What’s Risk, Part II

Last month, we touched on different types of risk associated with investors in the accumulation phase of investing. For this month’s topic, we are going to look into a few major risks that must be planned for when in the retirement income stage of one’s life. The three basic risks we are going to look at are: longevity risk, inflation risk and health care cost risk.

Longevity risk, in its simplest form, is the risk of outliving one’s assets or running out of money. When working with clients, this is probably the biggest fear portrayed to us when deciding to venture into retirement. Almost everyone wants to retire as soon as possible, but no one wants to be broke and solely dependent on Social Security when they are in their 80’s! The tricky part when trying to plan for longevity risk is that no one knows the exact day they will die. Life expectancy tables give a vague idea of estimated ages of living but the reality is that there are so many variable depending on family history, past health issues, lifestyle, etc. that relying on those numbers is not a sound strategy. Plus, there continues to be more and more data suggesting that life expectancies are increasing each year—they are saying now that for a 65 year old couple that retires together, there is a 50% chance at least one of them will leave to be 90 or older! So, what are some strategies to plan for this risk? Well, the first thing we do when working with clients is to develop a plan where we try to plan for asset levels to keep maintained over time. We don’t want investments to be eating into principal and approaching zero as one gets older. This is done by actually having a written plan and also by understanding that only a certain percentage of assets can be withdrawn each year to provide retirement income.

A second basic risk when planning for retirement income is inflation risk. The risk here is that inflation, over time, will decrease the purchasing power of one’s income. Someone who needs $50,000/yr income in 2011 will be in for a big shock if they don’t plan on increasing their income in retirement over the years. Here are some figures to show the impact of inflation over the past 25 years—in 1986, a loaf of bread cost $.56, a gallon of milk cost $1.92 and new car cost $6,700. Compare that to 2011 when a loaf of bread costs $1.50, a gallon of milk costs $3.32 and a new car costs $25,170! Someone who retired in 1986 and didn’t account for inflation would be in for a real hurt right now. The first way to combat this risk is to understand the impact of inflation over time. We hear too often of people who say they can retire on a certain level of income but they didn’t factor in the inflation impact of needing a rising income as years pass. In our income plan projections with clients, we always factor at least a 3% inflation rate over time so that retirement income can keep up with rising costs. Also, it is important to not be too conservatively invested in retirement. Those who are too conservative often ignore the damage that inflation will have on their assets. Our strategy with clients in retirement is to have more conservative funds to provide income for the next 5 years with other assets still in more growth oriented funds that have historically outpaced inflation over the long term. You may know of someone who had money invested in CDs that were earning 4-5% five years ago but are now earning 1% or less and are feeling the sadness of this 60% loss of purchasing power, especially since inflation costs still went up!

A final basic risk in retirement income planning is health care cost risks. There are a lot of unknown parts with this risk because it will be different for almost everyone who retires. Unlike planning for a certain level of income, health care costs are largely unknown at the start of retirement and can change at any time if a health need arises. Being as prepared as possible is one of the best ways to combat this risk. The first thing everyone retired should do when eligible is making sure they apply for Medicare Part B coverage. Anyone over the age of 65 is eligible for Medicare Part A coverage (which is usually free); however, it is up to each individual to enroll for and pay for Part B. Also, one thing about Medicare that is usually misunderstood is that it is not a comprehensive coverage of medical expenses. There are ‘gaps’ within the coverage—but these can be lessened by purchasing a Medigap policy (sold by private insurance companies). Another way to be prepared for potential future medical costs is to buy long-term care insurance to help cover nursing home, assisted living or home health care needs that may occur. We all tend to fall into the trap of thinking ‘it will never happen to me!’ The reality though is that roughly 70% of those over 65 will require some form of long-term care before they die₁.

There are certainly many other types of risks to consider when planning for retirement income from one’s assets. The key in our mind for these (and other) risks is to understand the challenges they may present and have a strategy on how to combat them. Everyone is a little bit different in what their goals and desires are in retirement, so risks are different and could potentially be constantly changing over time. Part of our job as your advisors is to help you plan for these ever-changing risks and answer your questions about them. If any risk is causing a concern for you now or you see as a potential risk in the future, please get in touch with us…our lines of communication are always open.

