Investing Specialists

Retirement Tips from a Top Planner

Christine Benz

The market environment over the past year has roiled all investors, but especially retirees, many of whom are questioning their game plans amid epic losses. To help provide guidance, I recently interviewed financial planner Mark Balasa, an Itasca, Illinois-based financial planner whose firm, Balasa Dinverno Foltz, manages more than $1 billion in assets for high-net-worth individuals and families. During the course of our interview, Mark weighed in on asset allocation, taxes, and more.

Christine Benz: After 2009, a lot of investors have been questioning the concept of long-term strategic asset allocation--buy and hold--and have begun thinking about being more tactical. How tactical should investors be?

Mark Balasa: It's a great place to start because it's on so many people's minds. It's especially relevant for people who are at or recently moved into retirement, because people who were living right at the limit of what their assets would allow for have seen the market downturn permanently alter their course.

Philosophically, a lot of people over time came to the conclusion that a strategic portfolio with no tactical overlays was the safest bet--especially for do-it-yourselfers--because it's not as time-intensive or as involved as a more tactical strategy. Even some professional investors took that view. But what happened during the market swoon last fall after the Lehman bankruptcy and through March of this year was that people, the press included, were saying, "Well, that wasn't smart to just hang in there. With a strategic allocation you got pummeled, and you should have been more tactical. You should have looked at different metrics in the market, different triggers, different valuation metrics, and so forth. Because all of these things were telling you that things were going to go from bad to worse, and look at how much better off you would've been if you could've sold?"

If you fast-forward to today and you look back at the recovery since March 9, you see that the decision to be very tactical, especially if you raised cash or your bond allocation and you didn't come back into stocks, doesn't look so obvious now. I still think that, for most people, a largely strategic allocation is the correct way to go. If you put 10% or 20% or 30% in some tactical approach, that certainly can help, but as we've seen over this past year, when it recovers, did your tactical play recover as well?

Benz: To what extent do you employ a tactical approach in your own practice?

Balasa: Our strategic allocation is embedded with a tactical component. For example, our equity portfolio has a small-company and value bias. So we look different than the broad U.S. market or the broad global market. But that for us is strategic. On top of that, we will tactically overweight and underweight large versus small, value versus growth, both domestically and internationally.

Benz: What factors would you use to drive those tactical decisions?

Balasa: For us, it largely comes back to valuations. Large growth versus large value, small growth versus small value, based on relative price/book and price/ earnings ratios. And then there's a momentum component: Which asset class has done well and for how long, and how does that look in historical context? And on top of that, we have essentially a gut call saying,"Yes or no, and to what degree?"

Benz: Do you have any trepidation about this? Because the landscape of managers doing truly tactical approaches well is�

Balasa: Practically nonexistent. So the answer is yes, and that's why we don't make many changes. We might make one or two a year, we might go a year without making any. And when we do make changes, they're modest, for the reason you raise.

Benz: One topic that has gotten a lot of attention recently, especially in the wake of the bear market, is how to calculate an optimal withdrawal rate. How should retirees navigate that question?

Balasa: Everyone aches for some kind of rule of thumb when it comes to spending. That's just how we're built as human beings. You take any specific couple or individual approaching retirement, and of course, everyone says, "How much in savings do I need? What's my number?" And when they do retire, they want to know, "How much can I spend?"

So the rule of thumb is a 4% or 5% withdrawal rate, and we know that's a safe number for most people. The challenge is that 4% doesn't do the trick for most people, unless you've got a lot of wealth. There are other approaches, where you ebb and flow the spending either based upon an inflation rate or a market metric of some sort. But all of those approaches are trying to come up with a generic answer to a question that has so many variables. What's your family history, in terms of longevity? What do you think tax rates are going to be? How many new cars do you want to buy? What do you want to leave for the kids? And you see some very divergent views on this, by the way. Some people think, I put the kids through school and got them married, and darn it, I'm spending everything I've got. Others are determined that they want X amount left. That's a big influence on the decision. And, of course, people's views on those topics change. So you have all of these variables that can materially impact the actual answer for someone.

And, of course, when you do try to come up with rules of thumb, you're trying to solve for the lowest common denominator--in other words, the one that works the most often. But that might not be the right answer for a family where both sets of parents have died in their mid-70s, or the family has very specific goals about how much they want to leave for the kids. Those things, in my opinion, trump the rules of thumb.


Benz: I think one underrated factor in the withdrawal rate discussion is that for most people, a flat rate is just not the way it works. Maybe you spend more when you're just retired, but when you're in your late 70s your spending might taper off.

Balasa: You're absolutely right. What I usually draw on the whiteboard for clients is a horizontal line that breaks retirement up into three phases. You've got the first phase where you have a lot of health and energy. In the second phase, your energy and health might start to wane. And then you've got this final stage, which could be 10 days, it could be 10 years. But you're in really poor health and have a limited capacity to go out and spend. Each of these three phases has a different profile in terms of spending.

I also tell clients that just because you've settled on a withdrawal rate, that doesn't mean you can't exceed it in a given year: Say you have to buy a car, you want to take the grandkids to Disney, whatever it might be. It's still important to live your life, right? But in other years it's best to, as best you can, compensate for that. So many times people come in and say "I can't take the vacation this year with the grandkids because I'll go over my withdrawal rate." And I say, "Well no, we can still do that." If people are so myopic and rigid about adhering to some number, they sometimes make poor choices about the quality of life.

Benz: I did an interview with Ross Levin a few months ago and he asserted that most of his clients died with too much money, mainly because they had been overly conservative. Is that something you've run into as well?

Balasa: Yes. It's the paranoia about not having enough. And you have to think about the generation that has passed away in the last 10 years; these are people who came through the Depression. In general, that generation was willing to defer gratification.

Benz: So in some cases it's a challenge for you to get your clients to spend what they can afford to spend.

Balasa: Correct. But in some cases you have the opposite problem with people who are in their 50s or 60s right now. They didn't have that experience of living through the Depression so they want multiple homes, multiple vacations, big lifestyles--that's what you're fighting now, more so than not spending enough. Perhaps the younger generations aren't going to be so inhibited, but for some it's a big issue.

Benz: Let's talk about the current income environment, and the extent to which you focus on current income for client portfolios. My guess is that you'll probably say not too much.

Balasa: Bingo. We've all along focused on total return as opposed to current income, because when you focus on just the yield on something, you tend to get these disjointed portfolios that are either very interest-rate sensitive or have a lot of credit risk in them or call risk--you name it, it's there. So many times you'll talk to someone--especially if they're older, they'll come in and say, "I've got this stock, or this preferred, and it's yielding 12%. Why would we want to get rid of that?" And I'll explain that, "No, it lost 20% last year--your total return was -8%." And the response is, "I know, but the yield is great!"

So, from our perspective, if you manage for total return, the portfolio is more balanced and thoughtful, and you can also do a better job of managing for aftertax return because now we can get capital gains treatment and qualified dividend treatment as opposed to just income treatment.

A version of this article appeared in the December 2009 issue of Morningstar PracticalFinance.

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