There's No Silver Bullet For Retirement Cashflow
Source: FA-IQ @ IMCA 2017, Feb. 9, 2017
BRUCE LOVE, MANAGING EDITOR, FINANCIAL ADVISOR IQ: Hi, this is Bruce Love with Financial Advisor IQ, and I’m here with Matt Sommer from Janus. Matt, what do you think advisors need to think about when they’re looking at retirement cash flow for their clients?
MATT SOMMER, DIRECTOR, RETIREMENT STRATEGY GROUP, JANUS: Well, in 2017 there really isn’t a magic bullet. [An] 8% guarantee doesn’t exist. And so what advisors need to do is a holistic approach using many of the tried and true tactics that we’ve been using in financial planning for many years, combined with some of the recent things that we’ve learned about behavioral finance.
BRUCE LOVE: So you can apply behavioral finance to cash flow in retirement. How are you doing that?
MATT SOMMER: There are a couple of different ways. The first is that people tend to follow a plan when it’s in writing. And one of the best ways to do that is to create something called a spending policy statement, which is essentially a one-page document that outlines very clearly for the client how much they plan to spend each month, from which accounts are they going to draw from, under what circumstances will they review their spending patterns. And what the spending policy statement does is it’s a great tool to make sure that people stay on track and follow the plan that was created from them at the onset of the relationship.
BRUCE LOVE: Matt, let’s talk about the assets themselves, though. I mean, do you think there’s enough diversity in people’s portfolios to enable cash flow in retirement?
MATT SOMMER: There is. And we are advocates of an approach called cash flow consolidation, which essentially means that people in retirement often draw money from different accounts. The problem with that, not only is it haphazard, is that it’s very difficult to know at the end of the year how much money they spent and whether or not they’re staying on plan.
So one of the things that we would advocate is for individuals to set up what we call a personal pension account, a cash management account with check writing, ATM, ATF, bill pay, that individuals can funnel their disparate sources of income — Social Security, RMDs, pensions, et cetera — and then use that single account to pay their bills. It not only makes life a whole lot easier, but it also helps the financial advisor, in annual reviews, make sure that the client is staying on track.
BRUCE LOVE: Matt, what do you think people are doing now in terms of long- and short-term event horizons, and is there a better way of doing it?
MATT SOMMER: What many forward-thinking advisors are doing are setting up what is commonly referred to as a bucket strategy. Essentially, you would say to a client at the onset of retirement, the first thing we’re going to do is we’re going to set up 24 months of living expenses and put that in cash. So regardless of what happens over the next 24 months to the markets, the economy, Washington, we know that our expenses will be taken care of.
At the end of each year, we’re going to review our portfolio, and we’re going to use good years as an opportunity to replenish that cash pocket. In bad years, we’re going to do nothing. We’re going to leave certain investments that may have declined in value time to recover. Because the worst possible time to sell investments is right after they declined in value.
So from the client’s perspective, they know that they have at least two years of living expenses liquid. And if we do enter a prolonged bear market or correction — who knows what the future brings — there’s ample opportunity to liquidate bonds if needed. Therefore, we’re earmarking the equities for the latter years of retirement, again, carving out gains following good years, but leaving them alone following bad years and giving them time to recover.
BRUCE LOVE: Have you seen many advisors taking that approach?
MATT SOMMER: Many of the advisors are taking that approach. And even for advisors who may not necessarily have a tool or a platform that will automate the bucket approach, what they can do in their simple messaging is explain to clients that expenses are nothing more than future liabilities. Our cash reserve is what we use to make sure that we’re able to pay our bills when they come due. And over time, we’re going to work together to make sure that that cash reserve is full so that we’re not selling assets at the wrong possible time.
BRUCE LOVE: But Matt, you can’t just invest for income, can you? I mean, that’s a bit dangerous.
MATT SOMMER: It’s dangerous. And, for example, if you look at the correlation of core plus fixed-income managers today, it’s, on average, about 0.4. 10 years ago, it was between 0 and negative 0.1. And so what advisors need to think about is should we have some market volatility, or perhaps a correction? What exactly is it that they want their core managers to do?
Along the same lines, advisors need to be careful with certain sectors. Even given the recent pullback in the utility sector, for example, the three-year average EPS is about 2 and 1/2%, yet the PE ratio for the sector is north of 21. So that’s not to say that these strategies don’t work any longer. It’s just to say that security selection matters. Advisors need to dig in a little bit deeper and not just look at yield.
BRUCE LOVE: Where are taxes in all this, though?
MATT SOMMER: Taxes matter. In fact, people need to live off of after-tax cash flow, not their pretax retirement balances. So one of the things that advisors can add to their planning is something called asset location, which basically means you use your IRAs and other tax-deferred accounts for investments in things like fixed income, REITs, preferreds. And then you use your taxable accounts for your buy and hold equity, because it’s there you’re able to cash in on the more favorable long-term capital gain rate. Asset location is a great value add to portfolio construction.
BRUCE LOVE: Matt, the big question, how does Social Security fit into all this?
MATT SOMMER: So for many clients, Social Security will represent a pretty significant portion of their guaranteed cash flow in retirement. The question that many people want to know is, do I take benefits reduced at 62? Do I take benefits on time at my full retirement age, which is 66 or 67 or something in between? Or do I wait until 70, and each year you wait until 70 you get an 8% credit?
With yields being as low as they are today, for those individuals who have other resources to hold them over until age 70, and who are in pretty good health and expect a better-than-average life expectancy, they may choose to wait until 70 to maximize their benefit. The other thing that it does is it not only maximizes the worker’s benefit, but it also maximizes the spouse’s survivor’s benefit if he or she is going to collect on their spouse’s record.
BRUCE LOVE: You get a lot of people saying that the answer’s annuities, but that’s really not the answer a lot of times, is it?
MATT SOMMER: Well, it depends entirely upon the client and what the objective is. Remember that when we think about spending, it’s very important to prioritize between needs, wants, and wishes. Your needs are your essential expenses. So one of the ways an annuity could factor into an overall financial plan is to make sure that any combination of annuity products along with Social Security are sufficient to meet the client’s essential expenses and have the balance of the portfolio earmarked for those expenses that are a little bit more discretionary in life.
BRUCE LOVE: Matt, thank you very much.
MATT SOMMER: You’re welcome.