Creating an Effective Retiree Portfolio

Money management in retirement presents a complicated challenge. Over what can be a 20- to 30- year time horizon or more, most retirees need a significant return on their investments in order to deal with the corrosive long-term impact of inflation, pay for unexpected expenses, and maintain their feeling of financial security. This is difficult at any time, but especially hard to achieve in the current low interest rate environment.  There is one added difficulty that many retirees face: an increased concern about investment risk.

This sensitivity is not unfounded.  Retirees become subject to sequence of return risk and have to make sure they don’t have to withdraw equities to pay for living costs in a down equity market.  Feeling they can no longer earn money from work, many feel more vulnerable to a major market downturn.  This feeling of vulnerability leaves many fearful of major investment loss.

Current Methods for Addressing Investment Risk

Most retirees and their financial advisors try to address these issues through the lens of diversification.  They try to decide what proportion of their money to put in equities and what proportion to put in fixed investments.  People have learned during their work lives that diversification works well and they think it can be extended into the retirement years.  However, diversification requires time for the markets to recover. Time acts as a crucial protector.  Workers can typically wait a long time without having to make withdrawals until the value of their equity investments returns to its former levels, but retirees do not have the time workers have.  The stock market has lost at least half its real value (accounting for inflation) five times in the last 110 years, more specifically, once every 22 years.  Sometimes it has recovered relatively quickly, sometimes it has not.  How many retirees can withstand a 50% drop in equities that does not recover at least fairly quickly?

Some advisors use the “bucket strategy” to help their retired clients deal with investment risk.  But with retirees’ greater sensitivity to risk, bucketing may not be sufficient to help retirees feel comfortable with a major loss of assets and, as people age and their life expectancy is significantly reduced, even their “long range” bucket may be too close to wait out a sustained down market.  Our company’s research has found that as people age, their planning orientation gets significantly shorter range.

The Equity Allocation Dilemma

Here is the dilemma most retirees face: how much to allocate to equities.  William Bengen, whose detailed analyses of withdrawal rates in retirement led to the famous 4% rule, stated that allocations of at least 50% to equities are imperative in retirement, while lower allocations are “counterproductive.”  However, most retirees put less than 50% in equities. They think they are increasing their financial security by reducing exposure to equities, but they are not achieving this: many are robbing themselves of the ability to get the returns they need.

What about those who put half or more of their assets in equities?  They face the risk of a major downturn sometime during the course of their retirement that could lead to a loss that could severely damage their financial security.  The average age of retirement is now 63, with half of people retiring prior to that age.  A husband and wife, both retiring at age 63, have a significant chance of having at least one of them remaining alive and needing income 30 years later.  If the stock market has lost at least half its value five times in the last 110 years, what is the chance it will suffer that level of loss again within the next 30 years?  Is that a chance this couple should take?

There is a clear solution to this dilemma: products that allow the significant investment in equities that most retirees require and still protects against an intolerable level of loss.  There are three categories of products that are effective:

  • Downside protection products such as indexed variable annuities or non-annuity products that use options to protect against risk
  • Guaranteed lifetime income products that provide income no matter what the market does. The ability of those who own these products to continue to get income even in severely down markets allows them to invest more in equities in other parts of their portfolio and wait out a down market for an extended period of time
  • Other solutions, such as low volatility mutual funds, dynamic asset allocation, and non-correlated assets that can also work. These do not provide the level of assuredness that the others do, but they are certainly worthwhile solutions for retirees.

There is another advantage of these solutions that should not be underestimated.  They provide retirees with peace of mind.  Anxiety has a cost and retirees who are just depending on diversifying stocks and bonds often worry about the very real possibility of an unsustainable loss. With these solutions, they can be free of that worry.  When I have discussed these concepts with financial advisors, I often hear the objection that most people will be better off if they do not use these solutions because of the cost of the guarantees or the lower performance of solutions that reduce volatility.  To address that objection, I would like to discuss an informal survey my firm did, based on an airline analogy.  (The analogy was suggested to me by Eric Henderson from Nationwide. I made some changes to the analogy, so any defects are certainly mine.)

