The Four Horsemen of the Retirement Apocalypse – Part II 

Five Things You Should Know

1. Equity Markets – were mixed this week with U.S. stocks (S&P 500) up 0.24% while international stocks (EAFE) fell –1.6%.
2. Fixed Income Markets – fell this week with investment grade bonds (AGG) down –1.5% and high yield bonds (JNK) down –0.87%.
3. Labor Strength – In the first jobs report released post rate cut the labor force is signaling broad-based strength, with 254,000 new jobs added in September (well above expectations of 150,000) and saw multiple upward revisions to past month’s data that added an additional 72,000 jobs. In a survey of household employment, the economy also saw an encouraging tilt to long-term job creation, with an estimated 414,000 full-time jobs created in September while declining 95,000 part-time jobs. 
4. Oil Spikes – Oil prices saw their largest weekly increase in over a year amid rising conflict in the Middle East. Recent Iranian strikes on Israel have sparked concern of retaliatory measures on Iranian petroleum facilities and disrupting global oil supplies, surging crude oil prices almost 10% this week. As of writing the U.S. administration is still in discussions on potential response measures, with the G-7 urging restraint. 
5. Key Insight – [VIDEO & ARTICLE] We wrap up this series by addressing the “Fourth Horseman” that threatens retirees’ safety, as well as the key mindset and portfolio approach to render these scary threats harmless.

Insights for Investors

By Tim Mitrovich

The Four Horsemen of the Retirement Apocalypse – Part II 

Last week we touched on the first three of the four horsemen that we see threaten the longevity of people’s money in retirement. If you missed it, we encourage you to go back and watch/read last week’s commentary, The Four Horsemen of the Retirement Apocalypse – Part I 

The first of them was volatility and the associated sequence of return risk caused from needing to raise/use funds during periods of market drawdowns while employing a total return strategy during retirement (more on that below). The second was the incredibly erosive impact on purchasing power from inflation which we saw can erode over 25% of your purchasing power given a 3% inflation rate for just 10 years. And while the first two talked about the “supply” of money over your life, the last highlighted the heightened “need” created by ever increasing longevity expectations. 

Which brings us to this week, and the final horseman that can lead to the “death” of one’s financial stability and the key solution/mindset to employ to fight off these threats and enjoy a more secure retirement. 

The Fourth Horseman – Simplistic Planning 

One of the most disappointing things I see within our industry is the reliance by advisors on outdated maxims and related simplistic planning notions while building out plans for clients – if they have even built a plan at all. 

It could be the old adage that one should have the same percentage of bonds as their age, the practice of blindly following a 60/40 blend of US stocks and bonds, using an off the shelf model portfolio with little understanding of what’s in them, or espousing that one need only follow a 4% withdrawal rate (see charts below) to safely retire (or worse, those such as Dave Ramsey who argued for a much higher withdrawal rate while basing it on wholly unrealistic and unpredictable return rates; see article here Ramsey Withdrawal Rate Controversy). 

Not only are most of these approaches too simplistic in general, (using straight line averages to calculate distribution rates, let alone fail to reflect client’s individual circumstances and goals), they are often predicated on outdated studies or theories that fail to reflect current market realities. 

Just to highlight one of potential impacts of the above poor practices, consider what would have become of a retiree following a classic allocation model with 50%+ of their funds in investment grade bonds the last five years where they would have had a “theoretical” total return of just 1.65% over that entire time (see AGG performance 9/30/2019 to 10/2/2024 via Morningstar.com), and “practically” far less than that as they would have had to sell shares during 2022, which saw almost a 20% drawdown, that would have never had the chance to participate in the rebound. 

The first chart below shows both the danger of using simple averages to project distribution rates, as well as the risk of weak returns early in one’s retirement. As you can see, while the actual average of a 40/60 portfolio did both well in general (at over 9%) and better than a projected 8% return, it failed to last as long due to some early weak returns. Using a simple average would have created a false confidence in how long one’s money could have lasted. 

You can’t time markets, which means using a total return methodology vs. a cash flow-based plan, means you can’t time when to effectively retire without real risk either. 

Putting aside the big issue we just raised, the other big issue with plans built around funding retirement primarily through capital appreciation/total return is the lack of clarity and even limitation around what one can spend. As you can see from the next chart, the length of projected years of funding based on distribution rates can vary widely even before sequence of returns risk. 

After decades of helping clients, we know uncertainty and extra limitations on the lifestyle they can enjoy in retirement is near the top of people’s lists of things they hope to avoid. 

So, what’s an investor looking to, or in retirement to do? Let’s discuss. 

