Archive for April, 2013

Harold Evensky Transcript 4/05/2013 #941

April 5, 2013

CONSUELO MACK: This week on WEALTHTRACK, award winning financial planner Harold Evensky is on a crusade to protect retirees’ lifestyles, nest eggs and portfolios through their golden years. Strategies for maintaining your retirement castle are next on Consuelo Mack WEALTHTRACK.

Hello and welcome to this edition of WEALTHTRACK, I’m Consuelo Mack. Question: what is the greatest fear retirees have? Answer: outliving their retirement savings. On this week’s WEALTHTRACK, we are going to talk about a strategy to make your retirement portfolio last with one of the most respected financial planners in the country, Harold Evensky.

This topic could not be more timely or needed. Recently we learned some distressing news about the state of retirement finances from the acknowledged experts in the field, the Employee Benefit Research Institute. EBRI, as it is called, has released its 23rd annual “Retirement Confidence Survey” which gauges the views and attitudes of both working-age and retired Americans. The survey’s results have been worrisome for years, with confidence of both groups declining since the financial crisis. But even with the economy improving, the state of retirement planning and preparedness has not. The percentage of workers confident about having enough money for a comfortable retirement is essentially unchanged from the record lows of 2011. While 13% are very confident and 38% are somewhat confident, 28% are not at all confident and 21% are not too confident. Retirees themselves are more optimistic than workers, but less so than they were pre-financial crisis: 18% of retirees are very confident they will have a financially secure retirement and 44% are somewhat confident, while 14% are not at all confident, and 22% are not too confident. Debt levels are perceived as a big obstacle to achieving financial security in retirement. 55% of workers and 39% of retirees report having a problem with their level of debt.

And one of EBRI’s most shocking findings was the lack of even a short term financial cushion for many. Only 50% of workers and 52% of retirees say they could definitely come up with $2,000 if an unexpected need arose within the next month. If planning is key to a secure retirement, the future looks bleak. Just 23% of workers and 28% of retirees report they have obtained investment advice from a professional financial adviser.

They are clearly not viewers of WEALTHTRACK. We are consulting one of the best in the business this week. He is Harold Evensky, president of the fee-only financial advisory firm, Evensky & Katz. He has been recognized as a top financial adviser by numerous publications including Barron’s, Worth magazine, and InvestmentNews and was awarded the Dow Jones Investment Advisor Portfolio Management Award for Lifetime Achievement and is the author of several books, including Wealth Management. He is also known for having some unusual approaches to retirement planning. One is to have his clients assume they will live until 95. I asked him why.


HAROLD EVENSKY: Because people tend to focus on the probability, well, I’m not going to live that long. We remind them the consequences of being wrong. Even if there’s only a small chance of living that long, the risk of dying early means you leave some money on the table. Well, that may be sad, but it’s a whole lot worse to live beyond that and not have any money left, so that’s why, just the consequences are catastrophic if you don’t plan for it.


CONSUELO MACK: Harold, one of the other expectations that you have your clients depend upon in their retirement planning is to expect, number one, high inflation and also a significant market downturn, and here we are in a low inflation environment and, yes, we’ve had a significant market downturn, but guess what? The market’s more than doubled since the lows of 2009. So why those assumptions?


HAROLD EVENSKY: Because we’re talking 20 or 30 years. They’re likely to see a whole bunch of market cycles up and down. So we want to refocus our clients from the short term. Gee, interest rates are low today. What are we going to do? We’re planning for the rest of their life, so unless they’re prepared for volatility, good years and bad years, they’re not going to make it long term.


CONSUELO MACK: Some other reality checks, and again, you really have a different approach from most of the financial planners that are out there. One of them is that just about everyone in the financial planning industry basically has historical assumptions about future stock market returns, so you know, 10% plus annualized returns in the stock market, and let’s say 5% annualized returns in the bond market. You have ratcheted those expectations down considerably. Why?


HAROLD EVENSKY: We think the only planning that makes sense is forward-looking planning. It doesn’t mean we ignore history, but we need to plan about what the future’s going to be, and based on our best guesses and assumptions, we believe that returns are going to be relatively modest historically. So for the stock market our current assumptions for planning is about eight and a half percent with three percent inflation, and the bond market about just a little under five, about four and three quarters.


CONSUELO MACK: And so those are nominal returns.


HAROLD EVENSKY: Those are nominal, so take three percent inflation. Our inflation assumption long-term is three percent, and so it means that there’s not a lot.


CONSUELO MACK: Very conservative.


