Pods, Prides and Norcs

Whales cohabitate in pods. Lions thrive in prides. Owls congregate in parliaments not to be outdone by a murder of crows.  So what collective noun will be used for gatherings of aging Homo sapiens?  The answer may very well be "norc".  But first, a thirty second discourse on evolution and anthropology.

Humans are tribal simply because it was the best way to survive that daily trek from cave to water hole.  Non-conformist Neanderthals who chose to wander off may very well have won the admiration, if not astonishment, of their fellow hunter-gatherers.  But Nature took a harsher view of these iconoclasts who were summarily eliminated from the gene pool by the local saber tooth tiger.

Fast forward to today and look no further to the fanaticism engendered by sports teams, political parties and religious sects to see tribalism taken to the extreme.  This extends to the business world as well where group-think is a time-honored way to maintain one’s station.  Think about it, when was the last time you were in a meeting where a mid-level manager contradicted a high-level executive…? Exactly.  And those with the temerity to do so are inevitably given the opportunity to contemplate their IRA rollover options.

We are hard-wired to survive and thrive in groups.   But this remains problematic for an aging population as families become separated by work force mobility and societal norms (at least in the United States) that consider the elderly a burden.  So rather than get left behind on the savannah to fend for themselves, what is there to do for older Americans?

Naturally Occurring Retirement Communities (NORCs) are not-for-profit, grass-roots entities that are helping to solve the dilemma faced by the elderly who very much want to remain independent and above all else, avoid a nursing home.  Think of NORCs as a combination of AARP and Angies’s List brought down to a local level.  Essentially, NORC members pay annual dues (typically several hundred dollars) and in return get access to multiple services that can empower them to remain in their homes much longer than they might have otherwise; a major objective of most retirees. 

NORCs can provide access to pre-vetted repairmen who will work at discounted rates.  Ride share programs are available that can help that visit to the doctor or physical therapy much easier.  And beyond these practical services, NORCs provide a social outlet through academic lectures, trips to local cultural institutions and seminars ranging from how to navigate a smart phone to long-term care and estate planning (Wake up financial services industry!).  This is not to be discounted as more and more elderly Americans, and women in particular who tend to outlive men, are forced to live in social isolation.   This in turn makes the elderly increasingly vulnerable to financial scams so there truly is strength in numbers.

It’s surprising that the power of NORCs has yet to be embraced by the financial services industry which has a significant stake in the lifestyles of the elderly and their families (code for cross-generational marketing).  An organization with vision can help jump start the creation of NORCs by providing coordination among local hospitals, universities and social services. Imagine the loyalty that would result from helping a high net-worth client’s parents maintain a dignified retirement lifestyle.  Instead, the industry remains obsessed with the arcana of alternatives and other highly speculative investments.

 

If asked what is more important, the beta of their bond portfolio or avoiding a nursing home, the answer from most seniors would be quite clear.  Something to contemplate as that gaggle of geese flies overhead.

Ode to ERISA

It's just too easy these days for the armies of pundits, bloggers and tweeters to criticize in no particular order, the President, Congress, the Fed or any other person or institution that may appear overwhelmed by a world in turmoil.  So in the spirit of looking at the positive, this post will offer a bit of praise to an incredibly successful piece of retirement legislation that doesn't receive the recognition it deserves - The Employee Retirement Income Security Act.  Granted, it's hard to imagine John Keats waxing poetic about pension reform.  But there's integrity in this seminal legislation that for the most part has delivered beyond expectations.

Before ERISA, it was open season on pension fund assets.  There were no funding guidelines or fiduciary standards and as a result many plans were underfunded, subject to onerous vesting or simply pilfered.  (Think of handing over your retirement savings to Johnny Friendly - the union boss played by Lee J. Cobb in On the Waterfront). Then the Studebaker Motor Company went bankrupt and most pensioners discovered they would be lucky to get fifteen cents on the dollar.  That occurred in 1963 and the outrage that followed heralded the birth of ERISA in 1974.

