Thursday, July 7, 2016

Longevity of Retirement Income

In early May, we attended an “Inside Retirement” conference sponsored by Financial Advisors magazine; the topics were centered on “income and longevity.” Various nationally known speakers discussed pertinent items related to those themes. We found some presentations worthy of discussion here. Some presentations were individual speakers; some presentations, panel discussions. Various concepts were presented for discussion; we don’t necessarily agree with all ideas presented but did find most of them thought provoking.
 
The World Today
 
Interest rates today are at historic lows. The 10-year US Treasury note yields approximately 1.8%, and some overseas developed countries have negative interest rates for their sovereign bonds. Low interest rates mean lower earnings available from an investor’s bond portfolio to supplement retirement income. Also, since bond prices relate inversely to currently low interest rates (as interest rates increase, bond prices decrease), bond prices are currently high.  The Federal Reserve Governors have continuing discussion about when (not if) to raise interest rates.
 
The stock market also poses some interesting challenges. Volatility in the market is significant, and some market analysts feel that stocks may be overvalued. Low interest rates have made some investors move into dividend yielding stocks in search of return—taking increased risk in the stock market in exchange for a higher current yield. Note that this higher current yield could be offset by loss in value if the stock prices decrease.
 
Other sources of retirement income have come into question. Social Security, a major source of retirement income for many Americans, faces funding shortages in the not too distant future. Changes are needed; however, the nature of those changes is still to be decided.
 
Finally, retirement life spans appear to be increasing. As life expectancies increase (and people are not working significantly longer), the length of time spent in retirement increases. Couple that increased longevity with potentially higher health care costs, and we face increasing pressure for financial longevity.
 
What to Do?
 
Much has been written and discussed about retirement planning (or the lack thereof) of Americans. We believe that retirement should also have a defined plan. Such planning should include planning for contingencies, structuring an investment portfolio, and a distribution strategy from any qualified plans. Since our major discussion above was related to investments, that’s what we will discuss here.
 
Market volatility is a fact of life. Stock market downturns will occur: the questions are when and how much. A retiree needs a stock component in a retirement portfolio. Stocks provide the long term growth necessary to preserve buying power over the long term—especially given the longevity previously discussed. Consequently, an investment portfolio should be structured to provide several characteristics.
 
  1. Liquidity--enough liquidity to cover necessary expenses over years when the stock market is down. This structure implies cash equivalents and bonds to cover 4-5 years of needed income without having to sell stock in a down market. Liquidity also means the ability to readily convert a portfolio holding into cash. In the 2008 downturn, some securities (auction rates) could not be readily sold at a fair market price.
  2. Total Return—low interest rates practically guarantee that an investor cannot meet all income needs from interest income only. Therefore, consider an investment plan that encompasses interest/dividend income with harvesting some of the investment gain in the portfolio. That’s “total return” investing where the income needs from the portfolio are met from a combination of dividends, interest, and gain from appreciated securities.
  3. Diversification—much has been made of the need to diversify assets. That diversification should include asset classes that may not have been utilized in the past. Use of alternative investing strategies (hedging techniques, conservative option strategies, etc.) and asset classes (commodities, etc.) may be warranted in selected portfolios. Note that alternative investing may be used to reduce risk, not just as a yield enhancement.
 
Investing for long term income in the current environment poses special challenges. Not all items mentioned here are necessarily advisable for all investors. We at Paragon Financial Advisors assist our clients in building portfolios that match that particular client’s goals and objectives. Paragon Financial Advisors is a fee-only registered investment advisory company located in College Station, Texas. We offer financial planning and investment management.
 
 
There was an error in this gadget