HAROLD EVENSKY: We think it’s realistic. We’re not trying to be conservative, because if you’re conservative, then you leave money on the table. So the best we can do is try and make the most reasonable assumptions, and the other criticism I certainly hear is this buy and hold is out. It’s not buy and forget; it’s buy and manage. So five years from now, those assumptions may change again. They’re not going to change on a weekly or yearly basis, but we’re always constantly looking forward and trying to make the best guesses we can and at least on an annual basis revisiting those.


CONSUELO MACK: So with reduced expectations for returns from both your bond and your stock portfolio, things like expenses and taxes become very, very important in the kind of returns that you’re going to get. Right?


HAROLD EVENSKY: I lived most of my career in the good old days. We’re making so much, eh, a percent here or there, who cares; but if you believe anywhere near those kinds of numbers, and you figure out what’s left, it’s not very much. So we have no control over returns. We have some control over expenses and taxes, so if we can save a half a percent, that’s a huge increase. So bottom line, I absolutely agree. Real focus on managing taxes and expenses, it’s the one thing an investor has control over.


CONSUELO MACK: So let’s talk about how you do that, then. So tell us what strategies you’re employing to really minimize the impact that taxes have, for instance, and expenses have on your portfolio.


HAROLD EVENSKY: When we first face this decision, my goodness, nothing’s changed in our philosophy. We believe in diversifying domestic and international. So fairly quickly I came across an institutional strategy called core and satellite in stocks. It means the bulk of our investments are simply in the market. We’re not trying to beat it, so we use primarily ETFs, exchange traded funded, very tax efficient, very low cost, and that’s about 80% of our portfolio. Instead of taking a little piece of risk throughout, we concentrate in what we call the satellite. There we can take a lot more risk. They can be expensive, but we think those managers will overcome that drag, but it’s only a small portion of the portfolio.


CONSUELO MACK: So 80% of a total portfolio is in what you call the core, are passive investments? Is that right?


HAROLD EVENSKY: Eighty percent of the equity is impassive.


CONSUELO MACK: Of the equity, okay. Portfolio is impassive, and then the 20% of the equity is in the actively managed funds, for instance.


HAROLD EVENSKY: It can be anything. We split that into a lot little pieces. We’re afraid to make any major bets, so it could be there was a period after the recovery from the tech bust, and we have a value bias, and value came roaring back, so growth didn’t look so good, so we used the S&P 500 growth in the satellite. So we’ve used junk bonds in there, commodities. So it could be most anything. We had a position shorting 30-year treasuries for a while, so anything goes.


CONSUELO MACK: And what difference does that 20% make in the returns of the portfolio? What do you expect from that 20%?


HAROLD EVENSKY: The target is two percent over the broad market returns.


CONSUELO MACK: On an annualized basis.


HAROLD EVENSKY: On an annualized basis, yeah.


CONSUELO MACK: And how do you decide? For instance, right now… of course, we’re more interested in the satellite portfolio, at least I am because you’re actually choosing what specific managers you want to go to or what specific style. So right now what’s your satellite portfolio look like?


HAROLD EVENSKY: I mean, we have an emerging market position in there. We have a high-yield bond. We have a large cap, sort of a super large cap value-oriented. Again, it changes all the time. One of the ways in which we decide what to do is we start looking at, okay, what has done terrible for the last few years that we think is a fundamentally sound investment? And that’s going to get us interested. Someone comes in to us and says, “Wow, you know, we were at the top last year.” Don’t even want to talk to them. We want someone to come in and say, “Boy, it was a disastrous year. Our particular style or strategy is out of favor.” That’s what I’m interested in.


CONSUELO MACK: So what about the bond portfolio? How do you handle fixed income?


HAROLD EVENSKY: Fixed income we’re in to preserve principal. In a normal environment, we want an interest rate exposure, measured by what’s called duration, of about five years and quality A or better. We’ve been very defensive for quite a few years, double AA in like three and a half years. Hindsight, we were too defensive.


CONSUELO MACK: Right, because the high yield, the junk bonds did really well.


HAROLD EVENSKY: Yeah, well, and interest rates went down, so we could have been longer term and done really well, but we’ve done a couple of things. We have maintained our relatively short exposure in interest rates, because if rates go up, we don’t want to get killed, but we trust the Fed a fair amount that it won’t go up overnight. We think the short end may go up faster than the intermediate, so instead of sort of equally throughout, we’ve reduced a little bit that one to three years and increased a little more the two to five-year. Somewhat contrary to our normal approach because we tend to be plain vanilla, we’ve added two what are called unconstrained managers. These are managers who go anywhere, do anything.


