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March 12, 2006

Managing Retirement Income Conference

I promised to blog from the Second Annual Managing Retirement Income Conference that I attended at the end of February. I broke my promise!

 

I have received several emails saying you are waiting - with baited breath -to find out what was new in the world of managing retirement income. Truth be told - not much. That is why I didn't blog it in real time.

 

Not much has changed since last year's conference, although the conference itself was both better organized and better attended. Kudos to the conference co-chairs - Francois Gadenne of Retirement Engineering, Inc. and Charlie Ruffel of PlanSponsor for that.

 

I did, however, walk away with a couple of themes that seemed to run throughout the conference. Before I summarize them for you, I would warn you that the themes I walked away with are the product of my own very real biases and filters. It is not only possible but highly likely that the other attendees walked away with an entirely different set of themes. But you are reading my blog, so here they are:

 

The problem is real. Believe it or not, there is still some debate about this. But at the end of the day, it is plainly obvious that the retirement income problem is very real and very pressing. As to what is being done about it, I think the news is mixed. Clearly, the attendees to this conference are very aware of the problem, if for no other reason than that it represents a big, fat, hairy opportunity for those who address it - or a big, fat, hairy threat to those who ignore it.

 

My sense is that the big industry players cannot let go of the idea yet that they can solve the problem with existing products. There is still a overwhelming desire to cram a square peg (modern portfolio theory, mutual funds, annuities, et. al.) into a round hole (a very new and real problem). Yes, they may add a few bells and whistles to them but you can't put a suit on a pig and pass it off as a prince!

 

People wait until it is too late. Another flash of the blindingly obvious. You can posit many thoeries on why but the fact is that people in general wait until far too late to address retirement issues. They wait far too late to begin accumulating assets in retirement and then are forced to take on far more risk than is appropriate for money you absolutely know you are going to have to have someday. They wait until it is far too late to begin understanding the issues and risks that need to be addressed to successfully negotiate 30 years of retirement. And finally, they wait until they are far too late to switch from accumulation to income.

 

One of my biggest Aha! Moments came when Professor Zvi Bodie, from Boston University, mentioned that the academic evidence completely contradicted the conventional wisdom in the area of asset allocation theory. According to Dr. Bodie, this research indicates that rather than taking more risk when you are younger and less when you are older, a person is best served by a constant level of risk over their investment horizon.

 

This would be totally consistent with my view and my way of investing, not to mention my own experience. I will post more on this idea later. For now though, it supports two points I harp on all the time: 1) manage risk and the performance will take care of itself; and 2) income investing isn't for old people. The time to switch your portfolio to an income stream is early, way before you need income, in order to avoid the conversion risk. After all, income re-invested is growth.

 

There is a huge disconnect between retirement expectations and the retirement reality. The data suggests that we are largely still in a state of total denial! Proof of this fact lies in five major areas.

 

First, the replacement rate is steadily shrinking. Replacement rate is the amount of pre-retirement income that will be replaced by government entitlements (like Social Security and Medicare) and employer sponsored pensions. The federal government is mired down in finger pointing and politics as usual and with each passing day gets farther and farther away from fixing the Social Security and Medicare problems.

 

Meantime, the percentage of workers who are participating in pension plans is shrinking every day. According to the Bureau of Labor Statistics, the percentage of full-time workers covered by a defined benefit plan has gone from 42% in 1990 to 18% in 2005. Given the almost daily news of major corporations like IBM, Verizon and Gerneral Motors freezing or terminating plans, that trend is likely to increase or even speed up. And yet, the worker is in my view, very slow to recognize the implications or make course corrections. You have an entire generation, that being the baby boomers who are standing there like deer in the head lights!

 

If you ask baby boomers how they intend to deal with their savings shortfall, 66% say they plan to work past age 65. In reality though, only 26% of them actually do and EBRI studies say that a majority of recent retirees were forced to retire earlier than they wanted to by job or health issues. If this is plan A for 66% of 76 people, I would suggest we need to find a plan B and find it fast!

 

I heard at least one person argue (John Ameriks from Morningstar) that the problem wasn't as dire as all of us worry worts are making it out to be. I think it is worse. One reason I think so is the spiraling cost of healthcare. This was my other Aha! We know that few people have even done a thorough analysis of their income needs in retirement by the time they retire! I would bet that even those that have underestimated the cost of healthcare over their lifetime. In his talk, Jerry Kinney, Vice Chairman of Merrill Lynch reminded us that healthcare costs are increasing at 10X the rate of the CPI!

 

For someone turning 65 in 2006, it is estimated that, on average, 37% of their Social Security benefit will go to Medicare premiums, co-payments and out-of-pocket expenses. By 2026, that number is expected to be 53%. Combine that with the fact that Social Security benefits make up over 80% of the income for more than half of the over 65 population and that leaves little or nothing for even the most essential items like food, clothing and shelter.

 

Here is another example. The person who turns 65 in 2015 and lives to be 90 (which is a much higher probability than most people think) will spend an estimated $426,000 in cumulative healthcare premiums, co-payments and out-of-pockets expenses. That is huge by any measure, but especially scary when you consider that the average retiree doesn't have anywhere near that much saved, in total, at retirement. It's pretty hard to see that scenario playing out in a positive fashion.

 

Earl Wilson says we are a generation "driving mortgaged cars on bond financed roads using credit card gas." Strange but true, baby boomers will enter retirement with more debt than assets. According to FRC, the average American is now in a net negative financial situation.

 

Given that, it isn't surprising that Americans do not have enough saved to maintain their current standard of living. The average 401(k) balance for those in their 50s as of December 1999, in other words, the near retiree group, was only $129,218! According to the Employee Benefit Research Institute, 60% of baby boomer sill have to make hard choices about reducing their standard of living in order to keep from running out of money and another 20% will, barring some unforeseen miracle, run out of money before they run out of breath!

 

Call me Chicken Little but I really do believe the sly is falling. I am eagerly looking forward to the day that someone shows me overwhelming evidence to the contrary but until then I feel we must continue to ring the church bells and shout from the rooftops, "Retirement is coming! Retirement is coming!"

 

I am always very interested inhearing your thoughts and feedback. Please post your coments below.

 

SOURCES:

 

Too numerous to list here. General attributions were given throughout. If you need a source for any of these numbers I will be happy to provide them. Just email me.

 

Kim Snider, Kim Snider Financial Communications, Chronim Investments and/or Snider Advisors make no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. Call 866-952-0100 to request the Snider Investment Method™ Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing. All investments are subject to risk including possible loss of principal.

Posted by Kim Snider on March 12, 2006 | Permalink

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