Nahum Daniels, Author at Integrated Retirement Advisors

The Perils of a Volatile Stock Market

 

                      The emotions of investing have destroyed far more potential investment return than the economics of investing have ever dreamed of destroying.

                          ~John Bogle Founder, Vanguard Group

 

If you’ve been wondering about the book I wrote, RETIRE RESET!, we are publishing some excerpts right here on our blog so that you can learn more. Along the way, you will learn why our firm, Integrated Retirement Advisors, was founded: we’re on a mission to help people with retirement!

Here are some excerpts from Chapter 4.

Chapter 4: MINDING YOUR BEHAVIOR

My first stock market crash began at the opening bell. Recently minted, I was a “financial advisor” for just over a year when Black Monday unfolded. What a day October 19, 1987 proved to be. Starting in Hong Kong and blowing through Europe, a chain reaction of market distress sent world stock exchanges plummeting in a matter of hours. As described by Donald Bernhardt and Marshall Eckblad in their report to the Federal Reserve Bank of Chicago, there was no sanctuary. In the United States, the DJIA dropped 22.6% in one day’s trading, and over three consecutive trading days back then, the S&P 500 lost a combined 28.5% of its value.

I took calls that day from panicked investors who were in the process of moving their pension assets to my supervision. Unable to get through to their brokers with sell orders, they were seeking my assurance that all would not be lost forever. Of course, even if their brokers had taken their calls, the sheer number of sell orders that day vastly outnumbered buy offers anywhere near previous prices. That lack of liquidity—i.e., the absence of buyers—in the face of panic selling is what gave rise to the downward cascade in stock markets in the first place.

This crash was different because it was truly a global event. For the first time, it brought home to American investors—including many baby boomers entering their prime earning years and just starting to invest—the interconnected nature of markets around the world. Donald Marron, chairman of Paine Webber, a prominent investment firm at the time, underscored the new reality: “Nowhere is that (inter-relatedness) exemplified more than people staying up all night to watch the Japanese market to get a feeling for what might happen in the next session of the New York market.”

In retrospect, there was no need for panic. In fact, according to the follow-up Brady Presidential Task Force report, panic selling was estimated to have needlessly cost investors $1 trillion. But in the moment, facing a financial loss of unknown magnitude, fear overtook rational thought, statistical analysis, and probability modeling. Under severe stress, many investors tend to react irrationally—often to their own detriment.

Our Financial Ticks 

Classical economic theory developed in the 18th Century proposed that human beings are rational, marginal-utility-seeking creatures who make financial decisions based on ice-cold calculation. But starting in the 1970s, a more contemporary school of economics emerged, focused on the study of measurable behavior when real people make real financial decisions. Working separately at Chicago, Princeton and UCLA, professors of psychology Richard Thaler, Daniel Kahneman and Shlomo Benarzi inaugurated the field of behavioral finance. Combining finance and behavioral science, its goal was to identify the emotional, psychological, and cognitive factors that shape real-time human financial choices in an effort to improve outcomes.

Kahneman recognized the roles emotion and intuition play in people’s decision making. He proposed a framework of “two minds” to describe the way people make choices: the intuitive mind forms rapid judgments without conscious inputs, and the “reflective mind” is slow, analytical and requires conscious effort. Aware or not of our cognitive biases, we are their prisoners. They’re like ticks. We have no conscious control over them. In fact, they control us.

When it comes to our finances, fear of loss—loss aversion—is said to be at the core of our biases, dominating our decision-making and behavior. Scientific studies have shown that people display a hyper-negative response to potential loss in all its forms. Research conducted at Harvard found that for the average person, losses hurt twice as much as equivalent gains yield pleasure. Researchers at Columbia concluded that retirees are up to five times more sensitive to losses than the average person, so for the people reading this book, losses hurt ten times more than equivalent gains give pleasure!

At the other end of the impulse-spectrum lies greed, the human desire for “more.” In his 2004 Chairman’s Letter, Warren Buffett, considered an investment oracle, advised that “the fact that people will be full of greed, fear or folly is predictable” so if investors insist on trying to time their participation in equities, they “should try to be fearful when others are greedy and greedy only when others are fearful.”

This was Buffett’s acknowledgment that individual investors tend to buy high and sell low precisely because they follow the herd instead of taking a contrarian position. After loss aversion, herding is acknowledged to be the key bias at the root of average investor under-performance. Investors following the herd have historically bought high (out of greed) and sold low (out of fear).

