Archive for July, 2015

CORTAZZO & FRANKLIN: SUCCESSFUL RETIREMENT TRANSCRIPT

When you retire and how you invest can mean the difference between a comfortable retirement and a disastrous one. How do we go the distance in retirement without running out of money? Award winning personal finance experts, Macro Consulting Group’s Mark Cortazzo and InvestmentNews’ Mary Beth Franklin share their strategies for retirement success.

CONSUELO MACK: This week on WEALTHTRACK, two personal finance champions show us how to train for the big retirement race, keep our portfolios in shape and able to go the distance. Macro consulting’s award winning Financial Planner Mark Cortazzo and InvestmentNews’ Social Security maven Mary Beth Franklin share their retirement workouts next on Consuelo Mack WEALTHTRACK.

Hello and welcome to this edition of WEALTHTRACK, I’m Consuelo Mack. As WEALTHTRACK celebrates its tenth anniversary year we have invited some of our regulars back to discuss how much has changed and how much remains the same since 2005.

One thing that has changed for everyone is that we are all ten years older, no exceptions, ten years closer to retirement and in some cases our viewers are now in retirement.

Another big change over the past decade is that interest rates have plummeted. Short term interest rates have been at or near record lows ever since December of 2008 when the Federal Reserve lowered its key short term interest rate, the Federal funds rate to zero. Much of the rest of the world has followed by lowering their official lending rates. That has set off a worldwide search for income.

Another major shift has occurred in stock prices. The S&P 500 which began WEALTHTRACK’s launch at the 1,222 level in July of 2005 peaked in October 9th of 2007, only to suffer its biggest decline since the 1930s, a 57% drop to its March 2009 low during the financial crisis. It took years for the S&P to surpass its old high.

According to one of this week’s guest’s award winning Financial Planner Mark Cortazzo when you retire and how you invest can mean the difference between a comfortable retirement and a disastrous one.

He cites three hypothetical examples. He calls them the “Three Brothers”. They each retire with a million dollars, they each withdraw 60,000 a year, or 5,000 a month, but retire three years apart. Brother 1 retires in 1997, as the tech bubble was gaining steam.

Brother 2 retires in 2000 at the top of the market, just before the tech bubble bursts and Brother 3 retires in 2003 as the credit bubble that imploded in 2009 was in its infancy.

But here’s the scary part. By 2015 there was a wide discrepancy in their investment results and under one scenario the middle brother had almost run out of money.

Scenario one has them all investing only in the S&P 500, by 2015 Brother 1 had $1.64 million in his portfolio… Brother 2 had only $63,945 left in his retirement account! And Brother 3 had $1.65 million.

Scenario two has them all investing the million dollars in a diversified stock portfolio, evenly divided among five asset classes, international developed country stocks, U.S. small cap, large and midcap and emerging market stocks. The results were quite different and much improved. Brother 1 would have doubled his money to nearly $2 million, Brother 2 would have one million, what he started his retirement with and Brother 3 would have $2.4 million.

What are the lessons to be learned from these outcomes?

Joining us is Mark Cortazzo, a Certified Financial Planner, Founder and senior partner of Macro Consulting Group, an independent financial planning firm established in 1992. Cortazzo was recently named to the Barron’s Top Advisor List for the seventh consecutive year, among many other recognitions.

Mary Beth Franklin is contributing editor at InvestmentNews, a leading trade publication for financial advisors. She is an award winning personal finance journalist, a recognized expert on Social Security and the author of a recently published book, “Maximizing Your Social Security Retirement Benefits.”

I began the interview by asking them why there was such a huge and frightening discrepancy among the “Three Brothers” portfolio results, especially under scenario one when they each invested their million dollars in the S&P 500.

MARK CORTAZZO: Really the only difference between the three brothers was the day they turned 65 and what happened the following three years. The first brother, the first three years the market went up, and they were taking withdraws from profits. The second brother, the market started going down, and those withdraws were eating into the principal, and the percentage of the remaining account value that that withdraw represented got bigger and bigger, and you get to a point where even if you have very strong performance and it’s on a small dollar amount, it’s still not enough to overcome that withdraw, and this cascading effect continues to erode your principal even in a bull market.