CONSUELO MACK: It’s strictly in fixed income?


HAROLD EVENSKY: In fixed income. They can lower the quality, increase the quality, go emerging markets. The reason that we did it and got interested, one, we work with both firms and respect them, but they’re using that flexibility not to try and make more money but to try and weed through what is clearly sort of a scary fixed income market, and they’ve done a pretty good job so far. So that’s the other sort of tweak that we’ve done.


CONSUELO MACK: So one of the things that you told me earlier was that an income portfolio kind of as a goal is really dangerous.


HAROLD EVENSKY: Yes, that drives me up a wall. Yes.


CONSUELO MACK: And you know that that is probably one of the most popular strategies now, because people in a yield-starved world are looking for income, and so that’s what they’re all focusing on. Why does it concern you so much?


HAROLD EVENSKY: It concerns me. It’s an easy sale, and it’s a story that sounds credible, but people don’t need income. They need real cash flow. If you do an income portfolio, presumably that’s based on dividends and interest. Your allocation, how much in bond and stocks, is completely driven by whatever interest rates and dividend rates have to be. So today it’s going to largely be a fixed income portfolio, fairly extended maturities which we don’t think makes much sense for anybody. Beyond that, okay, you have an income portfolio and interest rates go up. Now you feel rich. You’re getting more money. The fact of the matter, your portfolio value went down. Interest rates go down. You’re feeling poor. What’s happened? Your portfolio is worth more, so it’s counterintuitive, and finally the income goes up or down. There’s nothing consistent about it, and it’s not real return. Typically if it’s bonds, it’s a nominal return. So other than that, it’s perfect.


CONSUELO MACK: So for individuals, your clients who say, “Look, I want income, and you’ve got to generate income with this, my portfolio…”


HAROLD EVENSKY: Right, which is common.


CONSUELO MACK: So what do you do for them?


HAROLD EVENSKY: We designed what we call a total return portfolio so that we’re looking at the portfolio, trying to design it cost and tax efficiently. For the cash flow needs they have, we carve out literally… if someone has a million dollars and they need 50,000, so okay, we can invest 950. Fifty we’re going to put in a money market fund, set it up to pay you a check every month like a payroll check. We’re going to manage this portfolio. When stocks go down or bonds are up, we’re going to sell bonds and buy stocks. Oh, gee, let’s fill it back up. So we control when to sell something. We’re not forced to sell at the wrong time. We’re not selling little pieces throughout the portfolio, so we have a reverse dollar cost averaging, so it allows us to be very cost and tax efficient in the portfolio.


From a behavioral standpoint, it’s immensely powerful. We’ve started doing this back in the early ‘80s. We were doing it before the ’87 crash. So no one was happy, but our clients didn’t have to worry where their grocery money was coming from. They knew where it was coming from. Tech bust, no one was happy, but no one had to sell. They were able to stay in, kind of ignore it until the world went back up. Same thing with the Great Recession. Our basic belief is, over time, domestic and world economy will go up. Stocks earn more than bonds. That is a basic belief, but you have to have time.


CONSUELO MACK: Right, so how much time do you have to have to have that work?


HAROLD EVENSKY: I would have said five years until a little while ago. Now probably 10 years, but the fact of the matter is it hadn’t been five and balanced portfolios have recovered, so roughly an economic cycle, but again, having one year and constantly filled up, we’ve never hit a point that that’s been a problem.


CONSUELO MACK: So one of the things that you also told me, again contrary to common wisdom, is that a lot of investors have become very risk averse and, therefore, they have basically either gotten out of stocks completely or reduced their stock holdings dramatically, and you told me that they’re not actually being risk averse. They’re being loss averse, and there is a big difference. So explain the difference.


HAROLD EVENSKY: We hear all the time investors are risk averse. The fact of the matter is, people don’t want to take a risk to get rich, but they will take a risk not to get poor. I mean, the way we explain it, a very conservative client comes in to me, and I say, “Look, if you go to my buddy upstairs, a broker, and they’re going to see your portfolio, they’re going to say, ‘We got to make you some money. We got to put some in the market,’ you’re going to say, ‘I’m out of here.” We may go through this whole planning process and say, “You know, unless we put about a 50/50 portfolio, you’re not going to be able to maintain your standard of living.” So I’ve literally had very conservative clients say, “Wow. That makes sense to me. I understand why I have to do something that will make me uncomfortable, because if I don’t, the fact of the matter is it’s a bigger risk for not doing it.”