FIGURE 17. THE UPS AND DOWNS OF INVESTOR PSYCHOLOGY HAVE REAL-TIME EFFECTS

Some academics argue that better financial education can enhance investor savvy and strengthen investor resolve to stay invested through market downturns rather than rush for the exits.

Personally, I suffer from a version of what I call “DM Syndrome’—of the magnification variety—and try as I might, I can’t shake it. Black Monday left an indelible mark on me. Knowing that the circuit breakers installed into the stock market’s trading rules after the 1987 crash only limit a one-day index drop to 20%, I ask myself every morning if this might be the day the unforeseeable bears down on us.

Apparently, I am not alone. Writing in the New York Times on Black Monday’s 30th anniversary, Nobel Prize-winning Yale economist Robert Shiller opined that “we are still at risk (of a repeat of the worst day in stock market history)…because fundamentally that market crash was a mass stampede set off through viral contagion…(reflecting) a powerful narrative of impending market decline already embedded in many minds.” In other words, the primary cause of Black Monday, according to Professor Shiller’s research, was not financial or economic in nature. It was a shift in mass psychology fed by rumors gone viral (and that was before we had the Internet to instantly transmit them around the world).

[Recent events in March 2020 have borne this out with the stock market downturn. The coronavirus outbreak is a prime example of a Black Swan—unforeseeable—event that should be mitigated by the retirement portfolio’s design.]

Unlike in 1987, today I am prepared. And I believe my clients are also better prepared to weather market uncertainty, extreme volatility and even a sudden shift in mass psychology. Because the FIA anchoring the stable-core portfolio helps insulate investors from market losses, it can obviate panic, mitigate fear, prevent needless selling, and thankfully, help avoid recriminations. Investors in the FIA-anchored stable-core portfolio can stay calm and clear-sighted, their reflective minds in better control over their intuitive urges.

Chapter 4 Takeaways

  1. The school of behavioral finance illuminates the complex inner workings of our minds when it comes to managing our money under both normal and stressful conditions.
  2. Individuals’ decision-making is influenced by built-in behavioral biases that often overwhelm rationality and thereby undermine investment success.
  3. When markets turn back, fear-driven loss aversion can distort rational thinking and test our resolve.
  4. The need for confirmation leads the average investor to buy high, while the dread of bottomless losses induces the average investor to sell low.
  5. According to research firm Dalbar, buying high and selling low is believed to account for the 50% return shortfall suffered by average mutual fund investors when compared to the long-term average performance of the funds themselves.

###

If you would like to discuss your personal retirement situation with author Nahum Daniels, please don’t hesitate to call our firm, Integrated Retirement Advisors, at (203) 322-9122.

If you would like to read RETIRE RESET!, it is available on Amazon at this link: https://amzn.to/2FtIxuM

What I Wrote In Chapter 3 of Retire Reset!

 

by M. Nahum Daniels

 

If you’ve been wondering about the book I wrote, RETIRE RESET!, we are publishing some excerpts right here on our blog so that you can learn more. Along the way, you will learn why our firm, Integrated Retirement Advisors, was founded: we’re on a mission to help people with retirement!

Here are some excerpts from Chapter 3.

 

Chapter 3: TIME IS MONEY

Retirement clock management begins with the very first questions posed in the planning process: “When can I (afford to) retire? Can it be sooner, does it have to wait until later or will it be never? And by the way, how long should I expect my retirement to last?”

When a husband and wife aged 65 first visit with me and they’re in reasonably good health, I have to inform them that, statistically, one member of the pair (usually the female) has a 50% chance of making it to age 94 and a 25% chance of making it all the way to age 98. And if she makes it to 98, she has a 50% chance of making it all the way to triple digits, because actuarial science informs us that the longer we live, the better our odds of further survival.

When urging clients to get proactive about their long-term financial planning, I often relate the remarkable story of Dr. Ingeborg Rapoport. It brings home not only the indomitable power of the human spirit, but also the truly amazing advances in human life expectancy that have been achieved over the last century—and continue to be made with increasing velocity.

Dr. Rapoport had already been retired for thirty years when Hamburg University authorities finally gave her a chance to complete her doctoral degree—but only after following all the rules. She would have to stand for an oral exam, questioned face to face by a panel of academics, to defend her original dissertation on diphtheria. The dissertation had been well received when she first submitted it at the tender age of 25, but she was blocked by the Nazi regime from completing the process because her mother was Jewish. Although she went on to enjoy a professional career in neonatal medicine she always felt unfairly deprived and, after 77 years, wanted to right what she felt was an injustice.