It took some time but when you stop to consider the trillions of dollars that have become part of our retirement system and the relative lack of malfeasance relating to ERISA-protected plans, it truly is remarkable.  ERISA is much like a baseball umpire or football referee that you take for granted until a blown call. The regulations are far from perfect (not unlike instant replay) and provide lifetime employment  for legions of attorneys, pension consultants and actuaries.  And are they ever complicated (Every Ridiculous Idea Since Adam) as every plan sponsor, administrator and recordkeeper knows.

But for the most part ERISA has been effective in keeping the bad guys at bay at least from retirement assets. (No doubt Johnny Friendly's grandson is off the Jersey docks and managing a hedge fund across the Hudson.) It's especially remarkable when taking into account how complex 401(k) plans have become (daily valuation, loan provisions, self-directed brokerage, in-plan Roth conversions etc.) and the advances in technology that make it that much easier to separate retirees from their savings.

This is not about whether the shift from defined benefit to defined contribution plans has shortchanged retirees. Or that companies have put the needs of shareholders (code for the c-suite) ahead of employees by exploiting the ambiguities of ERISA.  And that too many well-meaning plan sponsors have been duped by the siren song of Madoff and his ilk over the years.

Sad to be sure. But given the magnitude of the assets at stake and the infinite cupidity that relentlessly stalks big money like a pride of lions, the guidelines have held up against enormous odds.  So whereas Keats had his Grecian urn, retirees have their 401(k)s to contemplate.   And they need to remember that even with ERISA, it never hurts to double check that statement now and then.

The New MPT

Retirement income planning isn't about making clients money; it's about making their money last.  This is the most fundamental change in thinking that investment advisors and financial planners must understand as clients enter the income phase of retirement.  Like it or not, relying solely on asset allocation and bucket strategies isn't the answer for most.  And yes, for many clients needing a guaranteed source of income, annuities can play a role. (A certain blogger will never forget his incredulous reaction when the concept of a SPIA was first explained.  The insurance company gets the money and the client can't get it back!)

But relying solely on annuities isn't the answer.  (That same blogger will never forget the incredulous reaction of an agent who asked in wonderment why anyone would choose a mutual fund over a variable annuity for their IRA rollover.  Mutual funds don't have a death benefit!)  And immediate annuities aren't a panacea for everyone with a retirement income need.  Like it or not, clients need a growth and income component in their portfolios free from M&E and surrender charges.  Clearly, the answer lies somewhere in between.

Income, not age, will trigger retirement for most.  But in spite of the focus on income planning, many advisors and Boomers remain at a loss. That's because transitioning a nest egg into an income stream is one of the least intuitive, but most important planning steps to get right.  Yet this is a generation that's been raised on margin, Magellan, and managed accounts.  In addition, income solutions (code for annuities) are complex and in many cases advisor / client objectives are not aligned (code for "annuicide").

Adding to the challenge is the fact that retirement income planning has no clearly defined process or end point. Accumulation planning has relative structure in the form of Modern Portfolio Theory and all those Greek letters.  Then there's salary deferral, contribution limits and a point in time when clients will at least stop working full time.  And the money making side of the equation also has iconic figures like Peter Lynch and Warren Buffet, not to mention the fictional Gordon Gekko. It's hard to imagine a Hollywood blockbuster based on an actuary or bond fund manager called Wall Street: Duration Never Sleeps.  The same wouldn't be said of the audience.

Income planning is like modern art; abstract, open to interpretation and with no clearly defined end-point (Modern Picasso Theory?).  But what's especially troublesome is that most advisors are significantly behind the curve when it comes to the basics of Social Security benefits, let alone the nuances required of quality income planning.  Bull markets allowed many advisors (and "self-service" investors) to get away with ham-handed, dart board accumulation strategies resulting in unprecedented  hubris and BMW sales. (The entourage of wholesalers, branch, regional and home office management also enjoyed the ride.) But that won't work given the compressed time horizons faced by retirees stretching for yield in a low interest rate environment. 

It's essential that advisors and agents play the role of docent by helping clients make sense of what they are looking at as they gaze at the distribution phase of retirement. Those same advisors and agents must open their minds and recognize there's much to learn before doing so.  Perhaps the first step is heading down to the local art museum.  

