Christine Benz: Hi. I'm Christine Benz for Morningstar. When you are investing for your retirement, avoiding the big landmines is more than half the battle.
Here to talk about some of the big pitfalls in retirement planning is Frank Armstrong. Frank is the President and Founder of Investor Solutions LLC, a registered investment advisor based in Florida.
Frank, thanks for joining me.
Frank Armstrong: My pleasure, Christine, always.
Benz: So let's talk about some of the big traps that you think investors often fall into when they are planning for their own retirements?
Armstrong: Well, first is they arrive at retirement with far too few funds. They've underinvested, they've saved too little, and they may have been too conservative or they may have blown some money somewhere along the way thinking that they could make it up. You just don't have time to make it up. You need to have a consistent, disciplined process from beginning to end in order for this to turn out well in the vast majority of cases.
Benz: So what's a strategy for someone like that who is getting close to retirement and who has under-saved? What levers can they pull to get themselves back on track?
Armstrong: Well, maybe one of the most helpful is to take a look at where you are, and if you don't have enough capital, then maybe you should defer retirement for just a little while, because, as a practical manner, if you were to defer retirement for five years, you might have 40% or 50% more assets from a combination of higher Social Security, longer time to invest the assets that you have, and additional contributions you can make.
So it can have a big impact on your total retirement income. Then, of course, you know you can downsize, but that's pretty painful for most people.
Benz: So, cut your expenses...Read Full Transcript
Armstrong: Cut your expenses. But if – like in any other enterprise, if you started out undercapitalized, bad things are likely to happen, and then you're going to stretch for too high of a total return, the portfolio you constructed in order to do that is likely to be unsustainable, and you're going to end up broke.
Benz: So a lot of people think about that 4% withdrawal rate as being a starting point. Do you think that's a sensible rate…
Armstrong: Well, I think advisors think about that and the research would indicate that's a pretty good idea, but unfortunately, a lot of retirees think that 8% or 10% is sustainable because they have this idea that the stock market has generated, say, 10% since 1926. Well, it has, but with a lot of volatility. And when the volatility bites you, your portfolio can self-liquidate in very short order.
Benz: So, for a lot of retirees, too, it's kind of luck of the draw when they retire. If they happen to retire when the markets at a relatively low ebb that's going to hurt them versus having retired, say, 10 years ago.
Armstrong: Well, the problem is if they had enough money to retire in the first place plus a cushion, they wouldn't care. The problem isn't that the market went down; it's they had far too little in the first place.
Benz: So not enough margin for error?
Armstrong: Right, no margin for error. And so, they start off skating on very thin ice, and if it gets thinner, they plunk through.
Benz: So I want to talk about another pitfall that you see, which is focusing on current income, generating income from fixed-income assets rather than using a total return approach. Why do you favor the total return approach and think it's better?
Armstrong: Well, today, we all know both dividends are down relative to what our parents had, and the income environment for fixed income is disastrously low. So you're just not going to be able to get the return you need, even if that was an optimum investment strategy. But it's not.
If you invest for total return, you diversify the portfolio properly. You can get a much higher return with lower risk than if you concentrate exclusively on dividend-producing stocks.
Benz: So would dividend producing stocks be part of a retiree portfolio?
Armstrong: They could certainly be part of it, but most of us believe that it's probably just another value screen. And rather than focus on dividend, dividend, dividend, you should be looking at, do you want to overweight your portfolio for value, because the research is overwhelming? Any place in the world where you invest on a value screen, you're probably going to do better than the market as a whole, and the same would be for small. So, concentrating on dividends as opposed to a total value strategy is probably sub-optimum not crazy but sub-optimum.
Benz: So let's think about inflation also. Do you find that clients often don't factor inflation expectations into how they position their portfolios?
Armstrong: No. I think they probably don't to the extent that they should. I said earlier that – I can remember passing gas stations because I wouldn't pay $0.19 a gallon for gas. And so, based on that experience, inflation is real. You can't get away from it and we're talking for retirees of 30-, 35-year time span, and 35 years ago price of gas was $0.19. So, every other thing else is going up along with that, but the gas is one thing that we could all identify with.
Benz: So how do you inflation-proof a retiree portfolio? Are you looking at TIPS?
Armstrong: Part of it has got to be invested in equities, real estate, maybe both foreign and domestic real estate, maybe some commodities futures. All of those assets have historically had very good inflation protection capability. So if you look at the long-term data, stock since 1926 have done 10%, inflation has been about 3.5%, that's 6.5% real return. That's an inflation hedge. And you can't get that in bonds or fixed income type securities.
Benz: Okay. Thanks, Frank. Very helpful insights. We appreciate you sharing them with us today.
Armstrong: Always a pleasure.
Benz: Thanks for watching. I am Christine Benz for Morningstar.com.