Now nearly blind, it was only with the help of friends that she was able to catch up on developments in diphtheria studies during the intervening decades. Dr. Rapoport passed her exams with no age-based indulgences and was finally awarded her degree in 2015, becoming the oldest person ever to be awarded a doctorate, according to Guinness World Records. She was 102.

And that’s the point: Underlying successful retirement planning at any age today is an appreciation of contemporary developments in longevity. No matter your starting point, if you’re in reasonably good health you’re advised to play the long game.

 

Most retirees are naively complacent about longevity risk

The wealthier and better educated the individual, the more life expectancy improves. If, as frequently happens, one spouse turns out to be 10 years younger when the primary earner reaches full retirement, then to be prudent we should be planning for a 45-year joint cash flow—ideally adjusted for inflation to preserve its purchasing power.

Portfolio design follows on from that core purpose. Thus, our first objective is to figure out how to guarantee a lifelong cash flow to replace previously earned income in amounts sufficient to match your expenses.

In an inflationary environment, time reduces money’s worth and therefore accelerates its use. In a deflationary environment, time enhances money’s worth and defers its use to another day when it will buy more. The longer the time horizon in which these forces play out, the more pronounced the antagonistic outcomes. Thirty years of inflation at 3% results in a 60% loss of buying power; three decades of compounding 3% interest can produce a 140% increase in buying power. That’s a 200% spread, making this a battle that is absolutely worth fighting.

 

Sequence of returns risk

If you think that an “average return rate” tells you anything about retirement investing, you haven’t seen the effect that sequence of returns can have on a portfolio.

 

Figure 10 illustrates S&P 500 total returns generated over the 20-year period from 1989-2008. The average return over the period was 8.43%. The first thing to notice is that no single year actually produced a return equal to the average; returns ranged from losses as great as -37% to gains as high as +38%. If we reverse the sequence, the average annual return remains the same.

Figure 11 shows what happens when a retiree starts pulling money out of their portfolio at a rate of 5% per year for retirement income. The clockwise sequence (based on S&P 500 from 1989-2008 from Figure 10) left a theoretical retiree with a $3.1 million asset pool at the end of twenty years available for spend-down over the next 20; the counter-clockwise sequence would have left the same retiree with a miniscule $235,000 that would have to be stretched over a decade or two!

 

Chapter 3 Takeaways

  1. Retirement planning starts with assuring that your nest egg (with or without inputs from other income sources) serves as a personal pension guaranteeing you the paychecks you’ll need for 30-40 years after you stop working.
  2. As an investor, you need to understand that time is of the essence and that playing the long game means hedging against numerous long-term cyclical risks decades in advance of their possible impact.
  3. Once you begin to spend down, retirement success depends more upon the sequence of returns you earn than the annual magnitude of those returns.
  4. To make your nest egg last for the long run, best practice is to focus on avoiding sharp losses rather than seeking high returns.
  5. True compounding will yield a more predictable outcome than the generation of random market returns that can offset each other, reduce the net result to zero (or less) and waste your precious time.

###

 

If you would like to discuss your personal retirement situation, please don’t hesitate to call our firm, Integrated Retirement Advisors, at (203) 322-9122.

 

If you would like to read RETIRE RESET!, it is available on Amazon at this link: https://amzn.to/2FtIxuM

 

 

Nahum Daniels Joins Jon Dwoskin On His “Think Business” Podcast

 

Nahum Daniels was interviewed recently by Jon Dwoskin on his THINK BUSINESS* podcast. You can listen to the entire podcast here: https://jondwoskin.com/2019/11/jon-dwoskin-interviews-nahum-daniels-certified-financial-planner-integrated-retirement-advisors/  THINK BUSINESS* is Jon Dowskin’s 1:1 in-depth and soulful conversations with executives, managers and sales people who are making a difference in their companies, communities and in themselves.

————————————————————————————————————————————–

Here are a few of the points made during the interview:

“I’ve been an entrepreneur all my life,” says Nahum Daniels. “I was originally in the publishing business. Early on in my career, I spent seven or eight years living in Japan. That was back in the 1970s, and I published a book which was at that time considered to be “alternative lifestyle” focused. The book was called The Book of Tofu, and it ended up changing everything in the American food retail industry. Today, you’ll find multiple types of tofu sold in every grocery store; you can’t escape it. But back then, prior to the book, no one even knew what tofu was.”