Rollover Replay

The days of relying on home ownership as a retirement wealth builder have gone the way of the dodo.  Likewise, defined benefit plans as a source of retirement income. This puts renewed importance on savings in defined contribution plans.  It also means paying very close attention to the process of rolling money over from an employer-sponsored plan.  At best a mundane topic but one that merits a closer look.

It's always been table stakes for investors taking a lump-sum distribution to get the paperwork right in order to avoid taxes and penalties. And most providers do a good job in explaining what a plan participant needs to do.  But a new element of risk has been introduced to the rollover process by today's tremendous market volatility that makes a successful rollover not just about the what but the when.

With frequent market swings of 3% or more, it's essential that investors understand when their current 401(k) holdings will be liquidated by the plan and then reinvested by the new IRA provider.  With respect to the former, most plans are self-directed and participants can initiate the sale rather than relying on the 401(k) provider. Getting an exact date when the dollars will arrive at the new destination can be challenging, but it never hurts to ask.  

It's also important to be proactive with the new IRA provider.  Even though you may have agreed on an asset allocation strategy prior to the lump-sum distribution, never assume the investment has actually taken place.  Understand the obligation of both the old and new provider with respect to the timely transfer and investment of rollover assets. Missing that 3% up move can wipe out a year's worth of earnings in today's low rate environment. If assets weren't transferred or invested in a timely manner, throw the challenge flag and ask for a replay.

It's ironic that with trillions of dollars coming out of qualified plans the IRA rollover process remains more of an art than a science. Be assured the last thing asset managers want is money sitting in cash where margins (if any) are razor thin.  But many firms are reluctant to invest in their operations while they continue to reduce back office staffs.  This results in highly manual, error-prone processing which is especially problematic given today's roller coaster markets.

If you're contemplating a rollover, understand the timing on both ends of the transaction.  If you have a rollover in process, look to see when the those assets were sold in the 401(k) or 403(b) plan and stay on top of the new IRA provider.  And if you recently rolled money over look to see if the assets were transferred and invested in the timely manner you expected.

Defined contribution plans will take on even greater importance in retirement as pensions march toward extinction and real estate remains a deeply troubled asset.  Paying close attention to the what and when of the rollover process can help keep your retirement off the endangered species list.

The World Turned Upside Down

As the British surrendered at Yorktown their band played a song called "The World Turned Upside Down" in wry acknowledgment of the improbable American victory.  By underestimating the Continental Army and applying traditional tactics to a guerilla war,  King George III and his Empire unwittingly gave birth to a new superpower that would eventually surpass it in dominance.  The world had indeed been turned upside down.

Arguably, the world of retirement planning is being turned upside down as well.  Underestimating how the rules have changed and applying the wrong tactics will result in too many Americans failing to achieve their retirement goals. Scare tactics that reference cat food as a retirement staple miss the point;  few people will actually run out of money. Instead, the risk lies in dramatically reduced lifestyles due to a lack of quality and relevant planning.

Ironically, the issues and trends that have changed the rules of retirement are hiding in plain sight.  The key is to recognize them and respond accordingly:

• An aging population is straining social programs.

• Longevity is a double-edged sword.

• The onus is now on the individual to accumulate wealth and turn it into retirement income.

• The transition from growth to income planning is counter-intuitive for advisors and clients alike.

• Cognitive impairment will be the next great challenge of retirement planning.

• Home ownership is fading as a way to build retirement wealth.

• Rising taxes will undermine the buying power of retirement assets.

• Low interest rates are rewarding borrowers, not savers.

• Volatility is reducing the appetite for stocks.

• Lost jobs and market declines are causing delayed retirement.

• Income, rather than age, will trigger retirement.

• The cost of healthcare and how to save for it remains the elephant in the room.

Future posts will address these and other challenges we all face when reconsidering retirement.  In the mean time it shouldn't take a midnight ride to warn of the reality that the rules of retirement are changing and we must rally accordingly.

The Problem with Lists

The fact that lists are becoming standard fare in our sound-bite, Twitter-obsessed society is no surprise.  No doubt "Best Places for Capricorns to Retire" is in the works.  And while lists can occasionally be fun (David Letterman) and very useful (The Ten Commandments) they can also be misleading.  Or, to paraphrase Mark Twain's screed against statistics; there are lies, damn lies and lists.

