Retirement Experts Recommend Startling New Approach: Increase Equity Exposure After Retiring
Tuesday, October 29, 2013 11:03

Tags: asset allocation | retirement | retirement income | retirement planning | risk

Talk about turning conventional wisdom on its head: A new study advocates a U-shaped investment strategy through life, with high risk at a young age giving way to low risk near retirement, followed by increasing risk during retirement.

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Conventional wisdom on retirement glidepaths is to reduce exposure to risk continuously, starting with high risk at a young age and giving way to lower risk as retirement approaches and even lower risk post-retirement.
The provocatively titled study, “Reducing Retirement Risk with a Rising Equity Glidepath,” was published by Wade Pfau and Michael Kitces. Pfau is a professor of retirement income in the new Ph.D. program for financial and retirement planning at The American College in Bryn Mawr, Penn., and Kitces is an author and speaker.
“We find, surprisingly, that rising equity glide-paths in retirement – where the portfolio starts out conservative and becomes more aggressive through the retirement time horizon – have the potential to actually reduce both the probability of failure and the magnitude of failure for client portfolios,” the study’s synopsis reads. “This result may appear counter-intuitive from the traditional perspective, which is that equity exposure should decrease throughout retirement as the retiree’s time horizon (and life expectancy) shrinks and mortality looms. Yet the conclusion is actually entirely logical when viewed from the perspective of what scenarios cause a client’s retirement to ‘fail’ in the first place.”
Pfau and Kitces point out that an extended period of poor returns in the first half of retirement will lead a retiree to hold few stocks if and when higher returns come back. Conversely, when equity returns are good in the first half of retirement, the retiree gets ahead of their income goals so that later asset allocation choices have little impact, even if returns fall off.
I agree with this advice up to a point. However, I believe that retirement years are too complex to offer a generalized, one-size-fits-all solution. For example, academics recommend a “pockets of money” approach in retirement, while others advocate a mix of annuities and self-insurance (personal investing). And now we have Pfau and Kitces recommending a pattern of increasing risk.
My research and experience shows that investors are best served by a glidepath that actually reaches the point of transition from the accumulation phase
to the distribution phase with all of the investor’s accumulated savings intact, plus reasonable growth in those savings. Only then, at entry into retirement, should investors plan how they will secure the remainder of their lifetimes with dignity. It is only at this point of transition that enough information is available (e.g., amount of accumulated savings, health status, amount of debt) to properly construct an investment plan for the third stage of the U-shape.
For a more detailed explanation, see my 2012 article, “The 3 Stages of Individual Investing are like a Journey into Space.”
You can be the judge of the best course of action for you and your clients.
Three American Professors Awarded Nobel In Economics; Fama Of DFA Is Recognized
Monday, October 14, 2013 10:28

Tags: advisor industry people | asset allocation | portfolio management

Three American professors — Eugene F. Fama, Lars Peter Hansen and Robert J. Shiller — were awarded the Nobel Memorial Prize in Economic Science on Monday for competing theories about the movements of asset prices.

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The three men, who worked independently, were described as having collectively illuminated the financial markets by showing that stock and bond prices moved unpredictably in the short term but with greater predictability over longer periods. The prize committee said these findings showed that markets were moved by a mix of rational calculus and human behavior.
The New York Times points out that the decision to honor Mr. Fama and Mr. Shiller as contributors to a shared understanding of financial markets, however, papered over differences in their work that have been enormously consequential in recent years. Mr. Fama was honored for his work in the 1960s showing that market prices are accurate reflections of available information. Mr. Shiller was honored for circumscribing that theory in the 1980s by showing that prices deviate from rationality.


U.S. Stock Performance Remains Red Hot In The 3rd Quarter, Moving Into A 5th Year Of Rising Returns
Tuesday, October 08, 2013 09:45

Tags: asset allocation | growth investing | sector investing | stocks | value investing

U.S. stocks earned 6% in the third quarter and were up a stellar 21% in the first nine months of 2013. That performance caps off a 145% run-up in the S&P 500 over the past 4½ years, in the face of serious headwinds. Here’s what’s been working, and not working, in 2013.


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In the first nine months of 2013, growth stocks, especially smaller growth stocks, have led the way with a 35% return, despite anemic economic growth, rising debt and global social unrest. Large-cap core companies earned 13% and large value earned 17%. Other than these extremes, style returns clustered around 23%, a pretty good place to be. On the sector front, consumer discretionary and health care companies have been hot with returns above 30%, while materials and utilities have not.



In foreign markets, Japan has outperformed the United States with a 27% return, and Europe has matched the United States’ 21% return. The rest of the world lagged, with Latin America losing 4% and Emerging Markets flat.




The most interesting details lie in the cross-sections of styles with sectors, especially if we are interested in exploiting momentum effects. Looking forward to the fourth quarter, I am forecasting winners in large-value consumer discretionary, mid-cap value health care and small-cap value industrials, and laggards in small-cap growth materials, small-cap core utilities & telephone, and large-cap core technology.


To see more details, including my results in forecasting winners and losers for the third quarter, check out the full version of my third-quarter market commentary. The full version also includes a survey and forecast for foreign stocks, special commentary on target date funds and hedge funds, and a link to an amusing new video that exposes the charade of hedge fund due diligence performed via peer groups and indexes.