An Airline Analogy

In the survey, we described a new hypothetical airline. The airline, we said, found that all other airlines invested a lot of money in safety programs, including parts replacement and checking programs, that contributed very little to overall safety. Indeed, their analysis concluded that they could spend considerably less money on safety programs and still have planes that would land safely 99.6% of the time.  In other words, their competitors were spending a lot of money that only made a difference in four tenths of one percent of the flights.  They decided to compete on price by not taking the safety steps that were deemed least effective.  When we asked respondents if they would take a flight with this airline if it landed safely 99.6% of the time, a third said they would do it for substantial savings.

Our next question involved this airline offering the following deal:  If you paid for two roundtrips per year for the ten years before retirement, the airline would let you fly for free for two roundtrips per year for ten years after you retired.  The benefits of that are clear.  For many retirees, the ability to fly for free for ten years would make a major difference.  The “fly” in the ointment is that the risk of being involved in a plane crash for those 40 flights would be at 16%.  How much of a discount would you need to take a 16% chance of being in an airplane that crash-landed?  None of the people I interviewed would take the deal.

The key point I am trying to make is that when people embark on an investment strategy for retirement, they are accepting a level of risk for an extended period of time. The risk of a major downturn may be small this year, but what about once over the next 30 years.  One could try to time the market, but is it wise to count on that?

In the airline analogy described above, 84% of the people would be better off if they took the deal the airline offered.  But all considered it unwise.  So, while advisors are right that most people will be better off without protecting against downside risk, the most important thing is making sure it does not happen to you.

When financial advisors state they do not want their clients to pay for protection that most will not need, they are missing the point that most retirees would be willing to pay that cost for the protection.  Further, even if the stock market does not go down significantly, retirees know that it’s a possibility, which causes a certain level of anxiety. Having downside protection or guaranteed lifetime income not only provides real protection, it also provides a feeling of security that has a value that should not be underestimated.  There is one more point: in many cases using these products will not cost the retiree anything, even though the principal protection products, the guaranteed lifetime income products or they dynamic asset allocation products do have a cost. That is because, with these solutions, many retirees can actually take more equity risk with other parts of the portfolio and in good markets, with this extra exposure to equities, their additional gains can more than pay for those product costs.

Conclusion: Develop a New Retiree Portfolio

Financial services companies and advisors have done a great job of teaching accumulators about the value of diversification.  In support, they have created metrics for how to allocate between stocks and bonds and how to change this allocation as retirement approaches.  They have also developed tools, such as the investment risk tolerance questionnaire, to help people decide how much to allocate to equities and to fixed income instruments.

I think the next task is to provide this type of  support for the effective  retirement portfolio, which is extended to include downside protection, guaranteed lifetime income solutions, and other investment strategies that protect against excessive investment loss while providing enough of an allocation to equities to allow for the opportunity for a needed return.

This means new metrics, new tools, and new educational programs.  For the current and future generations of retirees who have to depend much more on their own assets for financial security, and less on defined benefit plan income, these new portfolios will make a crucial difference.

Surveying Hard-to-Reach Consumers? No problem.

With everyone attached to their smartphones these days and accustomed to sharing so much information, it seems like it should be easier and cheaper than ever to reach your intended survey population.  That isn’t always the case.  Some populations, like immigrants, marginal groups, older consumers, consumer experts and those in more rural locations, are especially hard to reach.

Greenwald Research has some answers about surveying hard-to-reach consumer populations:

Start With What You Have

Leverage your own lists of consumers who are customers, employees, and potential customers.  Although you’ll need to refresh these lists regularly, this is one of the best places to start for sample.  Ask your research vendor with an in-house programming team for tips and tricks on how to keep these lists clean and ready to use.

You can also build on your current lists by creating landing page on your social media sites or your website.  Offer up a “call-to-action” geared towards your target audience such as an information sheet, a free e-book, or a coupon, which you can exchange for an email address.  Not only have you found someone interested in your survey topic, but you have increased the chances of having them participate in your survey by virtue of them having recently given you their email address.

Leverage Trusted Sources

Think creatively about other ways to learn about your target group.  Who do they trust?  Especially for populations that are more hesitant to provide personal information, like immigrants, finding one of their trusted resources can do two things for your research. 

First, qualitative interviews can inform your online questionnaire.  Conducting one-one-one interviews with trusted resources can help you know what to ask and how to ask it for maximum effectiveness.

Second, it can lead you to your target audience.  Trusted resources can introduce you to members of the population you want to speak to the most, as well as other trusted resources for that community.  This approach, known as snowball sampling, will ensure that you are getting quality respondents for your research project.

