Finding decent yields when many interest rates are near zero is tough. That's especially the case with people who are retired or nearing retirement. Stocks are doing well these days and lots of money has flowed into bond mutual funds as well. But older investors are especially vulnerable to another hit on their portfolios. Many want to begin locking in their recovery gains from the market's recent surge, and make the transition from investment growth to investment preservation. To help in this process, U.S. News spoke with several investment advisers.
The most striking outcome of these discussions was the dramatic differences in the recommended retirement investment vehicles cited by the advisers. So perhaps the first message to anyone seeking retirement investment advice is to think seriously about your retirement needs before you even sit down with an adviser. They have strong views about the right paths for the people they advise. You need to develop your own strong views.
Have you done the serious budgeting and planning work to create an accurate picture of yourself in retirement? How much money will you really need? Where will it come from? What is your tolerance for risk when it comes to investing your nest egg? For a 62-year old couple retiring this year (and 62 is still the average retirement age, despite the recession), the odds are that one spouse will live another 30 years. Would your retirement funds last that long? What kind of monthly or annual spending stream would they support?
Joy Slabaugh is a financial planner with EST Financial Group in Delmar, Del. About five years before her clients retire, they begin shifting their investments from accumulation into preservation mode. As they near actual retirement, they then shift into distribution mode.
She advises clients to have 6 to 12 months of their spending needs in cash or cash equivalents. "If they have a portfolio that does not have cash guarantees, they certainly need a large liquid fund to avoid having to sell securities at disadvantageous prices," she says. To get better income payouts in today's environment, while still seeking safety, "I'm encouraging them to look at savings accounts" that pay rates well above short-term CDs (certificates of deposit). Slabaugh thinks interest rates are headed up, so she wants to keep these short-term commitments as liquid as possible.
For longer-term sources of income, she also recommends variable annuities with guaranteed minimum payment provisions. These products now provide a return floor of less than 5 percent for younger retirees and a little more for older retirees. She stresses the need to look at the total costs for these products and to make sure they fit with your overall goals.
Slabaugh also likes the income streams in a type of real estate investment trust (REIT) that is not publicly traded and which can only be purchased through a broker. Returns on these non-traded equity REITs are now in the 6 to 7 percent range, plus the REITs' holdings may have depreciation expenses that pass through to REIT owners. But she emphasizes these are buy and hold investments that generally are held until the REIT is liquidated. The liquidation times of these REITs are known when they're purchased, and investors thus can find the right fit for their timing needs.
Erika Safran, with Safran Wealth Advisors in New York, has no love for annuities and thinks any promise of guaranteed income comes at too high a price. She is willing to take on more risk for appropriately higher returns in the fixed-income portion of client portfolios. "The high-yield bond funds still have decent returns" of 6 to 8 percent, she says. "The emerging market bond funds have done fantastic. . . . Treasuries have a very low yield so there's no value in buying them these days. I'm not a fan of government bonds or bond funds today."
However, if a client wants no risk, and has sufficient income to cover their retirement needs, she will accept a low-return portfolio strategy. However, she notes, "there is a price that you pay for that peace of mind."
Emphasizing that her client portfolios should be diversified, she includes stocks, mutual funds, index funds with attractive dividends, exchange traded funds, and some funds that offer lower management fees in exchange for very large investment minimums. She also says clients need to plan carefully in pulling income from their portfolios, and that tax strategies will be more important if income and capital gains tax rates rise, as is widely expected.
While yield and income are certainly important, they should not be sought to the detriment of other portfolio goals, says George Jackson, with Jackson Retirement Planning in Heathrow, Fl. "We invest for total return -- interest plus capital gains or losses," says Jackson, who is an independent investment adviser using the TD Ameritrade platform for his practice. "More money has been lost from yield chasers than stock scams."
"Even in retirement, our clients still want to see their accounts grow in value," Jackson says. The investment transition, he says, is "more switching from growth mode to growth and income mode. . . . We're not going to go to a straight income portfolio." This somewhat reduces the pain from today's low rate environment, although Jackson will invest in some government bonds, giving up some yield in favor of capital preservation. "I look to stocks to help make up the difference" and achieve a client's total return goals.
"We're trend followers," he says. "So we rotated out of stocks in early 2008." Last year, he moved back into stocks. "We don't believe in buy and hold. Everything is static," Jackson says. "Capital preservation is number one" among investment objectives. "Our clients' accounts are at an all-time high today."
Tom Brown, a wealth management adviser in Indianapolis with Northwestern Mutual, bases a client's investment advice on a very structured program. It begins with an intense budgeting process to determine retirement spending needs. These are divided into fixed expenses and variable, or discretionary spending, such as travel and entertainment.
Fixed spending should be covered by the fixed income the client receives -- Social Security, pensions, and the like. If this income does not cover the fixed spending need, Brown says, he would advise covering that gap by purchasing an annuity that generated the required funds.
Next, clients are asked to set up a buffer fund with cash or cash-equivalent investments to cover two years of their variable spending needs. The buffer fund is then replenished from their remaining nest egg. It, in turn, is managed in three buckets -- tax-sheltered accounts, taxable investment accounts, and tax-free money (such as a Roth IRA or life insurance). There is an asset allocation for these buckets that is aligned with the client's risk profile, Brown says. In client meetings, held every six months, decisions are made about portfolio rebalancing and what portfolio sales are needed to replenish the buffer fund.
Within this type of disciplined retirement funding program, Brown says, low interest rates are seen more as a cyclical inconvenience than a cause for major investment shifts. Interest rate shifts affect discretionary funds, not funds that cover fixed living expenses. And, over time, such trends work themselves out, he says. His clients tend to accept such situations as temporary dips, especially if their overall needs continue to be met.