MONEY OR INCOME: Which is most important to you?- Part 3

Rising Inflation ScreenJim Lorenzen, CFP®, AIF®

An income for life – a lifetime retirement income strategy is what most people want – but are they willing to do what’s required?

For most, if not many, the idea of ‘bucketing’ money into categories – current needs, emergency needs, and future needs – is intuitive.  An that’s the ‘secret’ behind having a retirement income for life!  It’s not a secret, really; just a common sense strategy for creating a stress-free lifetime retirement income.

We don’t want to take money from one to fund another unless we’re absolutely FORCED to, which we seldom are – yet, that’s what a lifetime retirement income strategy demands.

This likely explains why people generally hate the idea of annuitization, even though retirees routinely say their biggest fear is running out of assets  –  aha!  Assets!  Not income?

I’ve known people who’re retired with generous pensions (with cost-of-living adjustments) from the federal government and lived amazing retirements, living on Florida waterfront property with boats outside their back doors, even though they had only a couple hundred thousand dollars in savings… and loving it.  You couldn’t get them to trade those pensions for anything!   It was predictable – it would never stop – and they had COLAs built-in!

But, the rest of society seemingly isn’t willing to make the liquidity trade.  Research seems to back this up, finding that the size of liquid holdings is directly related to their sense of well-being and satisfaction.  Apparently if they can’t achieve their need for future income until they meet their need for current assets, they feel cash-strapped – or they’ll choose retirement solutions that are inferior but psychologically more satisfying..

Mental bucketing comes in two forms:

  • Time segmentation:  Cash, bonds, and stocks are segmented according to time frames.  Cash funding near term, laddering bonds for intermediate term and interest-rate risk, and stocks for long-term inflation-hedges.
  • Spending segmentation:  Using financial tools to put predictability into outlays – Using Social Security and immediate annuities to create an ‘income floor’ for meeting essential expenses, and using portfolio withdrawals throughout the entire retirement period to provide for discretionary expenses.

For many, however, the delineation between essential and discretionary expenses can be fuzzy.   When people prioritize their goals, some will classify travel and cable tv as a need, while others will find few needs beyond food, shelter, transportation, medical expenses, etc.   And, many neglect to think about the biggest outlay they’ll make during their entire retirement – the annual tax payment to the I.R.S.

The most straightforward solution to longevity risk

For most, the biggest risk is outliving their money.  In short, it means running out of income.  The straightforward solution is simple:  Trading a portion of liquidity to pay cash for a lifetime income – and transferring longevity risk to an insurance company in exchange for an immediate annuity.  For many, this is a tough sell because they aren’t willing to give up liquidity of current assets to secure a lifetime income, despite the fact all those retired federal retirees in Florida have been doing it for years – and loving it.  And, also despite the fact that an immediate annuity solution is far superior to that of using a variable annuity with a guaranteed lifetime withdrawal benefit.[1]

Not only that, retirees want the potential for an increasing standard of living, as well!  Others may have additional legacy goals!   Inflation-adjusted immediate annuities are available, but haven’t been too popular due to their lower initial payout

The Hybrid Time-Segmentation™ (HTS) solves many of the issues and may appeal to investors who need a greater degree of certainty for their income strategy.

 

The HTS strategy puts an ‘income floor’ under the segments – a floor that’s both predictable and expected to last a lifetime, while still preserving short-term liquidity needs and providing for long-term inflation concerns.  For example, one popular approach is to use a portion of assets to purchase a ten-year deferred income annuity that provides a lifetime retirement income beginning in year #11.  In this way, an additional guaranteed income source is added providing an increased floor as the rest of the portfolio grows for future years.[2]  The entire strategy, of course, should coordinate liquidity, security, inflation-protection, and income needs.

If you’d like to learn more – and it’s worth doing – we have a twenty-minute educational video that explains this lifetime retirement income strategy.  I think you’ll  like it!   Grab some coffee, sit back, and learn more here.

 

Enjoy!

Jim

[1] I must admit my own bias against variable annuities.  To me, using the stock portion of a portfolio to purchase a variable annuity is only turning a potential capital gain into taxable income – something that’s made little sense to me, expenses aside.