“That’s the power of the written word,” Nahum continues; “It can change an entire culture.”

Nahum spent more than a year writing his book, Retire Reset! What you need to know and your retirement advisor might not be telling you.

In the early 1980s, Nahum met Bill Gates through one of his Japanese business contacts. He ended up working for Microsoft, before it was a public company, back when it was a small start-up. At that time, PCs were just being launched, and computer books were extremely technical, complex and filled with jargon. It was Nahum’s task to revamp the books’ content and design to appeal to consumers as Microsoft set out to lead the way in the personal computing industry.

As a business mentor, Nahum found Bill Gates to be a very focused leader. “He totally concentrated on the people he was working with, and was highly-attuned to both their needs and his business objectives. He was at the leading edge of innovation and had a view of what the future looked like,” Nahum explains.

“Bill is a very unique individual. By the time he reached high school, he was spending the majority of his time programming and coding. At a very early age, he had a sense of the tremendous power of the personal computer. He wanted to make sure the future happened; he was out to reshape the world and he wasn’t afraid to be an entrepreneur or leader,” says Nahum.

Later on, Nahum Daniels moved from book publishing and personal computing into financial world, specifically retirement planning. But he found himself writing and publishing again [the book, Retire Reset!] when he realized how much complacency there was in the financial industry around the subject of retirement.

“Since the 1990s we’ve been taught by the financial industry that retirement planning involves investing in a mix of stocks and bonds comprising a “balanced portfolio” and expecting the best. Standard performance expectations for securities or stocks range from 9-12% returns per year, while bonds are expected to return 4-5% per year.”

“I make the case in my book that we may be facing a span of a decade or more of extremely low returns, much lower than these projections,” says Nahum.

“People need to spend more time focusing on this. We need to learn to see the alternative scenarios that might unfold, and adapt and hedge against them, achieving financial objectives even if lesser returns materialize going forward. This is essential to retirement planning and portfolio construction specifically for retirement.”

“We need to reorient. People are living much longer, but Americans think short term—only to the next month or quarter,” Nahum continues.

“Retirement planning is all about thinking 50 years down the road.”

“Even most financial advisors have not really made a scientific study out of how to create a portfolio that works this long, which puts us at a disadvantage. With interest rates dropping lower—getting close to zero, or even negative like Germany or Japan—we can’t get yield or income from our assets. How will we have enough cash flow without spending down our capital?”

“Writing my book allowed me to study the industry icons who have analyzed markets and done in-depth research on returns. They have uncovered options and they’ve run the calculations to show that some alternatives to the stocks/bonds scenario may perform better for retirees through time. That’s what I help people with.”

 

Rethinking Your Retirement Investing To Hedge Against A Market Downturn

 

Rethinking Your Retirement Investing To Hedge Against A Market Downturn

Studies show most Americans aren’t saving enough for retirement. A recently-released World Economic Forum report warned that most retirees risk running out of money as much as a decade before death. And the anxiety of being ill-prepared for the golden years can grow when portfolios do not, leading some advisors to recommend over-weighting stocks to provide the impetus for long-term growth.

Retirement planner Nahum Daniels thinks the risk-reward trade-off of investing a retirement nest egg in stocks and bonds can result in even more worry. And, given a bad sequence of returns -coupled with the fact that people are living longer than in previous generations -many retirees could run out of money faster.

“Psychologically, we’ve grown confused about the financial dynamics of retirement,” says Daniels (www.integratedretirementadvisors.com), author of Retire Reset!: What You Need to Know and Your Financial Advisor May Not Be Telling You. “Since the early 1990s, when the 401 (k) replaced the defined benefit plan in corporate America, there’s been a fundamental shift in perception. When retirement was pension-based, planning was about guaranteed income and the employer had to keep the promises it made. Today, participants in 401 (k) plans have to know about stocks, bonds and ‘Balanced Portfolio’ management because they’re responsible for their own unpredictable outcomes.

“Ironically, centering a retirement portfolio on Wall Street’s securities-driven risk/return tradeoff may actually be a formula for an even more insecure retirement. The reason is the cyclical volatility inescapable in equity markets. Nor are bonds immune from losses: The Fed’s rate manipulations, coupled with our nation’s current $75 trillion debt overhang, introduces an abnormally high level of volatility to bond prices. The real crisis in retirement planning is not just our savings shortfall but our misguided mindset; we need a perceptual shift about what our real goals are and a tactical reset to reach them.”