CONSUELO MACK: Right, and then the third brother …

MARK CORTAZZO: Got a fast start. He started in ’03, got the first three years where the market did quite well, and they’re both in great shape and, the middle brother, he better hope that he was very nice to the other two brothers, because he might end up living with one of them.

CONSUELO MACK: Exactly. Mary Beth, how common is this outcome where you have these vast discrepancies among retirees?

MARY BETH FRANKLIN: Well, it’s critical now. Particularly we have so few of the guarantees that the previous generation retirees had where there was traditional pensions, where there were guaranteed retiree health benefits. Now people don’t have those guarantees, and they are more heavily reliant on their investments. So consequently when they retire or when they start taking those withdrawals are going to make a huge difference in the outcome.

CONSUELO MACK: We can control when we’re going to retire now, except there are still people who have to retire at 65 or even in the early 60s for health reasons, for company policy reasons, whatever. So Mark, so how do I avoid being Brother 2 and ending up with $66,000 to live on in 2015?

MARK CORTAZZO: It goes back to you can avoid risk, you can manage risk, and you can transfer risk. You can manage risk by setting up a pool of money that will create an income stream for you for a certain period of time, five years, six years, and if the market isn’t doing well, that bond comes due. You have that pool of money. You can spend that. If the market is doing well, take some of that froth. Take some of that profit. Use that to live off and spend and keep this war chest there that will buy you time, because the markets in decline but they’ve come back, and if you were able to wait it out and not have to sell good equities at a bad time, you would have been fine.

MARY BETH FRANKLIN: I think …

CONSUELO MACK: So Mary Beth, I know you’ve had a strategy for an emergency fund for a long time.

MARY BETH FRANKLIN: Right. Part of the idea is what some people call the buckets of money strategy or time segmentation where you divide your assets into time frames. Maybe you have two to three years of cash that this is going to handle your out-of-pocket expenses, and maybe in years four through up to ten you have some sort of fixed investments, even if it’s a dividend-paying stock; that you’ve got some sort of predictable income coming in. And then you stay invested for the long term, maybe in years ten and beyond because, face it, a typical retirement now could last 30 years or more, so you’re still a long-term investor even in retirement, but the idea of these different buckets of money is no matter what happens to the stock market today, I don’t need that money for 10 years. I can sleep at night. I can stick to my retirement plan, and I think this is why you’re going to see an increasingly important role for financial advisors in the retirement income phase. This stuff is complicated, and people are going to need help.

CONSUELO MACK: We’re in that phase where we’re not accumulating our savings. We’re actually starting to distribute our savings. So Mark, you said up to six years of cash to pay your expenses for six years. That’s a lot actually.

MARK CORTAZZO: Well, and what we’ve done for clients is we’ve done a laddered strategy. So they’re getting a blended yield that is comparable to what inflation’s at on a tax- free basis, and it’s not there to make you money. It’s there to protect you, and protection costs money whether you’re buying an annuity to protect you. It costs money. You’re sacrificing performance by being in lower-returning investments for protection. So you’ve got to make a choice of how much upside do you want and how much protection do you want, and as you get closer to retirement or in retirement, if you make that call wrong, you don’t have a lot of time or resources to recover from that. So it is a critical decision.

MARY BETH FRANKLIN: There’s this increasing philosophy in retirement income planning of creating this floor, some sort of predictable or guaranteed income, whether it’s a combination of annuities, Social Security, maybe if you have a pension to at least cover your fixed costs in retirement.

CONSUELO MACK: You create a floor that every year will cover, I think, your …

MARY BETH FRANKLIN: Your essentials.

CONSUELO MACK: … your essentials, the food and shelter essentially and transportation, whatever it is.

MARY BETH FRANKLIN: And then on your discretionary income, maybe you can’t take a cruise every year, but with the stock investments perhaps, maybe that’s going to fund the cruise every other year, and you can adjust accordingly, but I think it’s very important again where there are fewer sets of guaranteed income to create your personal pension in some sort of way, whether it’s buying an annuity or exercising a Social Security claiming strategy that’s going to result in more money so that those fixed costs are covered.