[2] Using an ‘investment grade’ insurance company is more important, in my view, than simply grabbing for the best-sounding promise of a slick marketing campaign.

If you would like help, of course, we can always visit by phone.


Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER® professional and An Accredited Investment Fiduciary® serving private clients since 1991.   Jim is Founding Principal of The Independent Financial Group, a  registered investment advisor with clients located across the U.S.. He is also licensed for insurance as an independent agent under California license 0C00742. The Independent Financial Group does not provide legal or tax advice and nothing contained herein should be construed as securities or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader. The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.

MONEY OR INCOME: Which is most important to you?- Part 2

Jim Lorenzen, CFP®, AIF®

Last week I asked which was most important to you:

Never running out of money

Never running out of income

Whether you’re building a house or your ‘financial house’, it begins with a plan – that’s common sense.  Yet, I’ve seen more than a few people make major financial decisions BEFORE ever walking through my door for the first time:  Ready, fire, aim.

I’ve seen them retire, make Social Security claiming decisions and even pension decisions… then seek out financial advice – moves that often put them behind the 8-ball before they start.

So, what are the hazards retirees face?

  • Being underfunded.   It’s not uncommon today for people to live thirty years in retirement – one good reason why so many are opting to continue working after their ‘formal’ retirement.  It takes a lot of capital to fund thirty years of income after taxes and inflation – for two lives.  The problem with this hazard is that it’s extremely difficult, if not impossible, for an advisor to change at the point of retirement.
  • Bad timing.  This is something we call ‘sequence of returns’ risk.   To illustrate using simple numbers and ignoring taxes, imagine this scenario:  You retire with $1 million and plan to withdraw 4% annually.  That $40,000 combined with Social Security should meet your needs.

If the market goes up 20% and you withdraw 4%, you should have $1,160,000 after the first year.   Allowing for a 3% inflation rate, you can withdraw $40,000 + inflation = $41,200 in your second year, which computes to 3.55% of the second year’s beginning balance.  Not bad.  If the market does that every year forever, you’re fine!

What if the market goes down 20% in the first year as you withdrew your $40,000 (4% of the original balance)?  The market loss was $200,000 and you withdrew $40,000.  At the end of year #1, you’re down $240,000 and your new balance is $760,000 at the beginning of year #2.    And, of course, prices are higher – inflation has driven your living costs up by 3%!  You’ll need to take $41,200 in the second year, just as in the first scenario above, but now it’s coming from a starting balance of $760,000, which means your withdrawals now represent  5.42% of assets.  Another down year could be disasterous.

Diversification can help[1].   Diversification is all about using asset classes that have low correlation in their movements.  Think of pistons in a car:  If they all went up and down and down at the same time, where would they all be if the engine were to shut down?  Oddly enough, you may not want a portfolio that contains investments that all go up – the opposite could happen, too!

  • Withdrawing too much too soon.

Some people may simply not know how much they can, or should, withdraw.  With longevity risk becoming greater with our medical advances, knowing how much we can withdraw presents a problem for many.

How do you know how much you CAN withdraw and never run out of money?  The government has the answer!   They even publish it!  It’s the IRS required minimum distribution rules!  Just plug your numbers into the calculator[2] and that shows how much can be withdrawn!  The RMD rules apply to all qualified plans, but not to Roth IRAs while the owner is alive, and can be used for other accounts as a guide to avoiding longevity risk.

The good news:  RMD math virtually guarantees against running out of money within 45 years if the amount withdrawn is that calculated and no more.   There’s a practical weakness in this method as a guide for annual income, as well:   Remember our sample $1 million portfolio?

Practical:  Withdraw 4% of the original account balance each year, adjusted for inflation, regardless of market returns, i.e., $40,000 base adjusted only for COLAs each year.  Weakness:  Could lead to early depletion of assets if there are continuous market declines.

Not practical:  The RMD calculation is based on a percentage of the account value.  If the market declines, the percentage could result in a declining income for one or more years.

The bad news:  The RMD amount might be less than what’s needed to meet living expenses and, as noted, could even decline!  So, asset allocation, using the RMD rules, does not affect portfolio survival; but it does affect how much the retiree might receive each year – an unpredictable income.