 

Daniels offers four principles to reset a retirement portfolio and hedge against a market downturn:

  • De-risk. Whether in the accumulation or spend-down phase, the retirement nest egg cannot afford market losses without eventually paying out less. “Insulate your nest egg from them and guarantee the outcome when you can,” Daniels says. “It’s unnecessary to resign yourself to self-imposed austerity to accommodate market volatility.”
  • “Size your nest egg as efficiently as possible by optimizing the sustainable yield it can generate,” Daniels says. “Work it back from your income need. For example, if your nest egg supports a withdrawal rate of 5 % rather than 3%, you can achieve your goal with 67% less capital.”
  • Daniels says the latest academic research favors the integration of actuarial science with investment expertise in the construction of a “stable-core” retirement portfolio. “Longevity insurance has a heightened economic value in an era of open-ended life expectancy,” Daniels says, “while historically no asset class beats equities for long-term growth potential. Balancing the two is key to getting the best result and hard-boiling the nest egg.”
  • “Today’s fixed index annuity (FIA) lends itself well as the actuarial component of a retirement nest egg,” Daniels says. “Anchoring a stable-core portfolio to it can protect against market declines while still participating in a needed share of upside potential.”

 

“Buying and selling securities at all the wrong times can increase the odds that you run out of money,” Daniels says. “Retirement investors need a form of protection that can keep them invested without costing so much that it devours their return in the process.”

 

About Nahum Daniels

Nahum Daniels (www.integratedretirementadvisors.com) is the founder and chief  investment officer of Integrated Retirement Advisors, LLC. He is the author of Retire Reset!: What You Need to Know and Your Financial Advisor May Not Be Telling You. A Certified Financial Planner and Retirement Income Certified Professional, Daniels has served mature investors for over 30 years.

How An FIA Can Replace Bonds As Your Hedge Against Volatile Rates

 

How An FIA Can Replace Bonds As Your Hedge Against Volatile Rates

Interest rates heading to zero or below in the United States, following the pattern set in Europe and Japan, will only make it harder for most nest eggs to do their job. They could also foreshadow low returns across most major asset classes, making both wealth accumulation and retirement-income generation harder to achieve. With the bellwether 10-year Treasury note bouncing around 1.5% and the 30-year Treasury bond hitting all-time lows under 2%, all fixed income yields are expected to trend lower. If governments and high-grade corporates start paying little if any interest, they will contribute less and less cash flow to a “balanced” retirement portfolio.

On the other hand, were rates ever to normalize, longer-dated bonds would suffer a capital loss, undermining the other role in Wall Street’s policy portfolio played by bonds as a counterbalance to the volatility of stocks.

Keep in mind that the shrinking 10-year rate is also the key metric for appraising asset value and risk. Zero and/or negative rates may initially boost asset values, but longer term, the next round(s) of rate reductions may trigger a major reset in equity, bond, and real estate values, already considered on some measures to be inflated.

A strong argument can be made that retirement investors are living through a systemic paradigm shift and that the resulting uncertainty should focus them on the potential utility of hedging. Recent academic research agrees that investors in or near retirement can benefit from reallocating their nest eggs not between stocks and bonds but by integrating equities with longevity insurance.

Today, the Fixed Index Annuity (FIA) stands out as a rapidly evolving form of longevity insurance designed to anchor a retirement portfolio. Independent research, most notably under the auspices of Yale School of Management Professor of Finance Emeritus Roger lbboston, makes the case that the right FIAs can complement or even replace bonds in the nest egg, adding as much as 1 % to 2% of excess annual return – or even more in a low-rate environment. Add to that excess return the 1 % to 2% a year that actuarial science can contribute in the form of “mortality credits” and we can start to breathe a little easier.

 

Long-term pros may outweigh the cons

It’s important to note that the FIA is complex and has been characterized as such by the Securities and Exchange Commission, the National Association of Insurance Commissioners, and the Financial Industry Regulatory Association. Any guarantees are backed solely by the financial strength and claims-paying ability of the issuing company and the instrument offers varying levels of access during a gated surrender-charge period. Thus FINRA rightly stresses that investors do their due diligence when choosing among advisors before deciding whether a certain FIA is right for you.

The effort may well be worth it. Emphasizing downside protection, the FIA aspires to deliver steady mid-single-digit returns -without exposing the policy’s accumulated value to market volatility.

Because FIA performance is linked to a market index stripped of its downside risk, Wall Street’s risk-return formula trades off some of the index’s upside potential.

