Ultimate Tools to Longevity Risk Planning
From: Joeseph Clark, CFEd®, RFC®
Managing risk is as important today as it has always been. For example, when it comes to our biggest asset, our home, we’re protected with homeowners insurance. When it comes to our cars and the risk of liability in the event of an accident, our autos are insured. And of course, when it comes to our health and the enormous potential cost of doctors and hospitals if we were to become ill, we have protected ourselves with health insurance. Because health risks are so high, the government actually requires by law that they are insured.
There is even a way to mitigate the risk of having our loved ones exposed to economic hardship in the event of an untimely death with life insurance. But what about stock market and inflation risk? Surprisingly few have protected themselves from the inevitable dips and downturns in the market that exposes their hard-earned life savings to definite peril.
One of the largest groups of investors are people saving for retirement. According to a survey conducted by Legg Mason, the primary goal of retirement investing is for people to maintain their current lifestyle in their later life; however the survey also found there are three primary issues people fear which can prevent them from living the lifestyle they want later in life: 1) having a catastrophic health event that could use up their retirement funds; 2) living longer than their retirement funds would last (otherwise known as Longevity Risk; and 3) their income won’t keep up with inflation (Purchasing Power Risk).
These are all valid concerns, and they all point to the underlying issue: risk of market returns. Where do retirees put their assets today? Most people, not wanting to risk all their money in the volatile stock market, let their money sit idly by in what they perceive as safe investments. These traditional parking places are savings accounts, money markets, bank CDs and Treasury bonds. They hope that through these vehicles, they can earn a modest income stream. The problem is that the returns on these particular vehicles are actually very low. Right now, the average rate available on money market and savings accounts is about .50%.
The one year bank CD rate is around 1% and you might get 1.5% for a five year Treasury bond and 2% for a ten year Treasury, if you’re lucky. That means that you have locked your money up for a decade, and it’s earning you less than 55 cents per day. That does not provide enough to cover the modest income stream most hope for.
Let’s move to the opposite end of the investment spectrum and look at equities. Right now the current P/E ratio for the S&P 500 stands at about 25.7% (based on a report by Crestmont Research). This is just shy of its 20 year average of 26.8%. That is exciting, but if we go back to the technology bubble in 1999, the ratio stood at an extreme 44.2%. Twenty-six percent is high. It’s worrisome. Retirees need to be cautious. In fact according to Yale professor, Robert J. Shiller, this is a terribly fearful place for retirees to be because a normal long-term PE ratio should 15% based on trailing earnings.
In the higher-risk environment in which we find ourselves today, the goal is to not only invest, but to feel safe and secure. Retirees need to be less emotional about their money and be taught how to position their savings to take advantage of opportunities. The Great Recession taught us we cannot continually endure the dramatic ups and downs of the market. Right now we are in the seventh year of the most recent bull market. It’s one of the longest bull markets in US history. We don’t know when a market correction will come, but we can all agree it is coming, probably sooner than later. We also need to remember that brilliant research does not equate to beating the stock market. The stock market has out-smarted Nobel Prize winning laureates and Professors at Harvard Business School and MIT. Many a guru have claimed to have figured out the market, but no matter how compelling their logic, advisors need to use common sense and good judgement in their client’s investment decisions.
If we look at the current economic status both in the US and the global environment, one fact stands out. We face a real crisis, but this time, equities will not be the cause of major consumer loss when the collapse occurs. The losses are going to happen in the bond market. Bonds get overlooked because the mainstream financial media knows that stocks get papers read, the news watched, and radios listened to. Stock market stories are usually much more dramatic then bonds or currencies. That may soon change.