How do we create a sustainable LIFETIME income?

That’s our subject for next time.

[1] You might want to access our report, Understanding the Diversification Puzzle.

[2] http://apps.finra.org/calcs/1/retirement

Enjoy!

Jim

If you would like help, of course, we can always visit by phone.


Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER® professional and An Accredited Investment Fiduciary® serving private clients since 1991.   Jim is Founding Principal of The Independent Financial Group, a  registered investment advisor with clients located across the U.S.. He is also licensed for insurance as an independent agent under California license 0C00742. The Independent Financial Group does not provide legal or tax advice and nothing contained herein should be construed as securities or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader. The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.

MONEY OR INCOME: Which is most important to you?

Jim Lorenzen, CFP®, AIF®

Which goal is most important to you?

–   Never running out of retirement money

–   Never running out of retirement income

–   Both

Sure, you said both.  And, maybe that’s possible!

The problem for many is that not only are substantial assets required to provide a comfortable retirement income – you also have to live a lifestyle below what many would believe you could afford.

I have a client couple who have done just that.  They’ve worked hard, invested responsibly, and lived well within their means allowing them to save at a rate greater than what would appeal to many others.  The result:  They’ve been able to retire in their late ‘50s in a beautiful area  – and doing it at a time their son graduated from college and is now entering grad school.  How many parents could afford to retire with a child entering grad school?   In short, they’re set!  They’ve taken all the right steps to insure their future, even into their 80’s and 90s… and even if everything in “the markets” went south on them.

I’ve also seen others who have amassed ten times that couple’s assets, but are living at a lifestyle that keeps them in perpetual jeopardy.  They’re constantly in danger of running out of money.   Their lives are like a hamster running on the spinning wheel, constantly chasing the cheese.  The lesson:  Even people with $30 million dollars can still be on the edge of disaster.  Think of all the multi-million dollar sports and entertainment figures who’ve ended-up broke, sometimes due to poor management, sometimes due to overspending, sometimes both, virtually always because of ignorance…. either on their part or the part of their ‘managers’, or both.

Choosing the right strategy

What kind of retirement income or wealth management strategy makes sense any given investor?  Naturally, it depends on age, goals, asset level and lifestyle.  It also depends upon what type of strategy the individual is open to considering – most of us have built-in biases based on how we’ve been programmed.

Given the level of financial literacy in America today, it’s a real concern.  Most of what people know about financial instruments they’ve learned from entertainment gurus, their parents, or their friends.  I saw a recent study that revealed more than 31% of Americans didn’t know they could lose money in fixed income investments; and 68%  thought rising interest rates would be good for bonds… all while 60% said they don’t consider themselves knowledgeable regarding fixed income, the market, or economic forces that drive bond pricing.

Generalizations are always dangerous; but hey, you’ve have to start somewhere, right?   So, let’s begin, as a starting point, with this basic admittedly oversimplified outline of what an overall retirement strategy might be:

Retirement Strategy

You might be wondering why those below age 45 aren’t included in my little over-generalized grid.  The answer is simple:  In 25 years’ of practice, only ONCE has someone below age 45 come to my office.  That was almost 20 years ago and I haven’t seen anyone in their 40s come to my office since – they’re still watching Kramer – but, I’ll see them after they turn 50 and finally figured something out they don’t know today.

Back to our grid:

The definitions of “modest” and “substantial” are somewhat squishy.  It’s like trying to define what a ‘middle-market’ company is – you can ask a hundred people and get a hundred different answers.  So, let’s just say the definition is whatever you think it is.

If you’re worried about running out of money, you might consider yourself to be a “constrained investor” – and you probably shouldn’t be trying to ‘make up for lost time’ by making risky bets.

If you’re like the couple who’s sitting pretty and just doesn’t want to blow it, you might be preservation minded – someone who wants to maintain their lifestyle after inflation and taxes and not do anything stupid.   [See my blog post, “Inflation and Stockshere.]

Back to our initial quiz:

Which worries you most:  Running out of money or running out of income?