Those trade-offs take the form of caps and participation rates quantified by the investment banks serving as an insurer’s counter-parties. Accepting less upside to avoid market losses and stabilize returns is the price investors have always paid to hedge, and it’s up to each of us to judge whether it’s a price worth paying in the FIA.

 

Nahum Daniels is the founder and chief investment officer of Integrated Retirement Advisors, LLC., a Registered Investment Advisor in the State of Connecticut. He is the author of Retire Reset!: What You Need to Know and Your Financial Advisor May Not Be Telling You. A Certified Financial Planner and Retirement Income Certified Professional, Daniels has served mature investors for over 30 years.

Retirement Guidelines for Millennials

Millennials looking to retire at age 65 have thirty to forty years to prepare and another thirty to forty years to provide for.  Here are some guidelines we use in our practice:

 

Acquire discipline: set aside 10% of disposable income to the retirement nest egg.

Open your eyes:  Retirement investing is intended to ultimately generate decades of income in the distant future to sustain unprecedented longevity.

Learn patience: the nest egg should be “put to work” by compounding consistent gains; aim strategically for singles and doubles rather than swinging for the bleachers.

De-risk:  Market volatility and realized losses, especially early in the accumulation or spend-down phase, can undermine the best-laid plan and the ability of the nest egg to achieve its long-term income objectives, so avoid them.

Seek shelter: The retirement portfolio should be insulated from rising taxation, the most consistent drag on growth especially for Millennials who may face higher taxes than their forebears.   It should therefore be “nested” in IRAs, Employer qualified plans, deferred annuities and cash value life insurance to provide the needed tax shelter.

Hedge:   Invest the nest egg for the long term insulated from downside risk but positioned to share in the market’s upside potential.

Diversify:  Another key to long term investment success, diversify across asset classes in terms both of tactics and strategy.

Think outside the box:  Explore the economic advantages offered exclusively by actuarial science rather than limit yourself to conventional stock-and-bond investing.

Integrate:  learn how next-gen longevity insurance can complement securities in a retirement portfolio to achieve more predictable results.

Consider the alternative:  Evaluate the multi-faceted fixed index annuity (FIA) and the role it might uniquely play as a retirement portfolio’s stable core.

 

The Solo 401k

 

  1. The solo 401k is ideally suited for successful Millennials setting themselves up as single-employee businesses making enough money in the “gig” economy to start thinking seriously about tax-advantaged saving for retirement. The 2019 maximum deductible contribution of $56,000, possibly doubled by a contribution for an eligible spouse working in the business—no matter the ages of the plan participants—can be a powerful incentive to get serious about the long-term future.    Of course, the solo 401k can be useful for older GenXers too and even for Baby Boomers who have become consultants to the corporations and/or industries that have laid them off as full-time W2 employees.

 

  1. Whenever the right fact pattern presents, Integrated Retirement Advisors quick to recommend this plan. The key is for the business owner to be making enough money to take advantage of the plan’s generous capacity and low-cost simplicity. Another determinant is the expectation of doing so in future without the need to hire employees.  Once employees (other than a spouse) enter the picture, the solo 401k plan must be converted to a standard employer plan that gets more complicated (due to non-discrimination testing) and more expensive (due to additional operating and administrative costs).  Of course, every contribution to a solo plan can incent and boost a retirement investing effort, so even setting one up for a few years while a business scales up can be very advantageous.

 

  1. Limited access to the plan’s accumulating account is probably the greatest drawback to this arrangement.  Like any tax-qualified plan, once a contribution is made access to the funds is limited by IRS regulations.   Withdrawals before age 59-1/2 are subject to income tax plus a 10% premature withdrawal penalty.  Solo plan loans of up to $50,000 can be taken, but they’re tax-inefficient and must be repaid with interest over five years.  If they default, they too can generate early withdrawal penalties.

 

  1. In terms of investment, the more diversified and flexible the platform, the better. Providers come in a variety of shapes and sizes.  The big brokerages offer prototype plans that may limit their offerings to stocks, bonds, funds and ETFs.  Some securities boutiques offer self-directed plans that provide access to real estate, precious metals and other alternatives, including bitcoin!

 

  1. We make it a point to inform clients that 401k plans, including the Solo variety, permit insurance contracts as investments. Today’s fixed index annuity (FIA) can provide market-linked growth potential together with downside protection, a combination that lends itself well to long-term compounding. Integrated with securities, these contracts can help de-risk a retirement portfolio without necessarily imposing an unbearable opportunity cost.  Roger Ibbotson’s recent research suggests they’re worth considering as a bond alternative.