Stocks Stay Strong Despite Government Shutdown
Thursday, October 03, 2013 14:55

The Wall Street Journal  didn’t run the very postive headline to this post, but it could have.


Instead, WSJ went with, "Washington’s Grim Face-Off.”

Nonetheless, the stock market's reaction to the government shutdown is a bit suprising. 
Politicians and pundits have been throwing around all kinds of scary stuff labout how the shutdown will “crash the economy,”  “throw people out of work,” and “cause a debt default.”

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You’d need to suffering from amnesia to think this shutdown is an aberration in American politics.


And, while unsettling, the history of Washington’s playing chicken with the budget and debt ceiling is that partial government shutdowns have not, in reality, created material economic or market dislocations as both sides factions like to suggest as a scare tactic. The market knows this.

The market’s reaction to previous shutdowns was summarized earlier this week in Investor’s Business Daily:
“If the government shutters its doors, it wouldn’t be the first time. A research report from U.S. Trust noted 17 such instances since 1976. Shutdowns have been as short as one day to as long as three weeks. Nine of those times, the S&P 500 was flat to up 2.5% over the period of the shutdown.”
Looking past the "crisis" in Washington, some of the most important of the latest economic data have, in fact, strengthened and are key to the strength of stocks.
  • Leading economic indicators both in the U.S. and abroad have picked up.
  • Key US purchasing managers indexes remain very strong.
  • Unemployment claims have broken to the downside and ADP’s September employment figure continued the slow but steady new jobs trend.
  • Household net worth back to trend and hitting new highs. The Fed just released new household balance sheet data.

Please join me for our October 8 webinar for a complete tour of the latest economic and market data, addressing these data point as well as the following:

  • Earnings, P/E multiples and stock prices. Can stocks go higher this year? Next year? And, Wall Street’s latest forecasts.
  • Are record profit margins sustainable?  Analysts are expecting higher-still margins in 2014 from 2013’s record high levels.
  • Fed’s QE taper. What does it mean for the economy and stocks?
  • The Fed is printing money. What does this mean and why does inflation keep dropping instead of surging?
  • The fiscal crisis. CBO just released a new set of federal income and spending


Higher Interest Rates Benefit Your Clients
Wednesday, October 02, 2013 19:49

Advisor, educate thyself! Don't foolishly believe that rising rates are bad for long-term investment goals.

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Private client advisers are at a crossroad. Interest rates have risen steadily and though they moderated some recently, are likely (though not certain) to rise again for awhile -- at least until the Fed has unwound its Treasury bond positions (quantitative hardening?).   
Educate your clients to know that although their bonds' prices are falling, this is irrelevant unless they sell the bonds (or bond fund shares) and invest in something else like cash, shorter duration bonds, or anything other than bonds similar or longer in duration to what they have been invested in. Understand that we are talking about long-term portfolios, not money a client needs to spend or have available in the next four to five years. (This time horizon should influence the average duration of your portfolio of bonds). 
For your clients' long-term money, you, and they, should be hoping for rates to increase. Yes, in spite of the drop in their bond prices in the short run, they will benefit greatly from increasing yields as rates rise. 
I won't cite all the research available on the realities of how individual clients benefit from rising rates and are harmed by falling rates in the long run -- you can do that on your own. What's important here is the basic premise that clients with long-term portfolios should be happy to suffer the shorter term paper losses of falling bond prices, in return for higher yields over the long run. 
Unlike a stock, which might not come back for many years, if at all, a bond has a set maturity date at which time it is paid in full. (I'm assuming here we are focusing on investment-grade bonds with very low default risk). 
So every year, the "loss" resulting from the interest rise is lessened, until at maturity it is zero. Even if you paid a premium, you still get the original yield you purchased at that time. So nothing is lost here either. And, yes, this concept holds true even for a bond fund! 
Though the fund itself does not have a set maturity date, the bonds in it do. And every day the bond gets closer to maturity, the loss is lessened. If a bond is sold before maturity and another bond purchased, remember that the bond purchased is cheaper, too. 
Like a homeowner who has to move in a down market -- yes, your house has gone down in value, but so has the home you are buying! What have you lost? Nothing, unless you are downsizing! 
Always better to buy up in a down market and down in an up market. Every homeowner knows that; bigger houses go down more than smaller houses! 
Bonds work the same way, only "buying up" means increasing the bond's duration, buying down means decreasing it. So instead of going shorter term when rates have risen, just the opposite may be more rational. 
Simple enough concept but it is up to you to get clients to understand it. Performance numbers may go down, but the client has lost nothing unless they panic and sell. 
Again, this is true even for a bond fund owner. Liquidations made to pay off frightened shareholders effects only the liquidating shareholder's return. The losses generated by the required bond sales will actually be useful for sheltering future gains. 
As long as you stay put, you will get the yield you paid for plus the higher rates as interest payments and other cashflows are reinvested.  Clients should be focused on yields first and only, and ignore total return when it comes to bonds.  A focus on total  bond return may be harmful to your client's long term portfolio's health.
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