Are Fixed Income Investments Really That Safe?

Let me give you an illustration. When we established an example of your number, we came up with $2.2 million. Using that figure, let’s say that you could invest it entirely in high quality, long term corporate bonds to yield 6%.
The first year, you have a significant cushion: your investment income is a third more than your income needs. (Six percent, by the way, is pretty close to the index return of high grade, long-term corporate bonds over the last eight decades or so.)

Here we track the growth of an income $100,000 that we would need to offset a continuation of 3% annual increases in the Consumer Price Index. NOTE THAT IT IS NOT A PROJECTION OF 3% CPI, BUT MERELY AN ASSUMPTION FOR ILLUSTRATIVE PURPOSES. Nor, for that matter, is it meant to suggest that if the CPI rises at 3%, your living expenses will go up in lock step. They may go up more, or less.

What it shows is that, for the first ten years or so, you’d have been able to keep your head above water. Maybe even a while longer, if you saved the excess income in the earlier years for use in later ones. But not that much longer.

Possible Implication:

Depending always on your personal financial circumstances and your ability to tolerate risk and volatiltiy,

a fixed-income retirement investment strategy may not sustain your lifestyle through thirty years of a rising-cost life.

I suspect we were all told, very early in our investing careers, that there were only two basic investment objectives: growth and income. I submit that, in modern three-decade retirements, where the maintenance of purchasing power becomes a fundamental objective, there’s a third, very critical, investment objective: growth of income. I provide the following anecdote, not as an attempt to prove anything – because past performance is absolutely no guarantee of future results – but just to offer you the perspective of one 30-year period: the most recent one.

Lets review the period 1981 to 2011: We have two really fine decades for equities – broadly speaking, the 1980’s and 1990’s – followed by a perfectly horrendous decade, in which equities afforded essentialyl no net return for a decade that was bookended by the two biggest bear markets since World War II : the ones in 2000 -2002 , and the most recent calamity in 2007- 2009.

From a obscure website called  Political Calculations, which features a service it calls “ The S & P 500 @ Your Fingertips”.
(http://politicalcalculations.blogspot.com/2006/12/sp-500-at-your-fingertips.html)

you can find the results of the particular 30 year period. I reflect as follows:
From September 1981 to September 2011:

• The S&P 500 increased 10 fold from 118.30 to 1,179.39
• The Consumer Price Index increased 2.43 times from 93.2 to 226.89 (almost exactly an annualized 3% per year)

Particularly fascinating is the Growth of Income of the dividends:

• In 1981, the amount of dividends was $ 6.52 from the S&P 500
• In 2011, its $ 25.05

This is a 3.8 times increase, i.e. the message is that, over a thirty year period, an investment in the S & P 500 not only increased in value by a multiple of 10 it also provided a source of income that increased 50% greater than CPI. That will never happen with fixed income investments.

Remember when a Coke only used to cost a quarter? Today, it is difficult to find soda for a $1.00. The cost of things rise over time, it’s a fact of modern life. Another way of looking at it is that the ability for a specific dollar amount to purchase goods and services decreases over time. Economies undergo inflation, costs increase, and other unexpected changes contribute to the overall decrease in the purchasing power of money.

To follow these changes, the Consumer Price Index (CPI) measures changes in the price level of consumer goods and services purchased by households. The CPI, in the United States is defined by the Bureau of Labor Statistics as “a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.”

Why does CPI matter to us?

So if we use the last 30 years of the CPI as an indicator, by 2041, today’s $100k  of expenditures will be $ 242 k ( in 2041) ! This may alarm some people, but unless you are hiding all of your cash under your bed, there is no need to panic.

CPI is relevant to those who are retiring because it shows us why we can’t just put all of our retirement money in the bank and let it sit. Over time, that dollar amount will become less and less capable of maintaining the lifestyle that was planned on. In a worst case scenario, you can outlive your retirement money.