 

  1. Life insurance is also a permissible alternative in a Solo 401k plan. When permanent coverage may be needed for personal and/or business reasons, funding it pre-tax in a 401k plan can prove very cost-efficient.  Given enough time, index-linked life contracts can provide temporary protection together with investment growth. Once the protection feature is no longer needed, the contract can be surrendered for its cash value that is then added to the account’s aggregate holdings.

What Is An Annuity?

An annuity is first and foremost a stream of payments.  For most retirees, the payor is an insurance company.  Properly regulated, an insurer can “guarantee” the payments it promises; in fact, if an insurer gets into trouble, annuitants in payout status are considered senior creditors, i.e., they get paid first—even before the rent.

Annuities can pay for a specified number of years or for a lifetime or two, which given today’s extended life expectancies, can be open-ended.  Today’s extended life expectancies gives actuarial science enhanced economic value when it comes to providing a return on investment:  an annuity can yield more from the get-go if average life expectancy is assumed while the longer an annuitant lives, the more payments received, the greater the IRR.  So annuities are best purchased by people expecting to live into their nineties– or even beyond—who don’t want to worry about running out of money no matter how long they survive.

In a traditional fixed annuity, the insurer invests in mostly investment-grade fixed income instruments to match its assets to its liabilities.  Based on its projected earnings (usually reflecting the yield on the US ten-year Treasury) and its projected expenses, it shares the blended yield on its portfolio holdings with the annuitant, paying a fixed return for the guaranteed duration.  The purchasing power of that fixed return will be eroded over time by inflation, which is a key drawback to this structure.  The payout, however, remains unvarying, unless you buy an inflation “rider” which increases it year to year based on some measure, but inflation riders tend to be expensive and depress the initial payout level.

A variable annuity also offers an income that will never run out, but the insurer invests the policy-owner’s premium in equities.  The objective is to generate a higher level of income over time, but the income payout is subject to market risk and can either increase or decrease from year to year.  The potential to decrease—possibly requiring “belt-tightening” and a reduced lifestyle that can end up being permanent—is the biggest drawback to this structure.  A poor sequence of market returns can end up undermining the income floor most annuities are intended to provide.

The fixed index annuity is a relatively new hybrid.  Like a fixed annuity, it guarantees an income floor from inception.  But unlike a traditional fixed, its earnings are linked to one or more market indices and those earnings can be applied to the annual income payout to establish a higher floor from year to year.  If markets are favorable, the annuity income can increase and those increases are rendered permanent; unlike a variable annuity, the income yield doesn’t suffer even if markets have a bad year or two.

The older an annuitant, the higher the initial payout of any income annuity.  So the traditional fixed can be very advantageous for retirees in their 80s.  They should shop for the highest payouts being offered by the better-rated companies and consider a portfolio approach.  The deferred fixed index annuity lends itself well to investors approaching or just entering retirement, say between ages 55 and 75, aspiring to give inflation a run for its money over the long term without taking a hit on the initial payout once begun and risking income reductions if markets decline.

Retiring at 45, the opportunities and the pitfalls

 

 

Even retiring in our mid-sixties today poses unaccustomed challenges revolving around our unprecedented longevity–the increasing odds that we might live deep into our mid-90s or even beyond–and our psychological tendency to electively compromise our lifestyles once we stop earning income out of fear of spending too much too soon and running out of money.  So if a thirty-year retirement is bedeviled by these factors, think about a 50-year period extending from age 45!

 

It’s crucial for anyone seriously contemplating early-retirement to make a study of the complex psychological and financial dynamics involved, or work with an advisor who has.  Most of us don’t know what we’re up against in modern retirement, and that goes for untrained financial professionals as well as clients.  True, it’s an opportunity for extraordinary self-realization but it’s also rife with the risk of financial ruin no matter how much money we may start with.

 

The “early retirement” planning process really needs to start at the “back end” with a vision of the lifestyle desired.  A new profession of retirement coaching has emerged to assist people in finding meaning in retirement no matter when it might start.  I call this aspect of retirement planning its “soft” side to distinguish it from the financial dynamics; I refer to them as retirement’s “hard” side.  The two are intertwined.