CONSUELO MACK: Before we get to that, because I do want to talk about how you create those income streams, is I just want to finish with the “Three Brothers”, and the other example, the discrepancy was the difference between just being invested in an S&P 500 for instance fund and a diversified stock portfolio, a huge difference.

MARK CORTAZZO: Huge difference.

CONSUELO MACK: Why? So how important is global diversification among just your stock portfolio?

MARK CORTAZZO: Well, 10 years ago we were having the exact same conversations that we’re having today, and that was people, all they want to talk about is being invested in the S&P 500 and comparing what they did the last year or two or three to the S&P 500.

CONSUELO MACK: I think 20 percent plus annualized returns over the last six years, the S&P 500.

MARK CORTAZZO: Absolutely, and the last time that happened was at the end of the ‘90s.

CONSUELO MACK: That should tell us something.

MARK CORTAZZO: The trees don’t grow to the sky as they say, and what happens is you get rotations. We’ve had a lot of things where the Fed’s been helpful. The dollar’s been strong. Rates have been low that have been very, very strong catalysts for large U.S. companies. That is starting to shift. Diversification across small cap, mid cap, large cap, international, emerging markets during a drawdown left you with significantly more wealth. The last 15 years a diversified portfolio with a little bit in each of that, the rate of return was double that of the S&P. We have this short-term reference point that the last one year, two year, three year S&P has done great, and diversification now seems lame, and your portfolio manager or your financial advisor is going to be wrong. I would much rather be wrong in a bull market and earn you a little bit less than be wrong in a bear market and have you be wiped out.

CONSUELO MACK: I see.

MARY BETH FRANKLIN: And that’s it. Diversification is key, but over the last 10 years the difference is we’re in an increasingly global economy.

CONSUELO MACK: We’re also dealing with obviously over the last 10 years just record low interest rates. So how has that changed your clients’ portfolios and their ability to get the kind of income that we all need in retirement?

MARK CORTAZZO: What has happened is the avoiding risk strategy. When we sat here the first time, money markets were paying four percent. If you had a million dollars and you just parked it in the bank, you were making $40,000 a year.

CONSUELO MACK: Which we would love those days to return.

MARK CORTAZZO: And you could have avoided risk and had that significant income stream cover your shortfall. Today at the bank, you’re earning $2,500 a year, and that’s not covering any base costs. So people have been forced to take risks, and they have gone down in credit quality and out in maturity on their fixed income just trying to grab yield and the concern I have with that is that they’ve been rewarded for taking risk because rates have continued to decline. I was in the market working at a bank as an investment officer in ’94 when we had seven increases, and those bond funds that were the best performers when rates were coming down got absolutely hammered when rates went up, and we haven’t experienced that and most of these fixed income investors haven’t experienced that. That is a bad, very expensive lesson to learn during your retirement. So that’s one of the things that we would focus on.

MARY BETH FRANKLIN: I think it also shows how people in retirement are going to have to pull a lot of levers. It’s not just about investments. For some people it might be continued employment, whether it’s consulting work or all those guys who really want to work part-time at Home Depot and play with the toys, or maybe it’s looking at your home equity. It could be selling the big house, moving to something smaller, banking the difference, or paying off your mortgage and living at a lower cost. So that’s where people are going to need the advice of which one of these sources of income. Is it my investments? Is it my home equity? Is it continued employment? Is it an inheritance or rental income? All these pieces are going to make up the future retirement income. A lot more decisions involved.

CONSUELO MACK: And Mary Beth, let me ask you about your specialty which is Social Security. You have made an industry out of maximizing Social Security. It’s something that we all took for granted and just didn’t really pay much attention to. It turns out there are huge discrepancies in what you can get from Social Security if your strategies are correct. So how key is Social Security now in this income-starved world?

MARY BETH FRANKLIN: It is critical for two reasons in an era where so few people have traditional pensions anymore and in this low interest rate environment because, for example, for every year you’re willing to postpone collecting your Social Security benefits beyond your full retirement age which is currently 66 up until age 70, you’re going to earn an extra eight percent per year.

