Investment & Portfolio Strategy

Transcription

1 Ivestmet & Portfolio Strategy Jauary 2014 Five Keys to a Successful Retiremet Thikig about retiremet is o loger a future evet or viewed as optioal for may Americas. Most recogize the eed for careful plaig throughout ad beyod their workig years as more ad more people are resposible for maagig their ow retiremet savigs rather tha relyig solely o a pesio. While it is a positive that Americas are expected to live loger, this ca also add to the already dautig challeges of fudig a comfortable retiremet. With the assistace of a PNC ivestmet professioal, ivestors ca map out a course to help meet their fiacial goals. This process ofte etails a objective of cotributig to ad costructig a portfolio desiged to help meet idividual cash flow eeds i retiremet while preservig capital ad maagig risk. We have writte several times about differet (yet ot mutually exclusive) methods of ivestig for retiremet (see PNC s May 2013 white papers, Retiremet: Total Retur ad Retiremet: Icome Floor), which provide isights o how ivestors may seek to achieve their stated objectives. With the goal of ivestig for retiremet i mid, we wat to focus o five of the keys to a successful retiremet as a follow-up to our September 2013 publicatio, Five Threats to Your Retiremet. Assess your situatio. Start early ad take the free moey. Ivest with the goal i mid. Adapt to market coditios but do ot chase fads. Stay o pla ad moitor the progress. Assess the Situatio There are a multitude of variables to cosider whe assessig a idividual s retiremet situatio. We will focus o some mai oes here, but there is o doubt that there are a sigificat umber of persoal circumstaces that this geeral treatmet will ot specifically cover. A startig poit for cosiderig a retiremet goal is to determie the amout of moey oe aticipates eedig aually durig retiremet. We thik a good a place for most people to begi is with their curret aual expeses, sice most people would like to live as well as or better tha they do curretly if they possibly ca. E. William Stoe, CFA, CMT Maagig Director, Ivestmet & Portfolio Strategy Chief Ivestmet Strategist Marsella Martio Seior Ivestmet Strategist Michael Zoller Ivestmet Strategist Other geeral issues to cosider are: risk tolerace how much market fluctuatio ca you tolerate; other expected liabilities are there additioal costs you may eed to cover durig retiremet, for example, support of a adult child; pc.com

2 Five Keys Chart 1 Value of a Dollar over 40 Years at Various Assumed Growth Rates Dollars % 5% 7% Source: PNC Years Sice Iitial Ivestmet other expected icome are there ay additioal icome sources i additio to your retiremet accout, for example, Social Security; estimated time i retiremet at what age would you like to retire ad estimated lifespa; ad other cosideratios for example, do you wat to leave aythig to others or do you pla to use all the assets for retiremet? Will a survivig spouse eed fuds for support whe the other predeceases him or her? It ca also be helpful to thik of the cocept of lifetime capital to perhaps ucover other parts of the retiremet puzzle. Thik of youger persos as buildig up their huma capital as they go to school, trai, ad get experiece for their future career. They may have a sigificat amout of huma capital built up ad i most cases very little or egative fiacial capital (depedig o the size of their studet loas) because they have ot etered their peak earig years. Essetially, as persos age, they wat to use this huma capital eared i youth to build up fiacial capital to save for retiremet. This paradigm ucovers the fact that those early i their careers, especially those with families to support, may wat to cosider life isurace as part of the family retiremet blueprit. I the ufortuate circumstace that a youg perso dies, he or she has ot yet had the opportuity to covert itellectual capital to fiacial capital for a family s future support; all the future earigs power is likely lost. Iterestigly, we believe this argues for a lower eed for life isurace products as oe ages ad amasses more fiacial assets. There are otable exceptios to this geeral tred whe oe cosiders estate tax plaig ad other specific situatios. Start Early ad Take the Free Moey Startig early focuses o the amazig aspect of time i the compoudig of moey. Rather tha eter ito the mathematical calculatios, let us illustrate with some examples. Usig a coservative costat retur rate assumptio of 5%, $1 would become more tha $7 i 40 years. If oe lets that $1 grow for oly 20 years, it would be worth $2.65 or about a third of its value after 40 years, despite beig ivested half the time (Chart 1). The focus here is o the legth of time that oe ivests because that is somethig directly i the cotrol of the ivestor. It should be oted that differeces i returs over these periods is also illustrated i Chart 1. As illustrated, over 40 years the value of $1 grows to more tha $7 at a 5% retur; while at 7% it grows to almost $15; ad at 3% it grows to oly $3.26. The secod part of this key is focused o takig the so-called free moey. This refers primarily to 401(k) plas i which may employers match a portio of employees cotributios to their retiremet. There ca be other istaces of this type of opportuity, but this cotributio matchig is probably the most commo for most employees. Let us assume that someoe cotributes $6,000 per year for 40 years ad the compay matches 50% of that cotributio. This $9,000 adds up to more tha $1 millio over 40 years if it grows at 5%. Agai time makes a huge 2 Jauary 2014