CONSUELO MACK: Right, so is there any such thing as a safe investment these days?


HAROLD EVENSKY: No, never has been.


CONSUELO MACK: Never has been? U.S. Treasury?


HAROLD EVENSKY: Relatively safe portfolio.


CONSUELO MACK: Securities at one point weren’t they? At least you got your money back, but…


HAROLD EVENSKY: You got your money back but with inflation it may not buy anything. So every investment is going to be subject to a couple of risks, either to the market risk. You can buy the 500 blue chips. If S&P goes down, you’re in trouble. Say, well, I’m going to be very conservative. I’m going to put it in bonds, you know, 10-year treasuries or munis, triple A. Interest rates go up. You’re in deep trouble.


So okay, now I’m going to put it in one-year CDs and roll it over every year which I had clients that did it. They were getting 15%, and next year they got 10. The next year they got five. They came in in tears. “Harold, I’ve got a third of the income.” Yeah, right. You still got all your principal. Wasn’t that safe? Well, of course it wasn’t safe. Then finally purchasing power of inflation. You know, you can have every penny you started with, and you can’t buy a hamburger. That’s not very safe. So the answer is, you need a “safe” portfolio. There’s no such thing as a safe investment.


CONSUELO MACK: So explain your bond strategy, because I know that you said that you have laddered portfolios in bonds. When we talked about having a core strategy in passive funds, ETFs and whatnot in equities, you don’t think that works so well in the fixed income world.


HAROLD EVENSKY: We’re still trying to get our hands around sort of the fixed income ETFs, and our belief is that the bond market is much more inefficient than the stock market. So we see potential advantages in active management in bonds. In a general universe, we’d have real simple, maybe three positions, something in a short-term bond fund, you know, Vanguard short-term and something we call short intermediate like three to five years and something in intermediate and put a third, third and a third. That would be what we would call the core. What we have in addition to that is we have an allocation to TIPS.


CONSUELO MACK: Still, even though the negative yields.


HAROLD EVENSKY: Even though. It’s not huge, but we don’t know tomorrow what’s going to happen, so the only way to protect is to be there, and then we have these two unconstraineds. So it’s gotten a little more complicated but as a function of what’s going on.


CONSUELO MACK: Looking at what’s going on, and we have the Fed doing unprecedented things. As you know, we’ve got worldwide easing. There are so many factors that certainly affect the market on a day-to-day basis. Is there something that you’re doing differently that you wouldn’t have done, let’s say, five or ten years ago?


HAROLD EVENSKY: Certainly would not have added two unconstrained managers. That makes me nervous. I mean, it’s not consistent.


CONSUELO MACK: Because you don’t have control over it, or…?


HAROLD EVENSKY: Because when you give managers that much flexibility, they can do a great job, or they can make some major mistakes. So again, we tend to be particularly plain vanilla in fixed income. We’ve added in our portfolio what we call an alternative category. We’re certainly familiar with the alternative, the hedge fund universe and private equity, but we historically stayed out of it because what’s available in what I consider the retail market, which I define under $100 million, is… my apologies to perhaps some of the listeners… I consider it opaque, expensive, and third rate. It’s just not institutional quality. So we’ve stayed out of it. What happened after the Grand Recession is there were managers who we respect who came in with sort of mutual fund type alternative product that we thought…


CONSUELO MACK: Well, Cliff Asness, Andy Lo.


HAROLD EVENSKY: Those are two that we use, and so said, okay, because they’re unleveraged, the returns aren’t going to be that extraordinary. We think they’ll be between bonds and stocks, so we took three percent from bonds and three percent from stocks and said let’s put it in these alternatives. We think they’re poorly correlated with the market so will provide some buffer. Because it’s half and half, it shouldn’t affect our returns, and so that was a major change for us.


CONSUELO MACK: And what about annuities?


HAROLD EVENSKY: Many years ago I was quoted famously as saying I’d wash my mouth out with soap before I talked about immediate annuities. I think it’s going to be probably the single most important investment for the next decade and longer. Not yet, but…


CONSUELO MACK: And why not yet?


HAROLD EVENSKY: Because what they pay is pretty totally dependent on what current interest rate environment is, and it’s so low.


CONSUELO MACK: So forget it now.


HAROLD EVENSKY: Right. The risk of waiting … and it really doesn’t make sense until someone’s maybe 70 or older.


