Note 1 – The impact of changing interest rate levels to returns.
Note 2 – The risk of defaulting on the return of principal.
As you can see from the table, there are significant differences in the risk and expected returns of sectors within the general category known as fixed income. The most widely quoted benchmark in the fixed income space is the Barclays Aggregate Bond Index (formerly Lehman Brothers Aggregate). The composition of the Barclay’s index includes 71% Treasury or government agency debt and 21% high quality corporate bonds. It contains very little high-yield and no emerging market or floating rate debt. Any portfolio that contains more or less high quality bonds versus the benchmark will outperform or underperform the benchmark in any given year. The risk attributes will also be different. Our goal is to incorporate enough sub-sectors to dampen sharp movements at the larger asset class level. While fixed income was used as the example, the same logic applies to equities and hard assets. Managing against a benchmark turns most investors into relative performance chasers (i.e. beating the chosen benchmark, instead of earning a prudent return).
Looking at an Investment Holding in Isolation
It is natural and prudent to review the performance of each investment within a portfolio. Advisors constantly review recommended positions to see if they continue to merit inclusion. Performance is one data point, amongst many, but it receives the most attention by investors.
Diversified stock mutual funds hold positions with unrealized gains and positions with unrealized losses. For example, the April 2012 Annual Report from the First Eagle U. S. Value fund shows a total of 63 individual common stock holdings, 14 of which were in a loss position. The reason these stocks do not garner attention is that they are invisible to the investor monitoring gains and losses purely at the fund level.
It is important to understand why a position exists in a portfolio before using performance as the sole reason to sell. A good analogy would be to evaluate a five player basketball team not based on their overall record, but by singling out and firing the player who scores the least amount of points, ignoring the player’s defensive contribution.
Enticing as it is to micro manage individual funds or securities within a portfolio, it is seldom wise to isolate positions based on performance alone.
We live in a world of record low interest rates, record high profit margins, highly leveraged (debt ridden) economies, and virtually zero inflation-adjusted wage gains for the vast majority of Americans. After years of consumption and bidding up asset prices, fueled by the availability of cheap credit, we find ourselves in a multi-year deleveraging (debt reducing) cycle that will take years to play out. We remain convinced that policy-induced inflation will be part of the solution, since it will allow debtors to make payments with increasingly less valuable currency.
It has become difficult to justify the traditional balanced portfolio of stocks and bonds, despite their low correlation with each other. Price appreciation in bonds has decreased expected returns, and with it their ability to buffer a decline in equities (stocks). Locking in returns of 1.6% for 10 years or 2.6% for 30 years for a substantial part of the portfolio does not seem attractive or reasonable to us. We will increase our focus on hard assets, and other non-traditional strategies, to prepare for a likely reflationary environment. A deflationary environment, on the other hand sinks all boats, and is the least desirable outcome. Below is an illustration of a deflationary spiral.
We are pleased to announce that Kate Madden has joined the firm in an administrative capacity. She replaces Lauren Heydt who has decided to pursue other interests. Lauren will be available on a part-time basis to assist with the transition.
Insights from Retired Clients
The results from our recent survey of retired clients are attached for your review. We want to thank those clients who responded to our request. Our hope is that these insights and observations will allow existing and future clients to be better prepared for retirement and to derive more satisfaction from it.
We continue to work daily to earn your trust and confidence.
Vincent A. Schiavi, CFP®, CPA/ PFS Ravi P. Dattani, CFP®, CPA
The following is a summary of client responses to our request for retirement transition insights, along with a few of our own observations:
Timing of Retirement
Some would have delayed retirement to better prepare themselves mentally and financially for the transition. Others retired in their 50s with no regrets.
When work ceases to be fun, it’s time to retire.
Retiring when you are in excellent health and can still do all the things you have always been able to do is the way to go.
I’m Retired, Now What?
For some, the biggest transition was figuring out what to do with the rest of their lives.
One client believes that retirees who don't have a consuming hobby or an interest in volunteering or working for some worthwhile cause are not going to be very happy.
One client submitted this quote from Joan Chittister, OSB, "Find the thing that stirs your heart and make room for it."
One retired executive was thankful for the insights provided by the career transition training he received that was sponsored by his employer. The personal discovery program resulted in an up-to-date view of his strengths and weaknesses, an understanding of what he enjoyed doing, and where he found a sense of accomplishment and happiness. The result was a clear decision to pursue completely new interests in retirement.
Retirement is an ongoing process – be ready to adapt.
Spouse / Partner Issues
The stay-at-home spouse does not get to "retire". It is important that the retiring spouse share home maintenance and care tasks.
Respect each other’s separate interests and alone time. At the same time, have an open mind when opportunities are presented to do things together.
Giving Back to the Community
Stay involved or get involved with community organizations, professional associations or charities. The best and most meaningful "job" you may have in your lifetime may be the non-paying, volunteer service you engage in during retirement.
Arrange regular lunch meetings with one or more groups of friends. It requires diligence to stay in touch and plan activities with friends.
Stay involved with grandchildren and their activities. If possible, take them on visits to historical sights or amusement parks.
Make it an ongoing, daily project to maintain good health via diet and exercise. Do not become a couch potato! Do not wait until retirement to implement a healthy lifestyle.
Nutrition and weight training play significant roles in maintaining good health. Educate yourself about their roles.
Health insurance premiums for retirees under the age of 65 before Medicare kicks in can be very expensive. It is important to explore coverage options well in advance of retirement.
While many retirees don’t have a desire to pull up roots and move, others want a clean break and take up residency in another state. We have seen clients do this and be very happy, and others who have moved and subsequently return. Our recommendation would be to spend considerable time in another location before deciding on a permanent move.
While not for everyone, clients who moved to a retirement community were glad they did. Most wish they had made the decision to move earlier. This seems to be one of the more difficult decisions to make during retirement. There is no right or wrong answer, only what seems best for you.