Long-term plans don’t change just because temporary conditions do.

You can have an income forever; but, it may not be enough to even pay your utility bill if the asset base is too small; and, if you

run out of money, there’s no income.

Navigating it all is much like navigating a ship at sea, surrounded by all sorts of potential hazards.

Too much to cover in a single post, as you might imagine; so, we’ll be covering the issues and strategies you can use in upcoming installments.  I hope you’ll find them helpful.

If you would like help, of course, we can always visit by phone.

Enjoy!

Jim


Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER® professional and An Accredited Investment Fiduciary® serving private clients since 1991.   Jim is Founding Principal of The Independent Financial Group, a  registered investment advisor with clients located across the U.S.. He is also licensed for insurance as an independent agent under California license 0C00742. The Independent Financial Group does not provide legal or tax advice and nothing contained herein should be construed as securities or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader. The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.

A Guaranteed Income for Life?

Jim Lorenzen, CFP®, AIF®

In a previous post I talked about how everyone now has to be his/her own actuary, if they want to create a guaranteed income for life.

I’ve even provided a 20-minute educational video on how it’s possible to actually create a guaranteed income for life.  I think you’ll find it helpful; grab a cup of coffee and you can register to take a look.

While I’m at it, here’s a link to a report that takes a deeper look at a a ‘hybrid’ scenario many investors might find attractive.  I think you’ll find the report interesting, if not eye-opening.  You can access it here.

How does one GUARANTEE an income for life?  Well, there’s only ONE way to guarantee that outcome:  An annuity.  NO OTHER FINANCIAL TOOL WILL DO THIS.

Oh, yes, they do get bad press (what doesn’t?).  The real problem, though is the confusion around the different types of annuities that exists.

  1. Variable annuities
  2. Equity-indexed annuities
  3. Fixed annuities – can be either immediate or deferred

Options #1 and 2 can be problematic.  They are often loaded with excess costs, moving parts, and restrictions.

Option #3 is generally more straightforward.  It’s more of an I.O.U. with the insurance company.  You pay them; they pay you.

Here are some sample payout examples.  Take the first one:  the payout represents a 6.54% payout; and as you can see, the payouts do increase with age.

There’s a trade-off, however, the money is not just illiquid – it’s gone!  You are essentially buying an income stream for life!   You’re paying cash for a secure retirement.

So, should you do that with all your money?  Probably not.  It should not be an ‘all or nothing’ strategy.  That’s why I think you’ll find this report on a hybrid strategy helpful.

If you would like help, of course, we can always visit by phone.  Just pick a time convenient for you.

Enjoy!

Jim


Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER® professional and An Accredited Investment Fiduciary® serving private clients since 1991.   Jim is Founding Principal of The Independent Financial Group, a  registered investment advisor with clients located across the U.S.. He is also licensed for insurance as an independent agent under California license 0C00742. The Independent Financial Group does not provide legal or tax advice and nothing contained herein should be construed as securities or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader. The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.

The Provisional Income Trap

 

… and what it means to your retirement income – particularly your Social Security taxation in retirement.

Jim Lorenzen, CFP®, AIF®

Most people believe that municipal bond interest is tax-free and won’t affect taxation on their retirement income.   Well, it is, I guess; but, there are tax ramifications few people have heard about.   It’s called “provisional income”.

Huh?

There are categories of income which, when added up, determine how much provisional income you’ve received in a given year.  And, during retirement, when you’re likely receiving Social Security income,  the amount of provisional income you receive determines just how much you’ll pay in taxes on your Social Security Income.

As you can see, when adding up your provisional income, it begins with 50% of your Social Security income.  Then they add in all distributions from tax-deferred accounts.  If you’re in retirement, that includes money you’re taking from your 401(k) or IRAs (except distributions from a Roth IRA, which are generally tax-free, and any money you’ve taken from a properly-structured permanent life insurance policy (withdrawals up to your cost-basis and policy loans).  And, as you can see, municipal bond interest is counted.

Once you’ve added up all your provisional income, how much do you owe in taxes?  Well, it depends.  Here are the provisional income thresholds.