Get Help with Consumer Research Panels

Panel providers are one of the most common places to go for consumer sample, but you have to be careful.  In our online studies, Greenwald & Associates has found that there is an ever-increasing number of respondents “gaming the system” by logging on multiple times or misrepresenting who they are. 

If you are going to use an online panel provider, be sure that you are managing them and screening your respondents vigilantly.  For hard-to-reach populations, find a specialty panel provider and/or enlist the help of a market research firm to write the screener and manage the screening process.  This will help you avoid a situation of “Garbage in. Garbage out.”

Go Retro

Some respondent groups just like to open a piece of mail or answer questions via phone, especially older generations.  If you are trying to survey respondents who are 60+ years old, consider a mail or phone survey.

Knowing your audience and how to best reach them is an art and a science.  Start gathering your list and thinking through your research mode early.  Or, if you are in a rush, reach out to a market research firm who has more resources than you might internally. 

Dynamic Segmentation: Maximizing Opportunities as A Black Swan Event Unfolds

One of the most useful tools that marketers, product developers, and thought leaders have is the ability to understand the composition of the markets and distributors they serve and be able to target strategies, products, and communications to the most responsive and valuable segments.  Today’s investment climate is so complex and difficult and has changed so significantly in such a short period of time, that we believe that an enhancement to that venerable tool is now required of companies offering investments, including annuities.  We call it “dynamic segmentation,” which is the tracking of segments over time and identifying newly developed segments: the re-segmentation of the market. 

This need is caused by the intense nature of the change we are undergoing, in both the investment climate and, probably, investor psychology.  Many investors and advisors are anxious and confused.  They are eager for guidance, education and advice from investment and insurance companies. This is a good time to act.  But, especially in this time of heightened concern, it is important to communicate effectively.

Twin Crises

We are now confronting, as you know, two related crises at the same time: a health crisis and an economic crisis.  To a significant extent, these twin crises have been about risk.  The media have besieged us all with information on the risk of becoming infected, the risk of becoming ill, the risk of dying, the risk of a Great Depression, the odds of the stock market reaching specific levels. 

Also, the stock market has experienced its steepest decline ever.  My company completed a survey of consumers and advisors one day before the first major coronavirus-related stock market decline.  Very few consumers, or even advisors, saw this stock market decline coming, even though cases of the novel coronavirus had been increasing in China for a while.  The fact that this change was so unexpected magnified the impact and reduced people’s sense of being able to prepare in advance.  This steep decline in the market certainly affected people’s feelings about stock market risk, while the health crisis probably changed views toward risk in general and investment risk in particular.

Issues Affecting Investor and Advisor Decision-Making

Investors and advisors are reacting to three related issues, which are ultimately causing them to re-evaluate their investment strategies.  The first is the very feeling and assessment of risk and tolerance for risk.  As the risk of death goes up, as the risk of job loss, a Great Depression and food shortages rise, the way people assess the value of taking investment risk can also change.  The strong focus on risk and the range and severity of the risks we face are quite likely to affect tolerance for investment risk, beliefs about risk, and responsiveness to solutions.

The second issue is the low interest rate environment.  Importantly, this is all occurring in an extremely low interest rate environment. In the past, there was often a reasonable place for investors to park money that was safe but still provided a reasonable return. This is certainly less true now.  This makes dealing with investment risk more complex.

The third issue is the equity market climate and outlook.  Before these crises financial advisors tended to take one of three approaches:

  • Diversify portfolios and ask clients to tolerate volatility in the expectations of higher returns over the long term
  • Use hedging, uncorrelated assets and other tactics to provide a “smooth ride” with less volatility, even at the expected cost of lower long-range gains
  • Use guarantees, such as annuities with downside protection and (for pre-retirees and retirees) guaranteed lifetime income to increase certainty and provide greater protection against loss.

During the over decade long bull run the first strategy worked very well.  But it is not working well now.  This will likely lead many advisors to consider new strategies and be receptive to new approaches.  They may well fall into different and, perhaps, new segments.

Why is Dynamic Segmentation Important Right Now?

The way investors and advisors are segmented, and the very composition of the segments has likely changed.  If you want to effectively identify and understand key markets, we submit that you should not depend on former segmentation models.

