Home » COMMENTARY: In today’s cheap money environment, retirees’ challenge is to have a plan and stick to it

COMMENTARY: In today’s cheap money environment, retirees’ challenge is to have a plan and stick to it

By Scott King
Unified Trust

LEXINGTON, Ky. (July 24, 2013) — Today’s retirees will confront a more challenging landscape than we have experienced since the 1950s. We have undergone a multiyear bull market in stocks that, while welcomed, has come at a price to savers and those reliant on conservative income sources.

This rally is being fueled by abundant access to cheap capital that exists, for better or worse, as a result of the loosest monetary policy our Federal Reserve has ever undertaken. Capital helps companies grow, which translates to stock market gains.

At a fundamental level, the real byproducts of Fed policy are rock bottom interest rates, which may be great for cash-starved corporations, small businesses dependent on short term credit and home mortgage applicants. But it is terrible for savers. Retirees, perhaps more than any other group, have found themselves at a loss in the search for investments that offer reasonable income streams with low risk.

Another key side effect of the Fed’s cheap money policy is the eventual hearty dose of inflation, which compounds the need for an income plan that enables retirees to maintain purchasing power and, by extension, their living standards amid a rising price environment.

We can start with the assumption that our audience has a full Funded Ratio, which means their retirement assets match their retirement needs. In effect, this means they have saved enough during their working years to cover basic and discretionary retirement expenses as long as their savings remain invested with a prudent strategy.

If the first piece of our puzzle is the critical Funded Ratio measure, then the second piece is represented by three more abstract considerations. An effective plan must manage a retiree’s exposure to sequence risk, inflation risk and longevity risk in order to achieve true income security.

Sequence risk is the potential for a large drop in the value of an investment portfolio early in retirement. All markets experience periodic downturns, but the real danger comes from exposing an entire nest egg to a single asset class. If stocks or bonds experience a sudden price drop, but an investor only has a portion of their assets there, then they have limited sequence risk.

Inflation risk can be understood by looking backward. Conservative investors in the 1940s and ’50s, scarred by the stock market volatility of the Great Depression, often stashed their nest eggs in U.S. Treasury bonds. Given their popularity, these bonds offered low yields relative to most other periods, though they were still higher than today.

The inflation rate during this timeframe was higher than prevailing short-term Treasury yields, so investors actually lost money in real terms. A decade of continual price increases left investors with about half their original purchasing power.

Inflation risk has a relatively simple solution. Retirees must ensure they plan for a potential return on their savings that accounts for both their income needs and inflation.

Longevity risk is a bit paradoxical. The risk of a retiree outliving their savings suggests that they must first have a long life, which is usually welcomed, but one that increases in austerity with age, which is considerably less desirable. A pension, managed investment plan, or annuity can all be used as part of a solution to the good problem of funding a long retirement.

Each of these risks requires different, but not opposing, considerations. They can be balanced in a plan that diversifies among asset classes and accounts for income needs, inflation and a long time horizon.

Only once these guiding parameters are factored in, and we understand the full purpose that a plan needs to serve, should a retiree begin to evaluate investment options. The oft-asked question of “what to buy” becomes much more straightforward endeavor once we know what those investments need to accomplish. Retirement, as with most things, benefits greatly if you follow a plan.

Scott King is a Senior Fiduciary Investment Advisor for Unified Trust’s Wealth Management Group, a national independent trust company headquartered in Lexington, Ky., that manages more than $3 billion in assets.