CONSUELO MACK: For a lifetime.

MARY BETH FRANKLIN: That’s a 32 percent increase. You can’t get a risk-free eight percent a year anyplace else.

CONSUELO MACK: And you’re dealing with a lot of high net worth individuals, but is it valuable? Or how valuable is Social Security to them?

MARK CORTAZZO: It’s extremely valuable. It’s one of those things. What we try to do is focus on the things that clients have control over. If they have pensions and they can take a lump sum or they can take only on their life or different options for their spouses, focusing on what their options are and making the right decision, Social Security is something you have options available to you. Understanding what they are and how to maximize them based on your individual circumstances, longevity in your family, your current health, your spouse’s current health. So things that you have control over, maximize those. We don’t have control over interest rates or the stock market. Those we have to hedge and manage risk, but there are plenty of things in people’s retirement lives that making good decisions can be more important than getting a better investment return.

CONSUELO MACK: Mary Beth, speaking of the search for income, annuities used to be a dirty word. Are they still?

MARY BETH FRANKLIN: In some circles they are still a dirty word, and you know, there are good annuities and there are bad annuities, but the difference is you have to figure out what is your purpose. If you’re looking for guaranteed income, you have to pay for that privilege.

CONSUELO MACK: But the point is you get a guarantee even though the insurance industry doesn’t want to say it’s a guarantee.

MARY BETH FRANKLIN: Exactly.

CONSUELO MACK: But you get a stream of income for life. Right?

MARY BETH FRANKLIN: Exactly, and the darlings of the industry at least among the academics at this point, not so much around consumers yet, is the idea of investing a little bit of money now to pay out way in the future, like when you’re 80.

CONSUELO MACK: Longevity insurance.

MARY BETH FRANKLIN: Longevity insurance.

CONSUELO MACK: Or deferred income. Whatever.

MARY BETH FRANKLIN: It’s a deferred income annuity, and it’s like the ultimate roulette wheel of investing. It’s red or black. If you live to 85 you’re going to get a great payoff. If you don’t, you don’t.

MARK CORTAZZO: If I’m 65 and I have this income stream that’s going to kick in at 80 or 85, I know that’s the end game. I just need to make it to shore and I’m fine.

CONSUELO MACK: What are the other things that you can control? And I’m thinking of taxes for instance.

MARK CORTAZZO: Taxes, cost, where you own what you own, where you draw from. Those are all very, very important things. Right now we have taxable money, IRA money, Roth money. There’s different pools, different pots of money. The cost and the tax consequences on your investment is very, very important, and we see this all the time. People have a 50/50 mix of stocks to bonds in their IRA and outside their IRA, and they own the same investments, and they have high-yield funds, and things are throwing off lots of income, and they’re not using it but they’re paying taxes every year on those distributions. If they just shifted those assets to the account that was deferred, their return doesn’t change. The amount of money that they have doesn’t change, but they’re not sharing it with Uncle Sam, and when you pay that $10,000 in tax, you don’t lose $10,000. You lose what that $10,000 would grow to over the next 30 years which is a big number.

CONSUELO MACK: That’s another way to look at it.

MARY BETH FRANKLIN: And the same idea of asset location is if you have those growth stocks that are throwing off capital gains which could be taxed at 15 or 20 percent, but they’re inside your traditional IRA. When you pull the money out, it’s at your ordinary income tax rate, so that idea of putting the appropriate assets in the appropriate vehicle. The other thing that I’ve seen changed over the past decade as far as retirement income planning goes, it used to be the hierarchy of how you tapped assets. Grab Social Security at 62 because, heck, it’s just greens fees, no big deal. Then we’re going to drain the brokerage account and hold onto that IRA, that Holy Grail of retirement income.

CONSUELO MACK: Until you have to distribute at 70.

MARY BETH FRANKLIN: Until you have to have it at 70 and a half. That may not be the smartest strategy anymore for several reasons. One is so many people do not realize that how much they’re going to pay for their Medicare premiums is tied to their income, and if they wait until 70 and a half to start tapping that IRA, it might be a big chunk of money that’s then going to push up their Medicare premiums. Wouldn’t they be better off taking a little bit out each year to supplement some of their other income so they don’t get pushed into that big high premium?

