Over the last few years I have met many Americans, either already in or nearing retirement, who have told me that they have been urged to “stay the course” with their portfolio. These investors are putting their retirement dreams in a philosophy that utilizes projections, and not guarantees. The problem is many investors are hoping to retire in the next 10 -20 years and are nowhere near their long term goals. Considering that the S & P 500 has yielded a negative return from 01/01/2000 to 01/01/2012, many portfolios are on track to either have retirement severely delayed, or not be able to retire at all. What many Americans do not know is that this planning approach is severely flawed, and is unlikely to achieve the desired results.
Most financial planners who work with current or converted (usually to an IRA) deferred compensation plans are utilizing a planning system that is missing a vital component. Most of their clients do not have an income stream, or pension, for retirement. Rule number one in investing; don’t put at risk what you cannot afford to lose. It is counterintuitive to expose your entire retirement plan to market risk when you have not established an income stream to meet your basic needs.
Before this flaw can be understood, it is crucial to understand the history of the financial planning model. Beginning in the 1950’s, financial planning revolved around precautionary savings and diversification strategies to manage personal wealth. Sound familiar? Today, the financial planning model has not strayed too far from its roots. Understand that throughout the 1940’s to the late 1970’s there was very little volatility in the market. Through the protection of the Glass Steagall Act, there was little if any need to change the traditional planning model. The Glass Steagall Act was put into place after the Great Depression to separate the banking, investing, housing, and insurance sectors, serving as a shield of protection against greed and volatility. Confidence soared in this model due to steady growth and very little volatility. This caused the economy to grow stronger which inevitably evolved into an appetite for higher risk and better returns. This appetite spurred a massive joint effort to deregulate the banking industry in order to try to maximize profits without any restrictions, which ultimately resulted into our global recession today.
The financial planning method used today is based on a model from over 50 years ago. In the 1950s there were two main assumptions that do not exist for working Americans today, and will likely never exist again. First, it was assumed that every US citizen born was to receive social security in retirement without question. Secondly, every American that at least graduated High School would enter a firm of their chosen industry, and was expected to climb the ranks from the bottom up (in the same firm). In exchange for their services, every working American expected to have a pension in retirement. Those Americans who were not working for a pension were considered poor planners, or were usually thought to struggle within retirement. When they couldn’t support themselves in retirement they often became a burden to their family and society as a whole.
When you use this traditional financial planning model today, the assumptions needed to make this model work do not exist. Ask yourself the following questions. Do you have a pension in place for retirement? Are you planning on receiving social security in retirement that is taken out of your paycheck each and every month? Do you think it’s possible to retire by the age of 70? If so, how do you plan on doing this? These questions never had to be addressed for retirees; and are questions that today’s working Americans are going to regret not asking.
The next generation of retirement is going to cause a whole new set of problems. Today’s working class is approaching retirement with less than a glimmer of hope in receiving social security, and the thought of having a pension for retirement today is comical. Instead, employers are providing deferred compensation plans in exchange for the once desired pension plan. These deferred compensation plans have been lucky to break even over the last 12 years. So if this is the case; why is the focus on hedging against risk (jumping out of one volatile market to be placed into another) when the real threat is a lack of income?
The only way to receive a guaranteed contractual income steam is through financial guarantees. Since investment banks utilize a business philosophy of leveraging assets (borrowing funds) in order to make money, they can’t offer financial guarantees. This is why investment banks are forced to purchase FDIC Insurance in order to offer guaranteed accounts like CD’s and checking accounts. Only through non leveraged assets (showing total assets exceeding total liabilities on a financial sheet) can a set income stream be guaranteed for life. Insurance Repositories that specialize in fixed assets can do this through a differentiated proven result. Instead of hedging against risk, these companies implement formulas (non cash values) to compound and withdrawal funds for a lifetime. Typically the longer you wait the more income you are eligible to receive, and even offer liquidity features absent in the traditional pension plan. How can they guarantee this income? Through acquired legislation, these companies are required to hold cash reserves to protect the interests of depositors (money protected against unforeseen events in the future).
Volatility will continue moving forward. Today our only defense against the volatility (brought on by toxic assets) is to hope that the Federal government will cut a check at the expense of every tax payer, regardless of whether you invest in the market or not. Investors who continue to try and “hedge against risk” in this environment without addressing adequate income planning (lifetime income) will eventually fall by the way side. If you are not preparing yourself with proper income planning in retirement, you will become tomorrow’s burden. Unfortunately, the financial planning philosophy is unlikely to change until the nation is forced to deal with Generation X retiring with no pensions or social security to count on (at least 10-15 years out). At that point it will be too late for many. In today’s financial environment if you fail to adapt, you will likely fail to retire.