3 Five Keys to a Successful Retiremet differece here, with the total amoutig to less tha $300,000 if cotributios are made for oly 20 years. Differece i retur makes a large differece over time, as well, ad we illustrate the same example with 3% ad 7% returs (Chart 2). Chart 2 Growth of 401(k) at $6,000-per-Year Cotributio with Employer Match over 40 Years at Various Assumed Rates of Retur 2.0 3% 1.8 5% 1.6 7% Years Sice Iitial Ivestmet Source: PNC Millios of Dollars Chart 3 Growth of 401(k) at $6,000-per-Year Cotributio with No Match over 40 Years at Various Assumed Rates of Retur 2.0 3% 1.8 5% 1.6 7% Years Sice Iitial Ivestmet Source: PNC Millios of Dollars The value of this employer match is really show i our fial illustratio regardig this Start Early key whe we show the same $6,000 aual cotributio as above, but with o employer match. Across all the cases, the fial value is oly two-thirds of the value of those with the employer matchig assumptio a differece of about $226, ,000 (Chart 3). Though ot illustrated here it should be oted that takig loas or withdrawig fuds from a 401(k) would have a detrimetal impact o the total expected value. Ivest with the Goal i Mid We believe selectig a appropriate log-term strategic asset allocatio that matches with the Assess the Situatio key is vital for maagig fuds set aside for retiremet. Focusig o the log-term aspect of this goal for the vast majority of people should help i selectio of a appropriate asset allocatio. It is worth otig that the period of ivestig for retiremet is actually much loger tha most people cosider. I our illustratios above we used 40 years, but oe should assume the total period actually spas from the start of a career though the ivestor s lifetime, which is actually 60 years or more i may cases. I fact those plaig to leave their retiremet accout to their estate or charity may wat to assume a eve loger ivestmet period. It is worth otig that a sigificat shift happes whe someoe actually retires, whe the ivestor, all other thigs beig equal, has less ability to withstad larger declies i portfolio values because there are o loger iflows ito the accout to support retiremet spedig, oly outflows. 3

4 PNC STAR This whole discussio matters because historically the best way to icrease returs both omial ad real i a effort to reach goals has bee to icrease the proportio of stocks i the portfolio. While we would expect that stocks will cotiue to outperform cash ad bods over the log term, there is o guaratee of these returs, ad stocks ca be subject to large declies at times. This is illustrated by the returs for various asset allocatios sice 1926 (Table 1 ad Chart 4). Table 1 PNC Asset Allocatio Profiles Preservatio Coservative Moderate Balaced Growth Aggressive Stocks 15.0% 35.0% 50.0% 65.0% 80.0% 0.0% Bods Cash Total 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Source: PNC The iformatio i this table is for illustrative purposes oly ad does ot costitute the provisio by PNC Bak of ivestmet advice or a recommedatio to buy or sell ay security or adopt ay ivestmet strategy. Chart 4 Historical Returs ad Rage of Returs by Asset Allocatio Profile (Percetage Aual Returs, ) -43.3% -35.6% Highest -Yr. Rollig Highest 1-Yr. Geometric Mea Lowest -Yr. Rollig Lowest 1-Yr % -23.4% -17.1% Aggressive -1.4% Growth Balaced Moderate Coservative Preservatio -6.9% 9.8% 20.1% 17.2% 0.4% 9.3% 16.3% 8.7% 1.6% 15.7% 2.8% 8.1% 15.0% 7.4% 3.8% 11.3% 17.7% 5.3% 1.9% 26.7% 29.2% 37.0% 44.5% 54.0% -60% -40% -20% 0% 20% 40% 60% Source: Ibbotso Associates, PNC Table 2 Historical Average Aualized Returs Jauary 1926-July 2013 Real Nomial S&P %.00% Log-Term Gov t Bod Day T-Bill Iflatio NA 2.97 Source: Ibbotso Associates, MorigStar, PNC I our opiio, the key to selectig a appropriate asset allocatio is to select the oe that produces eough returs for the ivestor to reach his or her goals i the log ru while withstadig, both i moetary ad psychological aspects, possible declies i portfolio value. It is importat to defie these potetial declies i portfolio value both i terms of omial ad real dollars. The real (after-iflatio) value matters because retaiig or growig purchasig power is a primary goal of essetially all ivestors. Takig a log-term view of aualized returs, we show the effects of iflatio o returs o several asset classes i Table 2. We have writte several times about differet (yet ot mutually exclusive) methods of ivestig for retiremet (see PNC Wealth Maagemet s May 2013 white papers, Retiremet: Total Retur ad Retiremet: Icome Floor), which provide isights o how ivestors may seek to achieve their stated objectives. 4 Jauary 2014