Communicators are most effective if they understand the viewpoints, concerns, beliefs, and attitudes of the people they are communicating to and tailor messages to specific segments.  A good marketing or thought leadership effort will be pertinent to all, but it will be most effective with a specific group and companies should be very tactical in selecting which groups to target. 

Companies that conduct new segmentation studies will identify the characteristics of investors, and advisors, who present the highest potential.  Importantly, they will have insights on how to approach key segments and what proof points and types of support will be most meaningful. 

It is obvious that the twin crises are far from over and that the range of possible outcomes is extremely wide.  During the period ahead investor and advisor views will be further impacted. Indeed, new segments may emerge as investors and advisors react differently to these further changes.  Successful companies will be cognizant of the degree of change and implement a new segmentation study when the level of change demands it, which unfortunately may be in a year or before. In this climate, segmentation must become dynamic.

Who’s Watching Junior? Benefits of Better Childcare Support Post COVID-19

Thirty-six million Americans have filed for unemployment benefits over the past two months.  While these are disproportionately less wealthy Americans, many high-profile companies have been laying off or furloughing their workforce as well, among them major hotel chains, airlines, clothing manufacturers, and retail stores.[1]  For those of us still lucky enough to be working, our offices are now co-located with our families.  Two questions frequently arise: when will this be over and what will working look like post-COVID-19?  While we have little control over the answer to the first question, the second one is important for us, especially employers, to consider.  A post-COVID world should reflect what we’ve learned about people and what they need to flourish.

A New Narrative for the Working Parent

One of the narratives that COVID-19 has disrupted is one about working parents, especially professional women/mothers/caretakers.  The narrative says that women can wear multiple hats – be power players at work and nurturers at home, and thus live to their full potential.  For this to be true, however, women need to be sure that the dual life is indeed worth it.  That might be harder than you expect.  (A Gallup poll in 2015 showed that 56% of women with kids under 18 would actually prefer to stay at home, if they were free to do so.[2]) 

In order for both parents to work outside the household, a decision is needs to be made: is it more valuable to be home with family and forgo a paycheck, or to be out of the  home and pursue a career?  COVID-19 has made it clear that this choice is not limited to how much we make, but the risk we are undertaking to pursue careers that limit the time spent at home or caretaking for family members.  This tension interferes with work quality, timeliness, and worker engagement. These are issues that we research frequently, lumped under “Social Determinants of Health” (SDoH), but they are largely discussed as they relate to the working class, immigrants, and the poor.  COVID-19 has shown that it is not limited to these groups at all.  In fact, the need for better support for employees/caretakers/women/mothers/fathers crosses race, class, and income levels.  Employers need to think critically about how to provide for employees with these needs if they hope to get their workforce back to work, both in body and in mind. 

There are two points that I’d like to make related to solving for the upended narrative of working parents.  First, when more women work, economies grow,[3] and so does the value of the companies they work for.  It is in employers’ best interest to find ways to support women in having careers to add to the value of their organizations.  Second, raising children is the most important of several jobs that some women have, but the ability to juggle multiple roles and to create value for employers is dependent upon the ability for mothers (and fathers for that matter) to be certain that their children are in a safe and healthy space and that the value of the work outside the home somehow improves the overall value of the family. 

Employers have made significant changes due to COVID-19.  This has allowed many to continue working remotely, from the home.  Even better, colleagues, employees, and clients have gotten used to hearing the sounds of home life in the background of work calls.  It has ripped up the guidebook for parents who work and, shockingly, it hasn’t disrupted work either – or at least not on the surface.  Many companies have made the move to telework semi-permanent and others are closing offices and preparing for the office of the future – the home.  But what does this mean for parents?  Is this the best way to support employees to achieve the greatest value at home and at work?

I argue that it does not address the central thesis of the narrative – the tension of the dual job: wanting to be there for Junior and for the employer. 

Parents May Need More than Simple Remote Work Policies

‘Who is watching Junior’ is a central point.  Parents who work need more than just the flexibility to choose where to work.  They need their children to be in a safe place while they are working, ideally not the same place as they are working.  Practically speaking, however, nearly half of licensed childcare centers will likely close within weeks without government funding, according to the National Association for the Education of Young Children (NAEYC).  But, even if childcare facilities reopen, how many parents feel like the second paycheck is not worth the risk?  And, for those who do continue to work, what is the plan for the next large health crisis?  It seems clear that employers should think carefully about what childcare looks like and to prioritize it just as much as laptops and healthcare for each employee.