If you’re a married couple and your provisional income is below $32,000 for the tax year, you will pay no txes on your Social Security income.  If your income is over $44,000, however, then 85% of your Social Security income will be taxable.  The whole idea was part of a package passed back in the 1980s to save Social Security.  One thing they didn’t do:  index it for inflation.

So, as your 401(k) grows and your assets grow—more importantly, as inflation continues through the years and it will require greater withdrawals for you to live in retirement—the greater the likelihood you’ll be paying taxes on your Social Security.  It doesn’t take much to get past $44,000 in retirement.

Let’s take a quick  look at an example:  Fred and Wilma.  They have $30,000 in combined Social Security income and also take $40,000 annually from their IRAs, giving them a $70,000 income in retirement.

For computing their provisional income, only half of their Social Security income is used.  Added to their IRA distributions, they have $55,000 in provisional income, meaning that 85% of their Social Security income ($25,500) is taxable at their tax rate.  If they’re paying taxes at 30%, their tax bill will be $7,650.

But if they need the entire $70,000 they’ve taken as income, they’ll have to take an additional distribution just to pay the tax bill, and, oh yes, it’s taxable, too.

But, Fred and Wilma have another problem they’re likely completely unaware of.  There’s a ticking time-bomb growing inside their 401(k).  It’s growing.

How can that be bad?  Well, it isn’t, of course, but it might come at a huge price.  If history has taught us anything, it’s that governments exist to get re-elected and they help insure than through spending which never seems to get undone.  Our nation’s huge debt  is growing and the money to pay the bills will have to come from somewhere—and it won’t come from people with no money.   With an ageing demographic bubble moving into the decumulation stage  and wanting more services, particularly health care, the long-term outlook for taxes can’t be too encouraging.    Let’s get back to Fred and Wilma:

If Fred’s 401(k) continues to grow at an 8% average annual rate until he’s 65, he’ll have a balance of over $2 million!  And, at age 71, when he’ll be required to take required minimum distributions (RMDs), his balance will be over $3 million—requiring RMDs of over $115,000 annually.

Fred and Wilma will be paying a lot of taxes.

And, as mentioned earlier, the long-term outlook for taxes isn’t likely very good.  Just take a look at the differences from 2012 to 2017.

How can Fred and Wilma mitigate, and maybe eliminate, their income tax payments in retirement?

Under current tax law, each has a personal exemption of $4,050, so they have $8,100 in combined personal exemptions.  They also have their deductions.  If they’re using the standard deduction, they’ll have $12,700 too, giving them a total of $20,800 in exemptions and deductions.   So, their key is to keep their  taxable income below $20,800.   All income above the standard deduction and personal exemption is subject to tax.

The good news is that  Fred and Wilma are still in their 50s and there’s plenty of time to plan.  Working with their Certified Financial Planner®professional, they can begin “reverse –engineering” the placement of assets in a way they can still grow their nest-egg, but re-arrange their ‘tax buckets’ so Uncle Sam becomes less of a partner—or no partner at all, which would be the ideal making their tax-jockeying a moot issue.  You can get our piece on 4 Steps to a Tax-Free Retirement.  I think you’ll like it.

Enjoy!

Jim


Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER® professional and An Accredited Investment Fiduciary® serving private clients since 1991.   Jim is Founding Principal of The Independent Financial Group, a  registered investment advisor with clients located across the U.S.. He is also licensed for insurance as an independent agent under California license 0C00742. The Independent Financial Group does not provide legal or tax advice and nothing contained herein should be construed as securities or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader. The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.

Old-Age Financial Security: Silence is NOT Golden, yet Some aren’t talking!

Jim Lorenzen, CFP®, AIF®

Generational planning didn’t seem important  for old age financial security in my grandparent’s day.   They were living at  a time when Social Security was passed and designed to last for a lifetime beginning at age 65.  Of course, life expectancy back then was around age 68!  Who needed to worry about generational issues?  Longevity wasn’t a risk.

My generation—the baby boomerss—became the first  to experience the ‘sandwich’ effect:  Taking care of aging parents and children at the same time.   And, as that was unfolding, people were beginning to realize they were living longer, too!

