It is time for the next entry in our blog series “The 7 Deadly Sins of Retirement Planning.” Today I would like to talk about Sin #4: Not Having a Volatility Buffer
The 7 Deadly Sins Are:
- No Holistic Plan
- No Spend Down Strategy or Exit Plan
- Too Focused On “Growth” Rather Than “Income”
- No Volatility Buffer / Non-Correlated Asset Classes
- Not Risk Smart
- Mistakes with Insurance
- No Strategy for Taxes
In my last blog post, I discussed the mistake of investors being too focused on “Growth” and never making the mindset shift into “Income.”
Conventional financial wisdom sets you up to rely 100% on the performance of the equities market for the success of your retirement.
That leaves the investor incredibly vulnerable.
We used to be able to rely on bonds as a “safe haven,” so conventional wisdom says that in retirement, invest your portfolio in 60% stocks / 40% bonds, and withdraw 4% per year.
But that no longer works in today’s world! We cannot rely on the 60/40 portfolio, as shown during the financial crisis in 2008: the prices of both stocks AND bonds went down.1
And think about this – the price of bonds is inversely related to interest rates. When rates go down, the price of bonds go up.
When rates go up, the price of bonds go down.
In today’s low-interest-rate environment, most pundits think that interest rates are as low as they can go – they have nowhere to go but up!
I personally do not think that rate increases will happen in the near future, but when it does happen, the price of the bonds will go down.
So much for the “safe haven” of bonds!
How does this impact your retirement income plan?
As discussed previously, the 4% withdrawal rate fails 20-30% of the time due to increased stock market volatility and persistently low-interest rates on savings and debt instruments.
The safe distribution rate has been lowered to less than 3%.
If you have $1 Million in your IRA, you have to pace yourself at $30,000 of withdrawals per year, at least if you do not want to risk running out of money before you die!
While our investments in the stock market tend to increase over a long-term period, they are extremely volatile & unreliable in the short-term.
Not only is it very dangerous for a retiree to rely on the stock market for short term income, but it is also incredibly stressful.
We should implement a “Volatility Buffer” into our financial plan.
A volatility buffer is a noncorrelated asset class that is not tied to the equities market. They should be safe, stable, and reliable.
Just as important, they should be efficient at generating cash flow!
Let me introduce a paradigm shift: the ultimate success of your retirement is NOT about your assets.
We cannot spend numbers on a piece of paper! We spend INCOME!
We need products that are designed to preserve your assets and to efficiently distribute reliable income.
Think about the most miserable people you know in retirement… they are LOADED!
They have got assets coming out the wazoo! They are swimming in assets!
But they are miserable because they are constantly worried!
They are worried about losing money in the stock market, they’re losing money in oil, they’re losing money in China, they’re worried about what’s going to happen if this bozo gets into the Oval Office vs. this yahoo over here.
People who retire only on assets tend to be miserable.
Who are the happiest people in retirement? People with pensions.
Retired teachers, military, government employees, etc. People with “guaranteed paychecks for life.”
They are never concerned about running out of money; their paycheck will last as long as they do.
The Wall Street industry and the financial media have conditioned us to value a large lump sum asset over reliable streams of income.
But why?? Because they make a ton of fees off us to manage our lump sum asset!!
Most people do not realize the capital equivalent value of a pension. If someone has a $4,000 / mo. pension, that is $48,000 per year.
Let us work backward, utilizing the safe withdrawal rate:
Example:
$48,000 per year / 3% safe withdrawal rate = $1,600,000
A $4,000 per month pension has the capital equivalent value of a $1.6 Million lump sum in an IRA or brokerage account. (This is not taxing taxes into consideration of course).
INCREDIBLE!!
If you have a pension, that is an incredible Volatility Buffer!
The problem? Most people do not have access to pensions anymore; only about 15% of Americans have a traditionally defined benefit pension plan nowadays.
The solution? Fund your own pension plan!
A retiree can take a portion of their
assets to buy an income annuity, which functions as a type of “personal pension” in that it distributes a regular stream of income (and it does so at much higher rates than the safe 3% withdrawal rate).
Think of this as “cash flow insurance.”
And for people who are 10+ years away from retirement, I often fund their “personal pension” by using cash value life insurance.
Why in the world would we use life insurance? Life insurance is the last thing you would think you want to use.
Why do we use it then? Because the tax code has anointed it.
The distributions can work similar to an annuity, but according to the tax code, distributions are completely tax-exempt, if structured properly. Amazing!
Here is the kicker: If immediate spending needs are secure because of the implementation of a Volatility Buffer, the rest of the assets can be invested even more aggressively for growth!
The presence of the Volatility Buffer significantly reduces the influence of “behavioral finance” (emotional decision making), even when the portfolio has sudden fluctuations due to short-term market volatility.
Why? Because the near-term is completely secure.
This tends to to reduce investing mistakes and leads to improved outcomes and better performance for the long-term investment portfolio as well!
Althought they may exist, I cannot think of a case where someone would not benefit from using a “Volatility Buffer.”
The sooner one begins to plan & fund it, the better it will perform in their long-term plan.
Keeping the majority of your money invested in the equities market can lead to a lot of stress & anxiety.
But allocating a portion of your assets into a Volatility Buffer can help improve long term outcomes, help you to enjoy your retirement, and help you to sleep well at night!
For a free, no-obligation consultation about how to implement these concepts into your retirement plan, feel free to contact me!
And do not forget to tune in for the next entry in the blog series: Deadly Sin #5 – Not Being “Risk Smart”.
P.S. If you haven’t checked it out yet, please stop by my mini online seminar How Retirees and Pre-Retirees Can Potentially Avoid Going Broke While Keeping Their Nest-Egg Secure! Tons of great information and bonus is it is 100% COMPLIMENTARY!
1 https://www.investopedia.com/why-morgan-stanley-says-the-60-40-portfolio-is-doomed-4775352
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