 

The process of planning a meaningful retirement isn’t “one size fits all ” In financial terms retirement can come in small, medium and large.  How much you’ll need to accumulate, and in what vehicles, will be determined by the cash flow you’ll need to sustain your envisioned lifestyle.   Is your goal to escape the grid and live the single life of adventure or is it to be a high-profile head of household educating your children and practicing communal philanthropy to make the world a better place?  It’s essential to start with your vision of a meaningful life freed from the need to work and earn.  Keep In mind, though, that “meaning” can be expensive to sustain.

 

Obviously, living on $50,000, adjusted each year for inflation, requires a much smaller nest egg than living on $500,000 or $5 million.  Once you settle on the cash flows you’ll need, you can size the income-producing nest egg required and focus on its core portfolio construction. The more income you can generate from your nest egg–the higher its yield and the more reliable its duration–the more efficient its construction can be and the less capital you will need to get the job done.  This frees up other capital to satisfy your risk appetite or philanthropic intent.

 

To retire early you will want to start saving and accumulating whatever capital you will need as soon as you have a clear vision and a declared objective.   If it’s to last a lifetime, the nest egg needs to be de-risked to avoid untimely market losses that could prove hard to recover.  Better to position your income-dedicated retirement portfolio to compound safely over time.  Smoothing returns and avoiding losses is key to portfolio design; we believe you should look for financial instruments that can guarantee the outcome.  Next-gen longevity insurance can play a stabilizing role in the nest egg.  Linked to the underlying markets, Its new varieties offer downside protection together with a reasonable share of upside potential both before and during retirement.  We use them extensively in constructing our “stable-core” retirement portfolios.

 

That’s because losses incurred in retirement planning can undermine even the most consistent effort.  Market risk should be hedged and minimized if not totally avoided.  Taking on uncompensated risk is anathema.

 

In fact, retirement at every stage is an exercise in risk management.   Risk sensitivity is accentuated the earlier you start and the closer you get to the goal line.

 

Avoiding depletion is like walking a tightrope.  Success is not dependent on how much wealth you start with; it’s more a factor of the ratio of your spending in retirement to your dedicated retirement capital.   Study the concept of the “safe” withdrawal rate and figure out a way to exceed it without prejudicing your ultimate success.  Getting good advice on how to do that may even be worth paying for.

 

Unless your income goals in retirement are modest, it’s hard to save enough out of one’s wages to build an adequate nest egg no matter how early you start, especially if you have a spouse and family to feed, house, clothe and educate.  Starting a successful business or owning shares or stock options in a start-up that ultimately gets acquired or goes public are more often the sources of wealth creation among age-45 retirees.  A carried interest in a real estate or financial firm—a share of the profits—can be another path to early riches.

 

Ironically, while risk taking is often the source of early-retirement wealth, the nest egg itself should be hedged and protected.  In our practice we go further and recommend insuring it for higher initial yield and longevity guarantees that can survive an individual issuer that may go under.

 

Retiring early only accentuates this ever-present dialectic that characterizes a retirement that, if starting at 45, can last far longer than your work life.

 

Retirement Investing For Entrepreneurs

 

Entrepreneurs are risk takers by nature; most swing for the fences in their chosen enterprises.  Most fail once or twice before succeeding.  Many businesses fail even AFTER having succeeded.

Retirement savings need to be approached differently. 

  1. The retirement nest egg should be fed starting as early as possible and should be focused on steady growth with downside protection.
  2. If started early enough and insulated from losses, even 10k per year can compound into a significant portfolio over time.
  3. Not sufficiently appreciated, life insurance is an ideal retirement tool for entrepreneurs under 50. Even older under certain circumstances.
  4. Investment-oriented life insurance compounds with doubled-up vigor by benefitting from the tax-avoidance features it offers; all internal growth is tax-deferred.
  5. In addition, life insurance offers tax-free access to gains in the form of policy loans, usually of the “wash” variety. This turns a life policy into an unlimited Roth IRA.
  6. The Fixed Index Universal Life (FIUL) policy offers the greatest growth potential; some varieties offer extraordinary loan features.
  7. Based on today’s tax regime, nothing beats the retirement funding potential of this financial instrument; what’s more, being tax-free on the payout side takes the recipient off the grid. The cash flow from this source is non-reportable.
  8. The instrument also serves the traditional family protection needs met by life insurance.
  9. It can also serve business needs: funding deferred compensation arrangements; buy-sell agreements with partners and co-shareholders; and key-person coverage to protect the on-going viability and on-going-concern value of an enterprise.
  10. Thus, retirement planning should be built into the wide array of planning needs unique to entrepreneurial endeavor.

 

Ask us for examples and stories from 30 years’ experience working with small business owners available.