The cultural quicksand began to materialize, but few have recognized it.  It’s like glaucoma:  You don’t see it coming; but, all of a sudden, it’s there.   It’s silence.  In a recent online survey (cited below), over half of GenX respondents and 60% of baby boomers indicated they’ve never had a conversation about planning for retirement or financial security in their old age, yet their fears were the same.

The reasons tend to tell is why.  They’re repeating the same mistakes their parents made.

Why do we study history?  Because we know human nature doesn’t change—it hasn’t changed for thousands of years.  Studying history allows us to learn the mistakes human nature, unencumbered by knowledge, tends to make.  But, knowledge helps us prevent a repetition!

When parents and children don’t talk about finances, guess what…

Why do they feel they’re not making enough money?  Why do they have too many other expenses and are paying off debt?  The answer is simple.

They’re  repeating mistakes.  But, the GenX group seems to be making more of them.  Are the boomers not talking to their kids?   Are their kids not involved in their parent’s own planning?   Maybe they should be.

As parents are living longer—longevity risk– they run a very real risk of needing long-term care.  If ever there was a threat to old age financial security, this may be it; yet,  relatively few address that issue usually because of cost or for fear of losing all that money paid in premiums if they don’t use it.   However if they do need it, and the kids end up having to pay some or all of the ultimate cost for that and their parents’ support, it also could eat-up their inheritance!

What we don’t know can cause financial hurt.  Perhaps they don’t know  that a professionally-designed life insurance policy might provide tax-free money that could be used to cover long-term care if needed and yet preserves cash if it isn’t—and still maintain the children’s inheritance!   It’s a financial ‘Swiss Army Knife”  type tool that can solve a lot of issues at once.

Unfortunately, few people take the time to have a generational financial planning session either on their own or  – maybe better—facilitated with a  family financial advisor acting as a guide and facilitator.   Some advance planning can make a big difference.  Here’s an example:

Real Life Case History (Names changed)

Fred and Wilma never discussed their finances with Pebbles or Bam Bam.  As Fred and Wilma grew into their 90s, it became evident they could no longer live on their own.  Fred was diagnosed with a terminal disease and Wilma, at  90, was diagnosed with Alzheimer’s.  They could no longer function and it was now Pebbles’ and Bam Bam’s turn to take care of their parents.  Fred lived for eight more months, but Wilma continued living for nine more years.  Despite the fact they did have some retirement savings, it was no where near enough to cover the more than $600,000 in costs that were incurred  by Pebbles and Bam Bam during that 9-year period. 

Had Fred and Wilma taken the right steps sooner, those costs threatening the old age financial security of Pebbles and Bam Bam might have been covered, or—at the very least—Pebbles and Bam Bam would have been reimbursed, protecting their inheritance … and all of the money might have been provided tax-free!   Unfortunately, their attitudes about various financial solutions available to them were colored by what they’ve heard from parents, friends, and even entertainment media, including television gurus selling DVDs.   Not surprising.  Some people even get their medical advice that way.

Old strategies simply don’t address today’s longevity and ageing issues.  Different strategies are required.   How can it be possible to make sure the parents have a lifetime of inflation-adjusted income and still provide an inheritance for the kids?

Rising Inflation ScreenYou might enjoy viewing this educational 20-minute video that shows one strategy that likely makes sense for many people.  While the tools used to implement it might vary, it’s still worth a view.  So, grab some coffee and see for yourself.

If you haven’t had a generational meeting with your family financial advisor, maybe it’s time you did.  Like Mark Cuban’s dad once told him:  This is as young as you’re ever going to be.

If you would like help, of course, we can always visit by phone.

Enjoy!

Jim


Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER® professional and An Accredited Investment Fiduciary® serving private clients since 1991.   Jim is Founding Principal of The Independent Financial Group, a  registered investment advisor with clients located across the U.S.. He is also licensed for insurance as an independent agent under California license 0C00742. The Independent Financial Group does not provide legal or tax advice and nothing contained herein should be construed as securities or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader. The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.

How to Diversify Investments – As simple as a pie chart?

