10 Jul Unpredictable Markets – a Harsh Backdrop for Retiring Baby Boomers
As a retirement income planning specialist I help clients structure their assets to cover lifestyle spending for an unknown duration, provide liquidity for unexpected expenses, and meet legacy objectives. Important variables such as inflation rates, investment return, volatility levels, tax policy, our health, and the viability of social promises are unknowable. That’s always been the case, but anticipating and mitigating macro risks appear to be getting more difficult as the rate of change accelerates and the range of potential outcomes expands.
This has profound retirement planning implications as timing risk amplifies investment risk for those in the Retirement Red Zone (5 years before and after retirement), who are in a precarious position in any market environment due to simple timing risk. The actual order and timing of returns has an outsized effect on portfolio value closer to retirement when wealth is at its apex. Anyone can retire; the objective is to stay retired. Understanding, and planning for, this “sequence of returns risk” can be the difference between running out of wealth and never having to worry.
An expending range of potential outcomes is a sub-optimal backdrop for those in the Retirement Red Zone, where the order and timing of returns has an outsized effect on portfolio value and sustainability.
A significant allocation to equities is often recommended to retirees as that asset class is believed to provide the long-term returns needed to keep pace with inflation over what for many will be a multi-decade retirement. If the ‘luck of the draw’ results in poor equity market performance just as you are in the early innings of taking portfolio withdrawals — your retirement savings could take a hit from which you can’t recover. Even as the bull market approaches its tenth anniversary, valuations are not inexpensive, and the range of potential economic outcomes in our rapidly changing world increases.
Sometimes the best way to illustrate that profound, unpredictable events can happen is simply to remember that they have happened. Going back in time a mere 29 years demonstrates a variability in outcomes, and bears witness to events and transformations which ‘could never happen.’
Not only can hard-to-fathom events happen – they have happened repeatedly throughout history.
So, let’s fire up Doc Brown’s flux capacitor for the trip back to 1989. George H. W. Bush was inaugurated, Game Boy was the dominant gaming device, gasoline cost $.97 / gallon, the DJIA closed at 2,753, as the Exxon Valdez, Berlin Wall, Tiananmen Square, Invasion of Panama, the San Francisco earthquake (during the World Series), and Hurricane Hugo dominated the news. The Miami Canes, Michigan Wolverines, SF 49ers, Detroit Pistons, and Oakland Athletics won championships, while The Cosby Show, Driving Miss Daisy, The Little Mermaid, Duran Duran, and Millie Vanillie’s lip-synching scandal dominated pop culture.
Interest rates were elevated:
- 1-Year T-Bill Rate 7.92%
- 1-Year CD Rate 8.48%
- 10-Year Treasury Rate 9.09%
- 30-Year Mortgage Rate 10.35%
Forget the impossibility of foreseeing many of the global news stories, or that Bill Cosby (and OJ Simpson) would go from beloved celebrities to complete pariahs. Reflect instead on global economics and capital markets.
Japan was on top of the world. With its Nikkei 225 at an all-time high (38,915), Japan was thought to be invincible with its keiretsu (interlocking) corporate ownership structure and advanced managerial acumen. Japan was buying up marquee US assets (Pebble Beach, Rockefeller Center, Firestone, Columbia Pictures), it boasted 8 of the world’s ten largest banks, and the world’s:
- highest savings rate (14.5%),
- most expensive real estate (Tokyo – $259,000 per square yard),
- “most admired company” (Sony – with its Walkman, Betamax and Trinitron products).
Americans fretted that our economy was in decline, particularly in comparison to Japan (think China today?). Regardless of how bright, astute, and capable the analyst, no one foresaw what happened next. By various points over the ensuing decades, prime Tokyo real estate lost 99% of its value, the personal savings rate nosedived to 1.7%, Sony’s share price declined by 95% as it, Panasonic, and Toshiba lost $ Billions in value, and Fukushima endured a nuclear disaster. In June 2018, the Nikkei was 22,272, representing a 43% decline over the 29 years!