CONSUELO MACK: To buy an immediate annuity.


HAROLD EVENSKY: To buy it, because the advantage of it is the mortality return. You can get a return. Any other investment is going to be dividends, interest or capital gains. An annuity has another component in mortality return, which sounds good. It means if you die early, you had a lousy investment, but you’re dead so you don’t care. If you live longer, you’re getting some of the money that whoever died early left on the table. If someone’s 70 today and we don’t do it, and we wait a couple years, well, the likelihood mortality is going to change dramatically is slim. If interest rates regress back to a historic norm, the payments will be much more attractive and, two more years, the mortality returns go up pretty substantially. So we think it’s going to be a really important vehicle.


CONSUELO MACK: So at what level of interest rates do you start seriously considering annuities?


HAROLD EVENSKY: I’d say when they come back to historical normal. In other words…


CONSUELO MACK: So five percent.


HAROLD EVENSKY: Yeah, somewhere in that range probably.


CONSUELO MACK: For a 10-year, for instance, something like that.


HAROLD EVENSKY: Right, yeah, exactly.


CONSUELO MACK: So another interesting approach that you have is that your intention for most of your clients, unless they express otherwise, is to spend their portfolio down. You want them to basically die penniless.


HAROLD EVENSKY: Yeah, I mean, the joke is, you know, the last check they write bounces. That’s the perfect planning. Okay? It’s not that we don’t want them to leave money if their goal is to leave, gee, I’d like to leave my kids a million dollars and my college. That’s great. We’ll build that in the plan, but unless they tell us that, we’re not looking for them to die with a big chunk of money, because it means they either had to invest more aggressively or they had to reduce their current standard of living. People talk about being conservative and forget there’s always a flip side. “Well, I don’t want to consider Social Security.” Okay, let’s not consider it, but then to do what you want to do, you’re going to have invest in leveraged pork bellies, or you’re going to have to cut your spending by 20%. So conservative is a nice word, but it really doesn’t have a lot of meaning, so the best we can do is try and make the most reasonable assumptions we can.


CONSUELO MACK: One Investment for a long-term diversified portfolio. What would you have all of us own some of?


HAROLD EVENSKY: For long-term, certainly S&P500, Russell 3000 as a minimum. Then next we would expand it to some small cap end value allocation, certainly international. That’s more than half the world economy, and last I would say emerging markets.


CONSUELO MACK: Harold Evensky, thank you so much, award-winning wealth manager. Thank you so much for joining us on WEALTHTRACK.


HAROLD EVENSKY: Thank you so much for inviting me. I enjoyed it.


CONSUELO MACK: At the conclusion of every WEALTHTRACK, we give you one suggestion to help you build and protect your wealth over the long term. This week’s Action Point picks up on Harold Evensky’s comment that immediate annuities are going to be “probably the single most important investment for the next decade and longer.” However, Evensky’s view right now is that with interest rates so low, the returns these annuities offer are not that attractive. Most other financial advisors agree with him- even though the payouts are still much higher than what you can get on long term U.S. Treasuries, for instance. So this week’s Action Point is familiarize yourself with immediate annuities. When interest rates do rise, which they are bound to do sooner or later, you will be prepared to act.


A second annuity strategy was brought to my attention by Mary Beth Franklin, longtime personal finance columnist at Kiplinger’s, who is now a contributing editor at InvestmentNews. Franklin advises looking into what are called deferred income annuities, which she says are a great way to lock in higher returns now to begin at a date in the future when you will need income. They are especially good for pre-retirees. Payouts can be 10% or more in ten years. You still pay a lump sum to an insurance company now, but you determine the date your monthly payments begin in future years. Some also allow you to add to the investments and change the date the payments start.


Franklin recommends looking into New York Life’s Guaranteed Future Income annuity because they pioneered the product, have been in business since 1845, and have the highest credit ratings of any life insurer. New York Life is a sponsor of WEALTHTRACK, but that does not affect the opinions of Franklin or any of our other guests.


Next week we are going to have a television exclusive with a mutual fund manager who is considered to be one of the top stock pickers of all time. CGM Focus Fund’s Ken Heebner will join us to discuss his bold, contrarian strategy and extreme performance. In the meantime, thank you so much for taking the time to visit with us. Have a great week and make it a profitable and a productive one.



April 3, 2013

Payouts are still much higher than what you can get on long term U.S. treasuries.
Mary Beth Franklin recommends pre-retirees check out deferred income annuities: you pay a lump sum to the insurance company and you determine the date future payments begin.

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