Jim Lorenzen, CFP®, AIF®

Most of us want to learn how to diversify investments  so we can reduce investment risk – but it may be one of the most misunderstood of investment principles.  Too many think it’s about simply selecting the right pie chart.

I’ve even seen tv stock gurus tell you that owning three stocks in different industries passes for investment diversification, implying that risk is being reduced.  I don’t think so; it’s just compounding investment concentration.

Believe it or not, you can’t possibly diversify-away market risk.  Think about it; you could own every single stock contained in the S&P 500 Index and all you would have done is duplicate the market’s risk.

I’ve also seen investors buy multiple mutual funds in an attempt to diversify; but, since everything they bought had to be “quality”, all they did was duplicate their holdings (portfolio A) instead of diversifying them (portfolio B) across multiple investment styles (growth/value, large/small, etc.).

Diversification, done properly, can smooth things out, as this simple example shows.

But, what stocks?  Which bonds?  Is buying a few enough?   The answer, of course, is “it depends”; but, it’s worth noting that there are five basic asset classes (stocks, bonds, real estate, commodities, and cash) and within each there are multiple sectors.  It’s also virtually impossible to know which will outperform all others in any given year.  Yet, diversification among them can smooth the ride!

I’ve been telling clients for more than two decades now, “We’re not diversifying money.  We’re diversifying risk; we just do it with money.”

So, how do we diversify risk?  It’s all about something called correlation.

You can think of correlation as pistons in an engine:  They all go up and down, but not necessarily at the same time.  Their going up and down is what propels the machine, but you wouldn’t want your money on any one piston.  If the engine were to stop, you’d have a 50/50 chance of being up or down!  But, if your money was spread over all the cylinders, you’d still have a stable overall value regardless of when the engine shut down.

It doesn’t really work all that clearly in the real world of investing, of course; but the theory is no less valid.  Here’s a chart the relative correlations among a number of classes and styles.

 

 

 

 

 

Correlations don’t remain the same, even from day-to-day; so, they’re not in stone – they just give us a historical look at their relative movements, but the numbers will be different depending on the time-frames chosen.

Diversification is all about correlation reduction in portfolios.  I created a report on all this a while back called Understanding the Diversification Puzzle.   You might find it helpful and you can get it here.

Enjoy!

Jim


Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER® professional and An Accredited Investment Fiduciary® serving private clients since 1991.   Jim is Founding Principal of The Independent Financial Group, a  registered investment advisor with clients located across the U.S.. He is also licensed for insurance as an independent agent under California license 0C00742. The Independent Financial Group does not provide legal or tax advice and nothing contained herein should be construed as securities or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader. The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.

Is the 4% Rule Still Valid?

 

Jim Lorenzen, CFP®, AIF®

Ever hear about the 4% Rule?  It’s about safe withdrawal rates for retirement income.  If you’ve been following my pontifications over the years, you probably recognize this; but, if the rule is unfamiliar to you, here’s a brief description.

The 4% rule was the result of some back-testing and research by a financial advisor named William Bengen.  The objective was to identify a ‘safe’ withdrawal rate for retirement income that would answer the question, “How much can I safely withdraw from my portfolio without having to worry about running out of money?”

His results were published in 1994 and identified 4% as the withdrawal rate that would provide an 80% success probability over a 30-year period, regardless of market conditions.

Of course, it’s a probability based on back-testing.  The problem investors face is that inflation, which has been historically low for some time now, could rear it’s ugly head and impact withdrawals significantly.  So, we’re still dealing in probabilities.

Let’s look at a hypothetical example:

The ending annual expenses using a 7% inflation rate is 53.8% higher than if inflation remains at 2% for the entire decade.  Is 7% an unreasonable figure?  If you’re old enough be be concerned about outliving your money – or your income – you know it’s very reasonable.  Remember the double-digit inflation of the late 1970s?

What does that do to our probabilities discussion?  GIGO.

Planning is as much about what we don’t know as what we know.  It’s about testing and stress-testing our assumptions.

For many, the real question is not whether money will last – it doesn’t do much good to have some money if that money won’t produce the income you need to maintain your desired lifestyle – it’s whether you will have the inflation-adjusted income you will need.