Of course, other significant unanticipated changes subsequently occurred: the Eurozone crisis, the global financial crisis and a coordinated Quantitative Easing (QE) response. How the future plays out is unknowable, as trends evident today – and those still emerging – unfold. Rapidly-evolving technologies and business models portent massive disruption leaving winners and losers in its wake. Robots are in transit for our jobs – most especially yours. Our country, and others, are bifurcated politically and philosophically, and how the populist movements play out is anyone’s guess. The gulf between the haves and have nots – at home and abroad – is enormous and widening by the hour. Class warfare is likely to escalate. Taxes can – and will – only increase from today’s levels; material increases are as near as the next political regime. The US and other developed countries are massively overleveraged, and the smartest people on the planet do not know how the reversal of $ Trillions in stimulus and QE will play out. This unprecedented global monetary experiment has delivered only low growth, subdued inflation, and elevated asset prices around the globe – thus far.
According to economist and financial commentator, John Mauldin, and the US National Debt Clock (http://www.usdebtclock.org/), total US governmental debt (federal, state & local) presently exceeds $24.3 Trillion, or more than 120% of our annual gross domestic product (GDP). Add tens of $ Trillions in additional “off balance sheet debt,” or the present value of fulfilling promises made for Social Security and Medicare, and we’re confronted with an untenable fiscal gap both in nominal terms and relative to GDP. No combination of dramatic income tax hikes and massive renege on promises closes the gap. How this gets resolved over the ensuing decades is hard to predict. The case can be made for an ultimate solution entailing some combination of the aforementioned along with either – or a combination – of:
- Some form of money printing (currency debasement). Paying with cheaper dollars is an option available as long as the US dollar remains a key global reserve currency.
- A net worth tax on the top x% of the nation’s wealthy. [Why did Willie Sutton rob banks? Because that’s where the money was.]
Either is a confiscatory tax on the wealthy, but the latter may actually be more palatable to a much larger voting bloc (i.e. those not affected). In other words, there is likely a practical limit to a maximum sustainable level of income and wealth disparity, and also to the political influence even mega wealth can effect.
“Them belly full but we hungry . . . . .
A hungry man is an angry man
A hungry mob is an angry mob.”
Bob Marley, “Them Belly Full”
Here’s the thing. There is no map or model to guide us for events that people believe are “impossible.” Financial and other trends persist . . . until they suddenly don’t. And whether we endure a hyper-inflationary currency debasement resulting in tectonic monetary (currency and price) shifts, witness an exodus of wealthy citizens en masse, or another ‘solution’ is tried, our over-extended condition cannot persist indefinitely. Its resolution and the timing thereof will largely NOT be seen coming.
“Currently our approach to risk is ‘probabilistic’ but we should also consider a worst-case approach to risk: the “possibilistic” approach. In this approach, things that never happened before are possible. Indeed, they happen all the time.”
Rutgers University sociologist Lee Clarke
Enter the need to think “possibilistic” more than probabilistic when it comes to income planning for constrained Investors. Retirees need plans that recognize a wider range of outcomes. Consider, in 1989, $250,000 in CDs could provide a retiree $1,767 in reliable monthly income. By 2012, it took $9,000,000 (36X more) to provide the same income. Interest rates matter greatly to retirees, and this relentless cascading of interest rates over multiple decades was not foreseen. Inflation is also an important unknowable factor, as such an invisible tax can severely compromise the buying power of a retiree’s income.
Longevity is the great multiplier of all the other risks and, with retirement horizons expanding – especially for the wealthy, today’s planning needs to be flexible and, to some extent, contemplate “impossible” outcomes.
“It is not the strongest of the species that survive, nor the most intelligent, but the one most responsive to change.”
This discussion looked at the inability to foresee with any degree of accuracy the unfolding of significant events and trends over the past few decades. What today’s trends and conditions portend is anyone’s guess. Trade wars, geopolitical crises, and other impactful things can occur without warning. My intent is not to ‘scare’ investors or offer any form of prediction. Rather, I’m reminding of the unpredictability of market movements based on random occurrences, and the profound detrimental effect such volatility can have on a portfolio in ‘decumulation’ mode.
Via formal retirement plans, my team and I help clients quantify their sensitivity to investment volatility, and determine that portion of their monthly retirement income needed to be predictable. Liquidity needs and desire to leave a financial legacy are addressed. We consider both idiosyncratic and increasingly broad macro risks and the use of risk-pooling options to flexibly managing the fragile retirement risk zone preceding and immediately following retirement.