Appropriately Weighing Risk

The problem with investing and maintaining course has little to do with stock market volitility. Instead, you ability to retire comfortably will boil down to your tolerance of the market’s volatility. It is extremely difficult to be an investor when the market tanks. Stocks drop and we immediately feel that loss of money.

When people see the money that they will be dependent upon in 5 to 10 years temporarily  disappear, it can make them behave irrationally. Desperately, they might pull their money out of a properly diversified equity portfolio and move it into fixed income – an unrecoverable mistake. Their emotions got the best of them causing them to weigh their risks inappropriatly. There is much more long term risk in moving all of your money into fixed income, than maintaining course after a crash.

Putting all of your money into fixed income is a silent killer. You don’t notice the mistake until long after you have made it, like when you go to buy an apple with the same money that used to buy 3 apples. With over three-decade retirements, we have to pay as much attention to the risk of outliving our money as we do to the risk of losing it.

During the worst part of the recession, we had an 80 yr old client who wanted to move all of his equity into fixed income – the equivalent of stashing your money under the mattress. For short term need, it would be OK, but what if he lived to be 90? He would need at least 10 year of distributable income to live off of.

Moving his equity into fixed income would have guaranteed his losses and increase the chance that he outlived his principle. After accounting for his losses, he still had 10 years of income distributions in passive equity growth, so his losses weren’t as significant as someone with a more active portfolio. Fortunately, we were able to talk him off of the edge of the proverbial financial cliff.

What You Can Expect From Retirement

What’s the average retirement age in the United States?

62

That may or may not be what you’re aiming for, but it is the average, because about half the people who retire in any given year do so as soon as they can begin drawing Social Security early retirement benefits, and that’s currently age 62. Now here’s the really important question:

What’s the “joint life expectancy” of a 62-year-old, non-smoking man and woman?

30 years

(Joint life expectancy is the actuarial expression of the mathematical reality that two people together have a longer life expectancy than either one does individually.)

What we’re asking here, in effect, is:

How long should the average retiring couple be planning to need an income from their investments that is continuing to rise in parallel with the continuing increase in living cost?

30 years

What You Need During Retirement

Neither the man nor the woman has a thirty-year life expectancy alone, but together they do. They estimate that half of all 62 year old couples will be gone before thirty years – or age 92 – and half will outlive that number. The point is that the risk of outliving your money is just as significant, or even more significant, than the risk of losing principle in equity. At least equity has the chance to rebound and grow. Moving equity into fixed income guarantees a loss when increasing costs of living are considered.

How To Calculate Your Number

Let’s try a very basic illustration. The numbers may not be exactly relevant to your situation, but the principles behind this method of calculation should apply to just about everyone:

1. You decide that the total income you need each month in the first year of retirement is $10,000.

$10,000/month

2. And you can rely on Social Security and perhaps a fixed pension benefit from a corporate plan for $2,000 of that.

$10,000/month – $2,000

3. Your investments will need to be giving you the other $8000 each month for that first year. Please note that I didn’t say your investments had to yield $8000, in terms of interest or dividends. I’m simply talking about an amount that you’d be comfortable withdrawing each month to support your lifestyle.

$10,000/month – $2,000 = $8,000

4. Eight thousand dollars a month is $96,000 a year, which let’s just round up to $100,000.

$8,000 * 12 = $96,000 ≈ $100,000

Now we’re going to make an assumption, which is that, in order to try to leave your capital intact, and even to give it a chance to keep growing, we’re going to want to withdraw no more than four and a half percent of your total investments that first year.

5. So we ask: of what capital sum is $100,000, four and a half percent of your total investments. By dividing $100,000 by .045, we arrive at your number: $2,222.222.22! (Maybe we should just call it $2.2 million, for the sake of simplicity!)

$100,000 * .045 = your number ≈ $2,200,000

Where do you stand right now?

What’s the current sum of your retirement investment portfolio. For this example, let’s say you have already built $800,000 for retirement. (Totally apart from other things you may still have to pay for, like your children’s education.)