Solution – Maintain Your Ownership 

The key to addressing the above starts, and largely ends, with creating a plan and related portfolio that will produce sufficient cash flow independent of overall market returns to fund your needs, and prevent you from having to sell off shares to help fund your retirement. 

The threats posed from Sequence of Returns Risk, Longevity, & Bad Planning all center on a plan which requires you to liquidate holdings to fund your retirement. 

If your shares stay in place, your cash flow stays in place (negating sequence of returns risk and longevity risk), and consequently by maintaining one’s shares you enable them to both produce greater dividends over time, (negating inflation; see below), as well as capture the long-term returns of markets.  

In short, the mindset you need to embrace around retirement is viewing assets not just for their potential to grow in their value, but their ability to create stability through income production. 

A quick word on some of the underlying aspects of this approach: 

Preserving Purchasing Power to Fight Inflation 

A common question we get is, “if the market goes down, don’t my dividends too?” In short, no. Dividends can be cut, but meaningful cuts are rare and in fact companies not only loathe having to cut dividends but seek to grow them.  

With meaningful allocations to core holdings such as equities and real estate, one has historically not only grown their overall wealth, but grown their cash flow at a rate above inflation thus preserving their purchasing power. 

Growth of Dividends and Rents/Dividends 

As to US Equities, see the chart below which shows that over every decade but one (the infamous 70’s and even then, it was close) that US dividend growth has far surpassed the growth of inflation, in particular look at the far right which looks at the entire post-WWII period as well as post 2000.  

As it relates to real estate, which we prefer to access through broadly diversified and professional managed institutional solutions, you see that “Since 1980, U.S. rent prices have averaged a compound annual growth rate (CAGR) of 3.91%.” (Source: Average Rent by Decade). Some quick math from the chart above shows that is well above an approximate sub-3% inflation average over the same time frame. 

Reducing Correlation to Improve Safety 

Another key to increasing the longevity of one’s portfolio in the case that events arise that require additional funds beyond one’s cash flow is to reduce the correlation between one’s holdings, which means they don’t/shouldn’t act the same way in the same economic conditions, by improving diversification. This improves your ability to seek such funds from a position that is doing well/holding up, while letting other allocation that may be experiencing negative volatility the chance to recover. 

Consider the chart below, which not only shows the erratic nature of returns among common asset classes but also a) the likelihood that even while one asset class is having a bad year, something else is likely doing well (even in a year like 2008 you had a positive asset class to tap in needed), and b) that a balanced approach will keep you from experiencing the depths of drawdowns seen by individual asset classes and rarely results in a negative overall year. 

On this subject, I want to once again share a great podcast interview of the legendary Ray Dalio of Bridgewater (see here Dalio Interview on Investing Principles), in particular listen closely around minute 35:55 for the following few minutes, where he not only discusses the foolishness of concentrated portfolios and trying to time markets, but states that “The holy grail of investing is to find ten to fifteen good uncorrelated return streams.” We add only that many of those “return streams” be in fact “income streams.” 

Summary 

Being an investor is a bit like riding a rollercoaster, and while avoiding all the stomach-turning moments is not possible, putting safe guards in place can certainly improve the ride.  

A solid plan provides the tracks to keep you on the right path, and sufficient cash flow creation can act like guard rails, and together they help you and your family to have the confidence that you have taken important steps to produce a safer, smoother ride than it would otherwise be. 

If you, or someone you care about, has questions or needs around these critical issues we are always here to be a resource for you. 

Have a wonderful weekend, 

Tim and the team at TEN Capital 

Data, Just the Data

• U.S. Jobless Claims – saw an uptick of 6,000 initial claims last week to 225,000, marking a new 3-week high. Continuing claims on the other hand saw a slight decrease of 1,000, bringing the total to 1,826,000 in the previous week.  

• U.S. ISM Manufacturing Index – remain unchanged at 47.2 in September, pointing to a sixth straight month of contraction in the manufacturing sector. The economy saw a decline in new orders, inventories, and backlog of orders while prices eased.  

• U.S. Unemployment Rate – September’s strong job growth saw the U.S. unemployment dip lower to 4.1%, bringing year-over-year wage growth to 4%.  

• U.K. GDP – Remain unchanged in July for the second consecutive month. An increase in services output was offset by a decline in manufacturing activity.  

• Euro Area Manufacturing PMI – registered a reading of 45 in September, the lowest reading on the year and signaling an even further decline into contraction for the manufacturing sector. A decrease in input costs weren’t enough to counteract sharp contractions in production and new orders.