Interestingly, this is not the case.  In a Greenwald survey conducted with The Insiders, our proprietary benefits broker panel, 64% of brokers said that they and their clients believe that work-at-home policies and supplies are important to reduce business interruption.  Only 3% feel that childcare resources and support are important to reduce business interruption. 

Work-from-home policies seem to be how companies want to address the upending of the narrative of working parents, but simply providing the option to work from home when one’s children will be underfoot will not create the greatest value for the company, nor for the employee.  There need to be better, more creative solutions if employers are to make returning to the workforce attractive.  Flexible work arrangements, support for affordable childcare options, and promotion of a culture that supports a healthy life outside the office are all good starts, but I’m anxious to see what other solutions employers invent. 

[1] Bureau of Labor Statistics, May 8, 2020.  https://www.bls.gov/news.release/pdf/empsit.pdf

[2] https://news.gallup.com/poll/186050/children-key-factor-women-desire-work-outside-home.aspx

[3] International Monetary Fund (2018). Pursuing Women’s Economic Empowerment

COVID-19 and the Markets: For Advisors, this is Not 2008

Over the past several months, our markets have experienced both volatility and an extremely low interest rate environment.  These occurrences, especially in combination, certainly present challenges to advisors and their clients.

Despite some reopening, the economy is facing a great deal of uncertainty. Unemployment is still high, having reached levels not experienced since the Great Depression.  Some expect major sectors of the economy, such as restaurants, airlines, hotels and commercial real estate, to be deeply affected long term, with some major companies failing to survive.  One of many challenges to investors is that the course of the economy is tied to the course of the pandemic, something that is extremely hard to predict. 

In recent weeks, Greenwald Research has conducted in-depth interviews with advisors to better understand their current approach to investment and income strategies, particularly for those approaching and in retirement.  Following the events of 2008, we conducted hundreds of interviews with advisors.  Our experience with this research suggests that the reaction to the current crisis among advisors is fundamentally different. 

In 2008, there was a widespread crash of the real estate and equity markets.  The prevailing advisor focus during this time was to prevent clients from panicking and selling their investments at a loss.  Because the loss was so deep, advisors did not report succeeding all the time. In the years following the crash, the market showed a steady rise and advisors reported that those who used a growth strategy were rewarded over those who attempted to blunt gain a little to provide a smoother ride or mitigate loss.

This market is has unfolded differently so far.  One reason is the impact of health concerns of Americans on spending behavior.  Some companies are not harmed by and may even benefit from COVID-19, such as Amazon or technology companies.  Other companies have suffered from COVID-19, but are valued lower than they should be or are in an area that could bounce back quickly. 

Because of this, we have seen some advisors who feel that rather than abandoning the market, this is an ideal time for active investment management among various sectors affected differently by COVID-19. 

Furthermore, there has been a different reaction among the older client base.  These clients have been through 9/11 and 2008 and have drawn some lessons from those experiences. On balance, advisors have seen as many or more of these clients that want to buy more equities as want to sell them. 

We see this environment having several different effects on the investment climate and potential strategies and products:

  • There could be further growth in target date funds and other forms of managed accounts because these accounts often use automatic rebalancing regularly. In a time of volatility, the advantage of this mechanism grows in importance.
  • We could see the comeback of risk mitigation strategies, such as alternative investment funds that incorporate non-correlated assets and hedging strategies or annuities that offer income guarantees or boundaries to limit losses. Compared to the steady growth environment over the past 10 years, the case for these products that provide a smoother rise should become much stronger.
  • There may be a growing interest in Smart Beta funds that adhere to a strategy that works in a COVID-19 world. For example, Smart Beta Funds reflect the beliefs of some advisors about the value of dividend weighting or weighting on earnings or book value rather than market capitalization.
  • Income may also be subject to more active management as advisors need new approaches to generate enough income for clients and as some sources of income, particularly stock dividends, decline.

Clearly, not all market downturns are the same and not all market downturns require the same adaptations.  This is especially true of the current economic decline, totally integrated in a health crisis.  Our research suggests that neither advisors nor investors have fully thought through the issues or how to respond or even if a new response is necessary.  As the health crisis unfolds, and the economic impact is resolved, investment strategies will have to adapt.  It is the role of the financial industry to develop new strategies in the interim that will protect advisors’ clients and give them an opportunity for a necessary level of return: a daunting task.