like?

Here’s the full article below-

Prospects for Stock and Bond Returns Are Dim


Source: WSJ 

When it comes to expecting stocks to provide them with any kind of decent return, many investors are throwing in the towel. After all, it’s been years of back-and-forth swings in their portfolios.

Meanwhile, the double-digit returns on bonds over the last 25 years have investors piling into fixed-income investments in record numbers—even as many money managers and analysts warn that investors shouldn’t expect those kinds of returns to continue.

It’s an especially confounding time to be sketching out expected returns on a portfolio, with both stock and bond markets buffeted by significant and unusual forces that could play out for many years to come.

A Grim Five Years
The outlook for stocks stretching out for the next five years or more would seem to be grim, thanks to entrenched fiscal and economic woes in the U.S., Europe and Japan. The U.S., for one, continues battling stubbornly high unemployment and the lingering effects of the housing collapse.

At the same time, some argue that the Federal Reserve’s unprecedented efforts to pump money into the financial markets will eventually lead to a flare-up in inflation. That would send interest rates higher and lead to a nasty bear market for bonds.

Throwing fuel on that fire was the Fed’s decision earlier this month to expand its effort to effectively print new money and prop up the economy. The Fed said it would make an additional $40 billion per month in bond purchases until the unemployment situation materially improves.

But those same efforts by the Fed are keeping the bond bull market alive by capping interest rates and, at the same time, feeding investor demand for riskier and higher-return investments, such as stocks.

In the face of entrenched investor skepticism, the U.S. stock market has staged a powerful rally in 2012. The Standard & Poor’s 500-stock index is up 16% so far this year.

This convoluted backdrop has sparked a vigorous debate over the kind of expectations investors should have for stocks and bonds. Keep in mind that returns are measured by more than just changes in bond or stock prices. What matters is total return—plus stock dividends or bond interest.

Attracting considerable attention have been particularly gloomy arguments from famed bond-fund manager Bill Gross, of Pacific Investment Management (Pimco). Mr. Gross believes bond returns will likely drop to 2% a year on average and stocks will gain only 3% to 4% a year.

Though it may seem like a meaningless debate among the talking heads on financial television networks, expectations matter for individual investors. “They’re a critical component to strategic asset allocation, establishing tolerance for risk and thinking about how asset classes interact” within a portfolio, says Joe Davis, head of Vanguard Group’s investment strategy group.

For Shawn Rubin, a financial adviser at Morgan Stanley Smith Barney, return expectations are central to conversations with clients about their asset allocation and rebalancing strategies.

Often, investors “underestimate the lumpiness of returns and how frequently riskier investments have 5% or more of paper losses,” he says.

Another issue is coaxing investors to think about expected returns in relation to inflation, and not just on a nominal basis. For investors whose primary goal is to avoid having inflation erode the value of their savings, “right now, you don’t need a lot of return to achieve that goal,” says Mr. Rubin.

Take the debate over bond returns. Hal Ratner, an asset-allocation specialist at Morningstar, is among those who think bond returns will dwindle in coming years. He notes that on a short-term basis, investors owning U.S. government bonds are effectively losing money once inflation is factored in.

“That makes you think, ‘Should I really buy government bonds?’ ” says Mr. Ratner. “But in the event that something bad happens [in the stock market], we know that they will protect your portfolio…like buying insurance.”

So for investors with a shorter time horizon, bonds, even with minimal returns, still can act as a cushion should the rest of your portfolio lose money. “Time horizon is absolutely critical,” says Mr. Ratner.

On the stock side of the equation, the calculus gets a lot more complicated.

For starters, expectations are often colored by recent experience, especially a negative one. In the case of stocks, they’re shaped by the financial crisis, even though the S&P 500 has returned more than 6.5% a year for the last 10 years once dividends are factored in.

“For investors, the last 10 years don’t feel like they’ve been up 7%, what they feel is what they felt [like] in 2008” when stocks collapsed, says Lisa Emsbo-Mattingly, director of asset allocation at Fidelity Investments.

Fidelity’s asset-allocation group, which sets the investments for the firm’s target-date retirement mutual funds, believes that over the next five to 10 years, U.S. stocks can generate average to slightly-below-average returns—roughly in the neighborhood of 6% a year.

This forecast is based on expectations that the U.S. economy is not mired in a Japan-like extended recession and will be able to post moderate—though below historical trend—growth of about 2%. Add in the productivity of U.S. companies and strong corporate balance sheets, and Fidelity thinks earnings growth should be able to power better future returns than many investors are currently expecting.

