There must be some way out of here
Said the joker to the thief
There’s too much confusion,
I can’t get no relief
Businessmen, they drink my wine
Plowmen dig my earth
None of them along the line
Know what any of it is worth
—Bob Dylan (1967) “All Along the Watchtower”
This is my favorite work by Dylan, who in my mind is the greatest songwriter of his generation. At his peak, in 1967, he wrote one of the most covered rock songs of all time.
The generation of Americans graduating from high school from 1967 to 1969 could have grown up listening to any of today’s pop idols, but through chance and good fortune, they were listening to Dylan at the same time Dylan was writing these masterpieces.
But was the Woodstock Generation so lucky? The graduating classes of 1967-1969 also experienced the largest draft years of the Vietnam War and its largest casualties.
No reason to get excited, the thief, he kindly spoke
There are many here among us who feel that life is but a joke
But you and I, we’ve been through that, and this is not our fate
So let us not talk falsely now, the hour is getting late
Now, for the graduating classes of 1967-1969, the hour is getting late. They have turned 65, or are soon approaching it, and thus many have retired. The same luck or chance that allowed them to experience Dylan—and disproportionately sacrifice in Vietnam—is also dooming their retirement safety.
Just as they are about to stop working, their retirement nest eggs are reaching their largest asset levels. At the same time, the stock and bond markets are at some of the highest levels of the past 145 years, yet are likely to generate returns far below that period’s historical averages.
Wade Pfau, a professor of retirement income at the American College for Financial Services, has developed research on safe withdrawal rates—taking into account the fees for mutual fund management and advisor management and refining the timing risk for people retiring at a specific date. He and I have written about these results in the past two issues of Financial Advisor. Click here to read the "Rethinking Retirement" Whitepaper. Click here to read the October story.
Our research determines that a safe withdrawal rate for the retirement class of 2014, 2015 and perhaps 2016 and 2017 is abysmal. This generation has picked a poor time to retire, no doubt about it.
Their safe retirement rate is 1.7%, assuming they retire on January 1, 2015. We used U.S. 10-year bond yields and stock valuations for the same date. This withdrawal rate is less than 50% of the amount that advisors had used as a common rule of thumb up to this point: the 4% withdrawal rule. That just became the 1.7% withdrawal rule for a 2015 retiree.
Simply stated, either retirees need to have saved twice as much money for retirement as predicted, or they need to spend approximately half of what they thought they would. If they were expecting $1 million to last through their retirement, they really need $2 million. If they believed they could live off $10,000 per month, they need to plan to live off $5,000.
That means this generation, if they are attempting to insure their longevity risk, must get by on less. Their alternative is to accept the very high probability that they will outlive their savings.
Why is this? Chance? Bad timing? Luck of the draw? The sequence of returns?
Well, it is all of the above, but it is especially the sequence of return risk and our ability—with great confidence—to predict that their unique set of early returns will be far below the average of the past century.
That’s because this is one of the worst times to base your retirement on the classic 60% stock and 40% bond portfolio. Stock valuations have been higher in the past 145 years, according to the Shiller cyclically adjusted price-to-earnings (CAPE) ratio, but only on three occasions: in 1929, from 1998 to 2000 and from 2007 to 2008. In those instances, the ratio was over 26x, and each time it presaged three market crashes in the S&P 500. The average of those declines, from peak to trough, was negative 64%.
The Shiller CAPE model is named after Robert Shiller, the Yale University economics professor and 2013 recipient of the Nobel Memorial Prize in Economic Sciences. Also known as “PE10,” this model is commonly used to predict likely equity returns in the 10-to-20-year time period.
The Times Are A-Changing Your Retirement
November 2015
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Comments
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60/40? Really? Who in their right mind puts 40% of anyone's money in bonds (and I wager your model uses long term Treasury bonds), when interest rates are near 35-year lows? 60/40 is so "Wall Street" passé. My gosh, it's not at all difficult to find better value, higher-yielding assets than 30-year government bonds these days, and assets that have some growth as well as growth of income potential. Small pieces of dividend aristocrats, energy MLPs and short duration bonds come to mind right off the bat. I'd also urge advisors to utilize inflation hedge tactics by using select asset classes that will likely benefit from the coming debt-bomb explosion. The academes of the world, along with political correctness, will surely become our downfall.
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The key to avoiding sequence risk is owning a large liquid asset which buffers against poor equity and bond returns, and also provides an income stream for years to come. Many of my clients own large cash value life insurance programs with hundreds of thousands of dollars in their cash values-some more than a million. These more mature policy cash values currently earn 4-5% tax deferred, with no risk of principal. The cash values also act as an emergency fund-so instead of Money Market cash, or short term bonds earning essentially zero, we capture 4-5% through cash value life insurance. Moreover, when we layer on lifetime annuity income which cannot be outlived, we mitigate sequence risk, and also accrue mortality credits along the way-meaning higher income downstream. No other asset class or product is capable of providing mortality credits. None. Mortality credits are unique to the annuity income strategy. And, if the lifetime annuity is also eligible for dividends via a mutual company, these dividends provide enhanced income, and, also help mitigate inflation risk. The annuity income also avoids advisory fee risk, along with elderly decision-making risk. Owning myriad streams of guaranteed monthly income-called "flooring", in addition to a robust equity portfolio, and hundreds of thousands of dollars in life insurance cash values, provide the optimal confluence of unique asset classes designed to provide enhanced Retirement Plan (RP) success probability. The higher the guaranteed lifetime income floor? The less pressure on equity portfolio performance to provide basic necessity income. And, when a retiree passes away leaving just a widow(er)? The life insurance death benefit replaces a lost SS check. Providing further income security in retirement. AUM advisors may not appreciate this truly client focused RP approach, however, it certainly is successful when properly implemented.
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Saying that this is a bad time to retire implies that those who are already retired are home free. Those just retiring and those already retired, all are just beginning the start of the rest of their retirement. That means that all retirees must deal with all of the adverse issues mentioned, except maybe those already age 100+. Sequence of returns is only an issue if the distribution rate is based on current portfolio value without adjusting the value to account for current over-valuation and current return expectations.