6. We assess the gap, if any, between where you are right now, and where you need to get to your number.

$2,200,000 – $800,000 = $1,400,000

7. How long do you have to close the gap? Let’s say there is 20 years before you plan to retire. You can divide the difference between what you currently have for retirement and your number. The remaining amount will give us a fair estimate of what rate of return your going to need.

$1,400,000 / 20 years = $70,000

If we decide that building $70,000 every year for retirement is not realistic goal, we still have options: retire a bit later than you’d planned, start off at a lower income, and things like that. But we’ll cross that bridge when we come to it.

The point is that you can sit down with a financial advisor and, using this simple process, quickly have a rough idea of where you currently stand. Figuring out how much you will need to retire will give you a clear picture of what it will take to comfortably retire.

After You Get Your Number

In a perfect world, you get to your number, you withdraw, at 4.5%, your hundred thousand dollars or whatever it is in that first year you’re retired. Then what? The challenge of modern retirement is keeping your income growing at least at the rate cost of living is inflating. It is imperative to keep up with the cost of living in order to sustain your lifestyle without running through the principal.

Here we start bumping up against what the phrase “modern retirement” means, and what it tells us about the battle to sustain our lifestyle in retirement.

After the holidays, many of us cannot wait to get back into a routine. Getting back into bed at a reasonable hour and waking up for a productive day feels good. It’s like tackling every bullet on a to-do list, it’s nice to accomplish something, even if it is routine. If you need something easy to check off of your list for the new year, add this bullet:

• Filling out the Williams, Horning & Company Organizer

We’ve done our best to make it as easy as possible for you to give us all of the information we need to properly file your taxes. Year to year most people’s tax situation remains relatively consistent, the Organizer is a great way for us to identify items that may have changed. If we don’t know the information asked for within the Organizer, there is a good chance you will end up spending unnecessary time with us on the phone asking you these questions. So if you want to get started, all you have to do is:

1.) Visit www.ga-cpa.com and Login

After you click the Client Login link, a pop-up box will appear for you to enter your username and password.

2.) Fill Out The Organizer

There are many folders within the Organizer, but fortunately, you don’t have to fill out every single one. If you don’t have Rent & Royalty information, than you can skip that form.

The General and Questionnaire folders should be filled in by everyone.

Look through the other folders and see if anything else applies to you. Remember to hit the Save & Close button when you are done.

That’s all there is to it. Completing the Questionnaire will cut down on our accounting time and the time you have to spend on the phone, so everyone benefits. The Organizer is just a starting point for tax filing. Turbotax and other programs will ask for similar information, but automation can expose you to unnecessary risks. Filing taxes is the easy part. If you want to minimize your tax liability and audit exposure, you will need an experienced tax accountant.

For the new year, make it a point to communicate with your accountants, and at the very least, fill out the Questionnaire.

By December, you should have enough information to start reviewing the year’s financial activity and start tax planning. But before you start, give your accountant a 15 minute call to check-in. Those 15 minutes can save you time and money if you take action before the year comes to an end. Here are some things your accountant might advise you to do:

Get All Of Your Information In Order

Hopefully, you have invested in QuickBooks or use some form of electronic record keeping, if not, there is no better time than now to invest. Paper records are cumbersome, stagnant, and hard to organize. They can be stolen, burned, or lost. Electronic record keeping can be backed up, transferred, and easily categorized and searched. December is a good time to start categorizing everything.

Last Minute Strategies

Once you can see where you stand, such as how much you have made and how much you have spent, you might want to think about buying that new piece of equipment you need in order to take the accelerated depreciation deduction for the year. Understand that if you spend a dollar in expenses, it does not mean that you will get a dollar deducted from your tax bill; understanding the tax savings vs. the out of pocket cost is important to properly making the best decisions for your unique situation.

If you had an unexpectedly good year and you feel the following year might not be as fruitful, you may want to wait until after year end to press your clients who owe you money for payment. If, however, you have a side business that has not brought in significant income, it may behoove you to press clients for payment by year-end so that you can show income for that business, especially if you plan on refinancing a loan or acquiring a mortgage.