Here's a short list of the problem with lists:

• Lists blur fact and opinion.

It's this distinction that got Socrates into all that trouble with his fellow Athenians, so some perspective is called for.   When you look at the American League East standings and see  the Red Sox in first, that's a fact.  When you read a list that says Hackensack University Medical Center is the best place in the Metropolitan Area to have a heart transplant, that's an opinion. It's a fact that "Unbroken" was a top selling hard back.   Stating "Reconsidering Retirement" is the best retirement blog out there." is an opinion, albeit a very good one.

The best rule of thumb is to always avoid lists and declarative sentences that contain the word "best."

• Lists are pure marketing.

US News and World Report was floundering until it began publishing numbing lists of the "best" colleges, graduate schools, hospitals and the like.  The magazine claims its rankings are based on a scientific formula (Is there any other kind?) which is proprietary. They also deflect any blame if colleges make too much of the rankings and students misuse them. Clearly, this has the same effect as the Surgeon General's warning on that carton of Marlboros.  In any event, it's remarkable how from Princeton to Pepperdine these esteemed institutions allow themselves to be compared like kitchen appliances in Consumer Reports.

Mutual fund rankings also deserve a mention (the credit rating agencies have been pilloried enough.) Many plan sponsors (and retirees) get caught up in a system where they may be reluctant to select funds without a certain number of stars. They fear criticism (and worse as plan fiduciaries) if an investment lineup doesn't have the highest ranked funds.  This over-reliance on rankings can distort the fund selection process by causing investors to overlook funds that in fact may be better suited to meet their goals in spite of "inferior" rankings.  

It's remarkable that the purveyors of lists and rankings have university presidents trembling and plan fiduciaries relying on stars. Pure marketing genius.

• Lists make you lazy.

The goal of most lists is to sell something. In spite of that, they can offer some useful information. Of course the same may be said of SportsCenter, Cliff Notes and retirement blogs.  However, watching SportsCenter's "Top Ten Plays" is no substitute for appreciating the unscripted drama of that particular game.  After slogging through Moby Dick it is tempting to recommend an abbreviated version but, needless to say, the experience won't be the same.  And blogs can be useful, but of course the most important thing is to have a well thought-out retirement plan that is unique to your needs.

If the list of top places to retire in Central America is the catalyst for creating a more serious retirement plan then mission accomplished. Just hold off on buying the banana plantation before conducting the proper research. 

The point is not to confuse information for knowledge. 

• Lists make the listed and listers do crazy things.

Clemson University acknowledged it was taking specific steps to improve its standing in the college rankings, such as manipulating class size.   Other schools have changed policy and awarded bonuses to presidents and administrators who spearhead a leap in rankings.  Football coaches run up scores to better their standings in the BCS rankings.  A number of college presidents have pledged not to participate in the US News survey to avoid being ranked. And did Standard & Poor's with their inimitable track record really have the chutzpah to downgrade the debt of the United States?  The list, if you will, goes on and on.

Clearly there is no best college just like there is no best place to retire.  College, like retirement, is not where you go but what you make of it once you're there.

Faculties Lost

Everyone knows the story of how the Dutch bought Manhattan Island from the local Native Americans for $24 in trinkets and tokens (there were no Metro Cards in 1626). Depending on your point of view, this was one of the greatest real estate deals in history or the first of innumerable financial swindles emanating from Wall Street. Interestingly, new theories suggest the "locals" who sold Manhattan were simply passing through on foot - undoubtedly the Acela had broken down - and were more than happy to part with an island they never owned in the first place. While in all likelihood apochryphal, one can only hope this version of the story to be true.

From Ponzi to Madoff, it's truly remarkable how investors in full command of their faculties are continually duped out of their money. So with an ominous nod to PT Barnum, consider the implications as millions of Americans live longer and, as a result, suffer from the insidious effects of dementia and Alzheimer's. 