Key question:  Are you comfortable dealing with probabilities or guarantees?  The strategy that’s right for you will be different depending on your answer.

We know that many retirement expenses are guaranteed; but, how of the income required to meet those expenses is also guaranteed?  If having a guaranteed income floor is important to you, we have an educational video you might enjoy viewing.

If you woretirement income planninguld like to see it, grab a cup of coffee – it’s about 20-minutes long – and you’ll learn about a process for arranging assets that may be eye-opening,  you can do so by clicking here.

Your Roadmap?

This educational video depicts an eye-opening strategy.  The specific financial tools used to implement this strategy will be different for each individual, depending on specific needs and desires; but, it is a strategy that could put retirement on ‘auto-pilot’.  Keep in mind, this is but one strategy for addressing retirement income needs.  There are others.  The one that’s right for you would depend on your plan

The plan comes first.  We don’t do “ready-fire-aim”.

If you would like help, of course, we can always visit by phone.

Enjoy!

Jim


Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER® professional and An Accredited Investment Fiduciary® serving private clients since 1991.   Jim is Founding Principal of The Independent Financial Group, a  registered investment advisor with clients located across the U.S.. He is also licensed for insurance as an independent agent under California license 0C00742. The Independent Financial Group does not provide legal or tax advice and nothing contained herein should be construed as securities or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader. The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.

Retirement and Income Taxes

Jim Lorenzen, CFP®, AIF®

Who better to talk about taxes in retirement and income taxes than a CPA?  You may be familiar with Ed Slott from his frequent appearances on PBS.  One of the very few gurus who actually is the real deal:  A CPA who is recognized even inside the financial profession as an expert – he even teaches CFP Board-approved continuing education classes.

Mr. Slott does have a unique ability to present financial topics in an easy-to-understand, entertaining way.  One of the hot topics right now is protecting retirement income from taxation.  The topic is hot primarily because of two issues:  Longevity risk (outliving our money) and taxation risk (the government debt is huge and the outlook over the next two decades, when we’ll need money the most, is that taxes are bound to rise).

I think you’ll find this video interesting.

If you’d like a report on how you might be able to create a tax-free retirement, you can get it here.

If you would like help, of course, we can always visit by phone.

Enjoy the video and report!

Jim


Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER® professional and An Accredited Investment Fiduciary® serving private clients since 1991.   Jim is Founding Principal of The Independent Financial Group, a  registered investment advisor with clients located across the U.S.. He is also licensed for insurance as an independent agent under California license 0C00742. The Independent Financial Group does not provide legal or tax advice and nothing contained herein should be construed as securities or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader. The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.

The Top 5 Myths of Retirement Planning

iStock Images

Jim Lorenzen, CFP®, AIF®

I came across this video on the Five Myths of Retirement – It’s by Northwestern Mutual.  I have no relationship with them; however, it’s an excellent educational video and I thought you might find it interesting.

We know that many retirement expenses are guaranteed; but, how of the income required to meet those expenses is also guaranteed?  If having a guaranteed income floor is important to you, we have another educational video you might enjoy viewing.

If you woretirement income planninguld like to see it, grab a cup of coffee – it’s about 20-minutes long – and you’ll learn about a process for arranging assets that may be eye-opening,  you can do so by clicking here.

Your Roadmap?

This educational video depicts an eye-opening strategy.  The specific financial tools used to implement this strategy will be different for each individual, depending on specific needs and desires; but, it is a strategy that could put retirement on ‘auto-pilot’.  Keep in mind, this is but one strategy for addressing retirement income needs.  There are others.  The one that’s right for you would depend on your plan

The plan comes first.  We don’t do “ready-fire-aim”.

If you would like help, of course, we can always visit by phone.

Enjoy!

Jim


Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER® professional and An Accredited Investment Fiduciary® serving private clients since 1991.   Jim is Founding Principal of The Independent Financial Group, a  registered investment advisor with clients located across the U.S.. He is also licensed for insurance as an independent agent under California license 0C00742. The Independent Financial Group does not provide legal or tax advice and nothing contained herein should be construed as securities or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader. The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.