My wife and I recently took my healthy, active and still working 76-year-old parents on a wine-tasting and hiking trip. It was a fun trip, during which we had many great discussions over fine wine and food. It was during one of our meals together that I realized my parents did not have the financial resources to retire comfortably.
When our Social Security system was created in 1935, the life expectancy for American adults was about 62 years. Now it is around 80 years, although my grandmother of blessed memory just passed away at age 100. I doubt my parents have enough capital to produce income for another 24 years while maintaining their lifestyle and charitable pledges. So here is the quandary: in a low- growth, low interest rate environment, how can people secure enough portfolio income to cover the new longevity they have gained? How can they avoid outliving their money?
When working with a short time horizon (say, five to 10 years before retirement), the conventional wisdom has been to invest in bonds so as to minimize capital risk and provide a steady income. However, the recent bond market gyrations have demonstrated that bond investors can lose principal in long-dated securities or in commingled funds. A portfolio of individual short-dated bonds might work - unless, as is the case today, 2- to 5-year treasury notes yield less than 1% before taxes and fees, and corporate bonds yield little more.
Higher yields do exist, but these investments take longer to understand, may be less liquid, and generally require fiduciary expertise to research, perform due diligence on and size appropriately in portfolios. We can find excellent investment stewards in the areas of distressed bonds, middle market loans, reinsurance and catastrophe-linked securities. However these choices are not for everyone: private wealth management is a bespoke process.
If long-term financial security does not lie in bonds, investors could then consider owning stocks, Master Limited Partnerships, hedge funds and commodities. Although these asset classes do diversify risk and improve the long-term returns of a portfolio, they may not provide enough income for retirees. If an investor needs money to spend, he or she then has to sell an asset at the prevailing market price, which is always a risky proposition.
The overarching solution for portfolio management is to source income from different places and to have enough liquidity in the portfolio to cover expenses. However, the optimal solution is to start planning at an earlier age and create larger and larger "pension funds."
Here are some strategies to consider:
• As long as the government is allowing high-income earners to open Roth accounts, one should consider funding these and all available types of retirement plans. I advise clients to make the maximum possible contributions to their Roth accounts and convert traditional accounts to Roth during their peak earning years, when the income tax bite has less of a sting.
• As capital gain and dividend rates increase, cash buildup life insurance and annuities - which grow tax-deferred - can beat the after-tax returns of and supplement taxable investments. The death benefits of these investments can also help provide an income, potentially free of estate taxes, to surviving spouses and other beneficiaries.
For my folks, I turned the low-yield stock-trading accounts they had into a conservative and diversified portfolio of equities, covered-call strategies, short and intermediate bonds and infrastructure investments. The portfolio now produces monthly income and has low management fees; and whatever they do not spend gets reinvested. In this way, I hope to ensure that they can enjoy the years ahead, regardless of whether they ever decide to retire.