5 Five Keys to a Successful Retiremet Adapt to Market Coditios but Do t Chase Fads With the seemigly ever-edig stream of ivestmet products ad advice beig dispesed, adaptig to market coditios is likely to remai a challege i terms of separatig the wheat from the chaff. A geeral rule of thumb for separatig betwee true ivestmet themes ad fads is to focus o valuatio, risk, ad whether the tactic is uderstadable. Focusig o valuatio ca help by givig a idea of both the growth expectatios built ito the ivestmet ad possible future returs. Thikig about the possible risks iheret i a ivestmet ca also help clarify views. For example, eve though this ivestmet might promise a high yield, ca the subject compay cotiue to pay these rates ad how? I may cases, if a ivestmet is too complicated to be explaied or you caot uderstad how the compay or ivestmet makes its moey, the it might make sese to thik twice. What really complicates matters is huma ature, which is predisposed to watig to move with the herd ad particularly ot watig to be left behid whe others seemigly are profitig greatly. To paraphrase Berkshire Hathaway Vice-Chairma Charlie Muger, evy is the deadliest of the ivestmet sis. The iterestig thig about bubbles i various ivestmets is that they begi with a kerel of truth but the cotiue to feed o the herd behavior beyod reaso. For example, there is little doubt that iteret techology did chage the world durig the techology bubble, but valuatios were drive to extremes ad may compaies durig that period had a usustaiable busiess model. Some busiess models were aki to we ll sell products at a loss but make it up o volume. Please ote that the geeral rule of thumb oted above may help ivestors avoid situatios like these. Rather tha focusig oly o the egative side of this key, let us explore some examples of adaptig to a curret market eviromet. Our Five Threats to Your Retiremet publicatio focused heavily o the curret very low level of iterest rates o both cash ad loger-term bods relative to history. Please see that publicatio for more details, but Table 2 (page 4) ad Chart 5 here tell the story. Though well off their lows, -year Treasury yields still do ot have much margi for error relative to log-term average iflatio. Cash (short-term deposits) yieldig essetially othig i effect results i a loss of purchasig power due to iflatio, while i the past, short-term deposits typically had provided at least a small amout of real (after-iflatio) retur. Our advice regardig this situatio has bee two-fold. Cosider your overall asset allocatio i terms of your goal to retai ad grow purchasig power. Cosider diversifyig your fixed-icome holdigs. For example, may ivestors typically had owed oly a core bod allocatio, such as muicipal bods or a taxable bod allocatio based o the Barclays Capital U.S. Aggregate Idex. So i our opiio it makes sese to cosider addig strategies icludig global bods, adjustable-rate securities (leveraged Chart 5 -Year Treasury Yield versus Iflatio Percet Year Less Year-over-Year Chage i CPI -Year Less Log-Ru Average CPI Source: Bureau of Labor Statistics, Bloomberg L.P., Ic. 5