Knowing Where You Stand

It is always better to be aware of your tax situation, before you actually have to pay them. In December, if you do not have the money to pay your taxes, at least you have the time to get it together. Do not let March or April hit you with an uneasy feeling because you have no clue where you stand.

With electronic phishing scams that are aimed at collecting an individual’s personal information, it is easy for criminals to make a quick buck. They can open bank accounts, file taxes, and purchase goods online without anyone noticing. Finally, when people discover that their identity has been stolen, they spend an average of 6 months working to get everything back in order. When it comes to tax identity theft, it can take even longer.

How They Do It

For criminals to have enough information, all they need is your name, Social Security number and date of birth. With those three pieces of information they have enough information to go online, file a fraudulent tax return and seek a tax refund or credit. It is easy money for them and the repercussions are slim. The chances of getting caught and punished are low because each fraud case amounts to an average of $3,400, often too little to merit prosecution. To make putting the criminals behind bars even more difficult, the IRS is limited by law in sharing information from a taxpayer’s return with local law enforcement authorities.

How You Can Protect Yourself

A few sites have been created by the Federal Government to help aid those who know of fraud and who are victims of fraud:

• StopFraud.gov
• The IRS Identity Theft and Tax Records Page
• The SSO Identity Theft and Your Security Number Page

Each page will let you know what to do in case your identity is stolen, but the best solution is prevention. Anytime you write something electronically, that information has the potential to be stolen. Make sure you only shop on reputable sites online and guard your information, especially your SSN, with great care.

Finally, to be safe, file your taxes early if possible. Identity thieves can usually only steal tax refunds if you have not already received your rightful refund. The first person to file wins. So if you are in the door first, it becomes much harder to file under your name and the thief will likely give up and go on to the next identity they have. If you think you might be a victim of identity theft, or you would like to know more ways on how you can protect yourself contact us at the number above today!

Some people are willing to hire anyone with a business or accounting degree. With the right amount of experience, those qualifications may be good enough to fit the bill. But the most common mistake people make when hiring an accountant to do their taxes is underestimating the role of experience. A CPA or business degree alone is not a good indicator of a person’s ability to file taxes.

The issue of hiring someone to do your taxes that is not qualified is much more common than one might think, but likely for reasons that one would not think. We most frequently run into issues with new clients who had family members or friends with some, although limited knowledge of the tax code prepare their returns. These preparers usually have full-time jobs not related to tax, but in the business field. While they can probably handle a straight forward return, such as a W-2 employee with itemized deductions. They may have difficulty in properly filing a return with greater complexity. To make matters worse, they may not even realize that a particular situation is complex and unknowingly file a return incorrectly.

A good indication of ability is the number of years an accountant has spent preparing other people’s taxes as their primary occupation. Filing taxes is the easy part, but if you want to minimize your tax liability and audit exposure, you will need an experienced tax accountant, someone whose primary job and experience come from doing other people’s taxes.

Leaving Money On The Table

One possible scenario when hiring a non-tax accountant to do your taxes is that they will inadvertently leave money on the table, meaning they miss a deduction or tax credit. Understanding best practices takes accountants years of accumulated knowledge from dealing with the tax code.

After an accountant has accumulated enough general tax knowledge, they may begin to specialize. Some industries have complicated regulations and uniquely applicable tax codes that take additional eduction and experience to understand. An accountant with a specialty in your industry can be invaluable resource in tax planning resulting in a lower tax liability.

Paying More Down The Road

Besides lacking experience and possibly causing a person to pay more in tax then necessary, you take on a risk in going with a non-CPA. If you are audited, there is a good chance a non-CPA, Enrolled Agent or Attorney will not be qualified enough to defend you. At the point of audit, it is probably in your best interest to hire a CPA (or other qualified individual) to handle the matter. But since it is an emergency scenario, it will likely cost more than if you had hired a CPA from the start.