CONSUELO MACK: Oh, that’s really interesting.

MARK CORTAZZO: Taking a little bit from each of the pots where you can blend your tax rate down, and right now the magic number is like $250,000, $400,000. You hit those numbers in income, all of these bad things happen to you. So you can get the same cash flow. You can get the same spendable income, and you’re just taking a little bit from your left pocket and a little bit from your right pocket. It changes how much the government gets and also can help you prevent hitting some of these penalty numbers.

MARY BETH FRANKLIN: And for years we’ve been talking about the value of converting some of your traditional IRAs to Roth IRAs, but I think now we have an even better reason, and one of it is this Medicare premium. If you know now if you convert a little bit of your traditional IRA each year, maybe up to the top of your tax bracket, that you are creating this tax-free pot of money in retirement and, as Mark said, you draw some from the fully-taxable IRA, some from the tax-free Roth IRA, some from your brokerage account that has a preferential tax rate, you’re going to hold down your overall tax bill in retirement, and that’s going to leave you with more spendable income. Just like we say on the accumulation phase; it’s not what you make. It’s what you keep. It’s even more important in retirement.

CONSUELO MACK: In the transition from the accumulation to the distribution phase, what is one or two of the biggest mistakes that retirees make in that transition?

MARK CORTAZZO: The biggest one is the things that have helped get them there and all of the things that they’ve been taught that make them a good investor are the things that can hurt you the most as a retiree. You have been taught about dollar cost averaging. When the market goes down, that’s good because you’re buying more and more shares on the dip. So when you’re accumulating money, time and volatility are your friend. I want the market to dip because I get to buy on sale.

The longer I’m investing, the greater my opportunity is to hit that expected rate of return. So you’ve been rewarded and been successful because you’ve done these things. When you retire and you flip the switch, time and volatility become your enemy, and that decline in the market with you drawing hurts you, and the longer you live, the greater the chance of you failing and running out of money. So you literally have to flip a switch the day that you retire and unlearn everything that you’ve learned because it’s a completely different game when you start drawing from the portfolio.

CONSUELO MACK: Biggest mistake that you can think of that people make in that transition?

MARY BETH FRANKLIN: I think on the accumulation side people deal with rules of thumb. I should save 10 to 15 percent of my gross income. I should aim to withdraw four percent of my portfolio in retirement. The mistake they make is rules of thumb are great for the long term, but when you get up to the actual retirement, you want hard numbers. If you’ve never created a budget in your life, you want to know how much your costs are going to be and what your expected sources of income are and match them up, and if there’s a gap, you want to know that before you retire and figure out how to fill it.

CONSUELO MACK: All right, so that’s the best thing that you can do in that transition. What’s the best thing that you can do, Mark, in the transition aside from what Mary Beth just said which sound brilliant.

MARK CORTAZZO: I think taking an inventory of the risk within the portfolio is very, very important. Fixed income, like we said, we’re seeing a lot of things that people go through a risk profile online. They say, “I’m going to be a 50/50 mix.” They come in to us because they want us to double check what they’re doing, and the 50 percent of the portfolio that they have that’s in fixed income is in preferred stocks and is in high-yield bonds and things that are …

CONSUELO MACK: Risky.

MARK CORTAZZO: … very risky. They’re called fixed income, but they act like stocks. High-yield bonds went down almost as much as the equity markets in ’08. So these are things that are named one thing, but they’re stocks in drag. They’re not bonds. High-quality bonds did very well in ’08, and they buffered some of that hit.

CONSUELO MACK: You know what the final question is. You’re both WEALTHTRACK regulars. So Mary Beth, one investment for a long-term diversified portfolio?

MARY BETH FRANKLIN: Well, I consider Social Security claiming strategy is probably one of the best “investment” decisions a pre-retiree can make. Don’t make it lightly. I don’t care what decision they make; just make an educated decision.

CONSUELO MACK: And you have a terrific book on that very subject which will be on our.