1- US Dept. of Health and Human Services, National Clearinghouse for Long-Term Care Information, 11/03/2010

Investment Education for the Month: Corporate Bonds

A corporate bond is appropriately named as they are bonds issued by corporations. These bonds serve the purpose to help corporations raise money in order to expand business operations. All corporate bonds have a coupon payment, which is financial terminology for what the interest payment will be. The interest payments from corporate bonds are usually taxable to the investors that hold the bonds.  Due to the taxable coupon payments, it is beneficial to compare the yield on a corporate bond to the ‘tax-equivalent yield’ of municipal bonds (which have tax-free yields, see March 2010 newsletter) to see which may provide the best after-tax yield.

Investors that own corporate bonds generally receive higher yields than investors that own government bonds (bonds issued and backed by the US government). This is due to the fact that corporate bonds have a higher default risk than bonds backed by the government; as individual corporations have the potential to go out of business (that corporation’s bonds would then lose value or could become worthless). Corporate bonds can be high yield (‘junk’) bonds which investors need to be careful investing in. These pay much higher interest rates than investment grade (highest quality) corporate bonds. However, these high yield bonds present the greatest risk of loss and greatest amount of volatility.

We do not believe in owning individual corporate bonds. We feel that presents too much risk by relying on an individual corporation by itself (do you know anyone that owned GM bonds that lost great value?).  We prefer investing in corporate bonds through mutual funds that own hundreds of different corporate bonds. The mutual funds provide automatic diversification between many different companies and also provide the expertise of the mutual fund portfolio managers who analyze individual corporations to try and invest in only the best of breed corporations. Within taxable bond mutual funds, corporate bonds typically are a sizeable portion inside the fund because of the yields they provide and the opportunity for appreciation.

Bonds offer many choices and yields that are much higher than CD’s or Money Market funds and should be a serious consideration for those looking for income. However, with any investment, the type of bond fund one should choose depends on many factors.

Announcing a new ”Crew” member of WealthCare Partners

We would like to announce that Crew Asher Ford was born on August 25th coming in at 6 pounds 12 ounces and 20 inches. All family members are doing well but Eric is not getting much sleep.  :)

Did you know?

A YEAR LATER – The S&P 500 has fallen at least 5% in a single trading day 24 times since 1950, most recently on 8/08/11. In the 1 year following the previous 23 “5% or more” tumbles, the S&P 500 gained an average of +18.5% (not counting the impact of reinvested dividends). The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the US stock market (source: BTN Research)

WORKING FOR THE GOVERNMENT – 1 out of every 6 American workers is employed by the government, either at the federal, state or local level. When you remove the 7.9 million public school teachers nationwide from the calculation (teachers are technically local government employees), the ratio falls to 1 out of every 9 American workers is a government employee (source: Department of Labor).

Stay Positive and Believe in Yourself!

“Faith is the confidence that what we hope for will actually happen; it gives us assurance about things we cannot see” Hebrews 11:1

“A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty” Winston Churchill

Don’t Keep Us a Secret!

We are always looking to help others achieve their financial goals. Any friends, family, or colleagues you come across needing assistance with planning for retirement or college, rolling over a 401k, or just frustrated with their current advisor please pass them along our name. Your referrals are the best compliment we can receive! Please feel free to forward this monthly newsletter to your family, friends or colleagues (see ‘Forward email’ link below).

Disney Vacation Home Rental

We have arranged a special benefit for “clients only” who wish to vacation in the Disney area. You can rent a 4 bedroom home 8 miles from the Disney entrance for a substantially discounted rate of $500/week + taxes. This is a fully furnished home with private pool, full kitchen, living room, master suite, 2 full baths, and washer/dryer. The house must be rented for at least a full week and is available on a first come/first serve basis. This discounted rate is the minimum to cover costs and is available only to clients at this special rate.

Disclaimer: © 2011 WealthCare Partners – Securities are offered through Cadaret, Grant & Co., Inc. Member FINRA/SIPC. WealthCare Partners and Cadaret, Grant & Co., Inc. are separate entities. WealthCare representatives are licensed in the States of Indiana, Florida, North Carolina, South Carolina, Texas, Washington, California, Oregon, Michigan, Illinois, Ohio, Mississippi, and New York.