This inexorable wave of the cognitively challenged will crash head on into advances in technology that will make it even easier to separate them from their retirement savings.  And more aging investors are living in social isolation given our increasingly mobile society making them especially vulnerable. You can almost sense the bad guys booking their tickets to Florida and other points south.

Addressing cognitive impairment will be the next big thing in retirement income planning.   Unfortunately, the financial services industry has been slow to respond, just as it was late to the game in recognizing longevity risk.  In fact, it's the medical community that's on the front lines of this epidemic that effects one third of Americans over the age of 71, according to a 2008 Duke University study.

Physicians are usually the first to hear about lost heirlooms, missing money or how a patient signed a confusing document.  But there's only so much a health care worker can do beyond notifying regulators, social services, friends and family.  But as seen by the mortifying trial of Brooke Astor's son, who was convicted of embezzling his mother's assets, family members aren't necessarily paragons of virtue.

Clearly this is an area screaming for innovation.  But until that time, it's easy to imagine  Barnum saying if he were alive today "There's a sucker turning 60 every minute." 

Adieu Monte Carlo

The time has come to put Monte Carlo analysis on the shelf as a retirement planning tool alongside privatizing Social Security, 8% load funds and horoscopes.  As a former advocate of stochastic modeling this is hard to admit. But when black swans become as prevalent as pigeons in Saint Mark's Square the whole notion of probability analysis as a planning tool should raise an eye brow. 

Before his conversion, a certain blogger would explain Monte Carlo by piously quoting Aristotle who allegedly said when an outcome is in doubt it makes sense to do what is most probable.  Who could argue with Alexander the Great's personal tutor?   The logic makes sense but the question to ask is what is most probable? (This assumes there is an answer.   Nassim Taleb, author of  the "The Black Swan", would scoff at the notion.)    

Whatever your philosophy, dramatic swings in portfolio values are not the low probability tail risk depicted by Monte Carlo analysis.  In fact, an objective observer might say the white-knuckle markets we've experienced going back to 1987 seem to occur with great frequency.   Accordingly, using  stochastic modeling to develop an asset allocation strategy is like using the metric system to plan a cross-country road trip. Intuitively it makes sense but it's the wrong standard to use at least when traveling in the United States.  This can lead to confusing outcomes that provide a false indication of where you actually are.  In fairness, relying on linear return projections is equally  specious.  Assuming a retirement portfolio will achieve consistent positive performance year after year is like waiting for Godot - it's not happening.  So how does this affect retirement planning?

The first step is to acknowledge that volatility is here to stay.  This can lead to the great temptation of buying several mattresses (which doesn't mean you're diversified) and learning to sleep with one eye open.   As with anything, there's risk in extremes and being fully invested in a particular asset class (or fully uninvested if there's such a thing) is imprudent for most. The key is to be honest with the amount of risk / volatility you're willing to accept.  This will help determine an allocation that's unique to your particular needs and if that includes a little mattress stuffing so be it. 

That's the easy part. The challenge is then sticking with it through regimented rebalancing, dollar cost averaging and periodic reassessment of your risk tolerance.  There are a number of quality planning tools that can help quantify your risk tolerance (just ignore the probability analysis most of them use.)   And an experienced advisor can be helpful in taking the emotion out of this process.

Retirement planning is more challenging today than it's ever been.  That's why using the right tools and measurements is imperative. Reconsidering the relevance of stochastic modeling as a retirement planning tool can be a catalyst in assessing your overall strategy. Doing so may one day get you to the real Monte Carlo.  Just remember they use the metric system in France.

Jack Daniels, Coke and Retirement

Taxes have been imbued in the American consciousness since the founding of the Republic.  In fact, taxes caused the founding of the Republic.  Ironically, many investors (and their advisors) seem unaware of how taxes are a major retirement risk along the lines of inflation and healthcare. Actually, for those in the highest brackets, taxes will be the greatest expense they have in retirement.  And with rates inevitably rising at the federal, state and local levels taxes will become problematic for virtually every retiree.

As an early advocate of Roth conversion, a certain blogger was surprised by how little of the conversion discussion focused on how to invest those assets once they were safe from the clutches of Congress.  Roth conversion presents a brave new world to retirees previously confined to municipal bonds as their sole source of tax free income.  So as a public service announcement please be advised the remainder of this post contains references to annuities that have been known to cause drowsiness due to the guarantees they provide.