Proactive approaches to finances will save you time, money, and worry. Accountants will store all of your historical records for you, so that they are backed up and easily accessible for a potential audit. Hiring a CPA from the start may help to prevent audit red flags and minimize an audit’s potential negative effects.

Getting What You Pay For

If you do not care about how much you are paying in taxes, or that your taxes are filed properly, than you will probably be happy with anyone who will file taxes for you. But if you need every corner and detail checked so that you minimize your tax expense, than you need a tax CPA or qualified return preparer.

When the age of retirement was first established in 1935, the average person only lived to be 61. Dying before, or soon after, retirement was the norm. If you were born in the 50’s or 60’s, living through your 80’s isn’t exceptional, quite the contrary.

For the first time in history, people in their sixties have a retirement longevity equal or even longer than their entire working career. That means we need to plan our finances and strategize for retirement more than ever before.

The Two Key Concepts

(1.) Lifetime Income – not just having enough to retire on the day you retire, but having that income sustain your lifestyle through longer retirements than any generation has ever had.

(2.) Planning for that lifetime income – not taking an investment portfolio into retirement and just hoping that it lasts. We can’t predict the economy, or what markets will do, but we can plan, and that’s where we start.

The 3 Phases Of Retirement

Financial planning for retirement is looked at by identifying what expenditures retirees normally incur. Anytime you categorize life phases, generalizations must be made. There will be many exceptions to the following retirement phases, but generally, we see some trends that are worth planning for:

(1.) Honeymoon/new lease on life phase – many people have deferred luxury and travel during their working years. They have had to raise families, juggle careers, and make enough money to retire. So when they finally arrive at their retirement, they want to get out and enjoy life. Most importantly, expenses do not go down.

(2.) Sowing oats – denoted as increased involvement community and family activities. While the honeymoon phase is fun, many retirees will eventually seek out more fulfilling pass times. Creating a deeper meaning in life normally requires donating time, energy, and money.

(3.) Health – by the time we reach our 80’s most of us will have a medical condition. While they might not be life threatening, they often cause a decrease in ability. There is a huge expense affiliated with receiving proper medical help and daily assistance.

Each phase requires it’s own investment planning and strategy. But these phases are broken down from one single number, the sum of your investment capital. If you would like to figure out how much you will need for retirement, read on in Establishing Your Number.

Preface: In this series on bear markets, we are going to explore not just the facts but the feelings associated with bear markets in order to try to derive effective ways of dealing with them.

The distinction between the facts of a bear market and how you feel during a bear market is crucial in determining your long term financial success. Our gut reaction to a drop in the stock market and our perspective of the market will dictate how we experience these inevitable declines. But your emotions should not be the determining factor in your financial outcome. If you want to come out on top, you have to use logic and reason to overcome strong emotions.

So What Is A Bear Market?

A bear market is when equity markets close 20% lower from the market high point. There are many ways you can measure a bear market, some measurements exaggerate the consequences, while others soften the consequences.

To exemplify a worst case scenario, we will use an exaggerated measurement that counts only pure price decline using the S&P 500 (and its antecedent until 1957, the S&P 90) as our proxy for the overall market.
We have seen thirteen bear markets (as we’ve defined them) in the 63 years since WWII ended – or an average of about one every five years or so. On average, bear markets bottom out in 15 months, cutting the S&P 500 down by a third.

That means nearly every 5 years, we spend over a year in a market decline and by the time the decline stops, a third of the equity has vanished. More importantly, instead of feeling like a normal market cycle, it feels like the world is going to end. The media confirms and feeds into viewers insecurity and sensitivity becomes heightened.

During a bear market, an investors goal should be to overcome emotions and make financial decisions based on reason and history. Since bear markets are a normal occurrence, the doom and gloom scenarios we see on TV or hear from are colleagues are derived from our own, current feelings, not the facts, and make us more likely to react irrationally. The Reality Of A Bear Market is quite different from what most of us experience.