Expensive Stocks
Ben Inker, co-head of the asset-allocation group at money manager GMO, takes a different approach, putting more weight on stock valuations compared with the outlook for corporate profits.

“Corporate profits are at all-time highs and we don’t think that is sustainable,” Mr. Inker says. That, he adds, suggests stocks are more expensive than investors realize.

As a result, over the next seven years “we don’t think the stock market is priced to deliver a lot of returns,” says Mr. Inker. “Maybe you will keep up with inflation.”

Still others take a different view of stock valuations. On balance, “valuations are close to average,” says Vanguard’s Mr. Davis. “That would suggest…returns that range in the high single digits.”

The 4% Retirement Income Solution


What is your plan for retirement income? Traditional asset management with a 4% annual distribution is a popular idea with professional advisors and consumers alike. New research from the Merrill Lynch Wealth Management Institute suggests this approach to be far too simple. An article published last week in Smart Money covers many of the potential problems with the 4% solution. Read the article here.

The author claims the biggest issue with the 4% distribution rule is that it doesn’t address the major risks retirees actually face. Longevity risk, sequence of returns risk(reverse dollar cost averaging) and asset allocation risk are just a few of those mentioned. If you’ve been following us for long you’ll know that we tend to agree with the assertion.

When you consider that age and gender are significant factors when devising an income strategy, it’s easy to see why there is no such thing as single plan or rule that can work for everyone, as mentioned in the Merrill Lynch study. Additionally there are a multitude of other factors that will affect your strategy so designing a plan that works will cost a lot of time and money. And even so there are no assurances offered.

I’m not going to rewrite the article but I do suggest you take a look at it to see what the exact risk factors are and how changing one can substantially affect the others. Education and understanding are critical to making decisions that will last a lifetime. There’s no way anyone can afford to make a mistake here.

We are obviously fans of guaranteed income. I personally think that keeping income and growth assets separate is a pretty dang good idea. Why worry about it for the rest of your life? When you’re ready for a discussion about the difference between asset management and income planning, simply contact us so we can help make sense of it all.

Have a great week!

Bryan J. Anderson
[email protected]

Will Your Portfolio Survive the Next Surprise?

This WSJ article will give you a good idea as to how to implement portfolio-wide risk management strategies. It’s a short read that should give everyone considerations about asset protection. And honestly, who isn’t concerned about market corrections given the roller coaster ride of the past decade.
The author, Gregory Zuckerman, points out that sell-offs in the market are often caused by seemingly unexpected events. For instance, think of the shockwaves sent through the markets as a result of the recent uprisings in the Middle East. The threat to the world’s oil supply could potentially come with far-reaching affects to our economy.
In order to protect yourself and potentially profit from unforeseen market volatility the article mentions a few good indicators for asset allocation.  Read the article here.
First of all, one advisor, Jeff Fishman, offers a good test to see exactly how much money you should have in the market compared to how much in cash or safe vehicles. He asks you to imagine the worst case scenario, which would be a 50% drop in the market across the board. Would that cause you to lose sleep at night? I’d imagine it would. If so, Jeff says that should tell you that your market exposure is too high and more of your assets should be held in cash.
The second one mentioned, diversification, is pretty much a cliché, although everyone really should know not to expose all assets to the risks of one specific strategy or investment class. As simple and widespread as that advice is, constant evaluation is necessary to make sure your portfolio is properly hedged for any market.
Finally, the article suggests options contracts as a way to profit from drops in the market that will offset other portfolio losses. It is true that strategies like this provide a way to profit nicely in volatile markets but proper use of options requires a specialized set of skills. Unless you are a seasoned market professional it would pay dividends to seek expert advice in this area.
This all leads me to a few points. Would you like to know how to get asset protection and growth at the same time?
I happen to know of some options that offer the safety of cash, fit into the portfolio diversification parameters suggested and come with the potential to profit from strong markets while protecting against weak markets.
The answer is simple and that is why so many people are moving away from the highly technical strategies that come with exposing assets to market risk. If there is an easier way, why wouldn’t you take the less complicated path?
I’d be happy to talk to you about the possibilities and address all of your concerns. Call, email or make an appointment now to add the ultimate combination of safety and growth potential to your retirement portfolio.
Bryan J. Anderson

800.438.5121 [email protected]