On the surface, a single premium immediate annuity (SPIA) in a Roth IRA may seem as horrifying as drinking Jack Daniels with coke. But after a few sips it just might grow on you so consider the following.  Allocating a portion of a Roth IRA to an immediate annuity is a way to generate tax-free income that can't be outlived.  Add an inflation rider which most SPIAs have and you've addressed three of the biggest risks faced by any retiree: longevity, taxes and inflation.

It gets better.  Unlike a municipal bond, SPIAs are not callable and several of the insurance companies that issue them have AAA ratings (if you still believe in that sort of thing) - a nice way to diversify and upgrade the credit quality of your tax-free sources of income. This strategy should be particularly compelling if your state and city have the temerity to tax your income.  As the old Lebenthal ads used to say about municipal bonds, "It's not what you make, it's what you keep."  This is especially wise advice in an environment where low interest rates are rewarding borrowers while punishing retirees stretching for yield.  A back of the envelop example helps make the case.

A 65 year old male can generate about $600 a month by investing $100,000 in a SPIA.  That's $7,200 a year in tax-free income if the annuity is purchased with Roth assets.  For someone in a combined 50% bracket (federal, state and local) that's a taxable equivalent yield of over 14% - an intoxicating number that hasn't been seen since the Reagan administration.   It's important to note this isn't an apples to apples comparison because a portion of the SPIA payments represent a return of principal which wouldn't be taxable regardless of the source of funds. This is called the exclusion ratio.  However, upon reaching your life expectancy, all of the annuity payments would be fully taxable unless purchased with Roth assets.

Of course drinking Jack Daniels has consequences as does annuitizing Roth assets.  First, annuitization has to be right for you regardless of the type of account where the assets are held.  SPIAs also mean you hand your money over to the insurance company in return for the guaranteed paycheck.  However, many do provide some degree of flexibility in terms of returning a percentage of your investment or guaranteeing payments for a certain period of time should your demise come earlier than expected.  Naturally all this comes with a cost in the form of reduced payments.

Then there are the killjoy pundits who rail at the idea of tapping Roth assets until the apocalypse and maybe not even then. Understood, but surely the sanctity of Roth assets should be reconsidered  based on the unique needs and circumstances of the individual.  And with the inevitability of higher taxes this concept shouldn't be dismissed out of hand.  In fact, the retiree who annuitizes their Roth will have more than enough to buy a JD or two.  Just be sure to do both responsibly.

The Big Shift

It's hard to imagine but a mere ten years ago there was little discussion about retirement income planning.  The Baby Boomers were ten years younger and the stock market was rising to the point where there was serious talk about privatizing Social Security.  Home values would always increase - it was only a matter of how much - and those steady gains could be counted on to fund a secure retirement.  The focus was on making money, not making it last.

Of course those sure things proved otherwise, The Boomers aged and today it's impossible to have a conversation about retirement without addressing income.  Consider some of the newest additions to the planning lexicon; annuitization, longevity and Monte Carlo (which was once a place you might visit in retirement).  Ultimately, dream books have been replaced by a stoicism that suggests it's not going to be a walk in the park, let alone on the Riviera, for most.

Income, not age, will trigger retirement.  But in spite of the focus on income planning, many advisors and Boomers remain at a loss. That's because transitioning a nest egg into an income stream is one of the least intuitive, but most important planning steps that we must get right.  Yet this is a generation that's been admonished since childhood not to touch the piggy bank.  In addition, product solutions are complex and  in many cases advisor / client objectives are not aligned.

Adding to the challenge is the fact that retirement income planning has no clearly defined process or end point. Accumulation planning has relative structure in the form of Modern Portfolio Theory, salary deferral, contribution limits and a point in time when you will at least stop working full time.  Income planning is more like a Picasso; abstract, open to interpretation and with no clearly defined end-point.  The goal for financial services providers is to help clients make sense of what they are looking at as they gaze at the distribution phase of retirement.

Future posts will do just.