6 PNC STAR loas), ad absolute-retur-orieted fixed-icome strategies 1 (ucostraied bod strategies) to both diversify credit exposure ad reduce iterest-rate risk. Other adaptatios to market coditios ad advacemets that are worth highlightig here are liquid alterative ivestmets ad smart beta. May of the strategies uderlyig alterative ivestmets have bee aroud for may years, but were typically oly available i limited-partership form or to very large istitutios. The ladscape has chaged i the wake of the fiacial crisis ad demad for mutual-fud-style alterative ivestmets. PNC developed a proprietary risk-targeted approach to usig these liquid alteratives for cliets that we believe should help diversify portfolio risks away from just the traditioal risks from stocks ad bods. Smart beta, while a relatively ew cocept, actually tries to systematically mie log-term strategies that were typically used by active maagers i the past to improve returs i a cost-effective maer. PNC STAR is our proprietary smart beta strategy that we thik ca be a attractive additio to may portfolios. Please speak to your PNC ivestmet professioal ad see our Jue 2013 Ivestmet Outlook, Evolutio of Alteratives, ad November 2013 Ivestmet Outlook, A PNC STAR Is Bor, for more iformatio about these strategies. As a closig thought o this key, it is worth otig that too much of a good thig might i fact be too much, so it is likely that the core of most portfolios should remai the traditioal buildig blocks of stocks, bods, ad cash alog with cosistetly attedig to key three, ivestig with the goal i mid. Stay o Pla ad Moitor the Progress Sice oe caot cotrol the market ad how it behaves, focus o some actios that you ca cotrol ad retai disciplie aroud those actios. There really are two tactics to stay o pla. Key oe, start early, focuses o the beefit of time i compoudig, but we have also show that cosistet added ivestmet over time, eve of a relatively small sum, ca really add up. Further if there is matchig ivolved, the portfolio ca grow at a eve more rapid rate. Edig cotributios to the retiremet pla ad possibly foregoig matchig cotributios ca have seriously egative cosequeces for the log-term value, so stickig with a ivestmet pla is crucial. It is imperative that oce you have assessed your situatio ad selected the appropriate asset allocatio that you do ot allow the market to dictate your pla. This importat cocept eeds more discussio ad illustratio, so we will delve ito it below. There may i fact be reasos that a ivestor should chage a ivestmet pla. Our Assess the Situatio key is actually a iterative process ad should be revisited at least every few years (we believe aually makes the most sese) or wheever there are sigificat chages to the geeral issues outlied i that sectio. A ivestor should ot, however, chage ivestmet plas solely based 1 Please see our July 2013 Ivestmet Outlook, Breakig the Bods, for more iformatio o absolute-retur-orieted fixed-icome strategies. 6 Jauary 2014

7 Five Keys to a Successful Retiremet o market behavior. Allowig the markets to dictate behavior is a recipe for retiremet failure as we will outlie below. Because publicly traded securities have a quoted price every day, they are subject to the whims of huma behavior ad irratioal activity at times. Imagie if a ivestor were to behave reactively with some other large assets, like a home. That behavior would lead to depedig o what people were willig to offer for a home o ay give day, the homeower may wat to sell just because others decided it was ot worth as much as it was the day before. What if o oe wats to buy it? Does that make it worthless or make the homeower wat to sell it more? Obviously this is a extreme example, but hopefully it illumiates the uderlyig philosophy. Aother illustratio will use the egative side to allowig the market to determie a ivestor s actios, but we will fiish with a more positive way to take advatage of market chages. The fiacial crisis provided a good example of the dark side of lettig the market determie a ivestor s actios. The S&P 500 hit a peak i mid-october 2007 at 1,576, the the market proceeded to get hit extremely hard by the fiacial crisis, bottomig i early March 2009 at 667 a stomach churig declie of about 58%. Ayoe sellig stocks durig that declie probably felt pretty good about it as stocks cotiued to feel pressure, but the, before the ecoomy eve started to recover, stocks bega to rise. With the S&P 500 aroud 1,800 i December 2013, stocks are sellig for 270% of the low idex value (Chart 6). Sellig stocks based o price actio aloe actually causes the eed to make two correct decisios, whe to sell stocks ad whe to buy them back. It is highly ulikely that ayoe ca time those trasactios perfectly. Usig this time frame as a example it is easy to see that ayoe sellig out of stocks ad movig to cash at ay poit is ow behid i terms of performace. Worse, ayoe sellig out aywhere ear the bottom has lost out o so much of the reboud that their et worth is likely impaired idefiitely. This illustrates the importace of stayig ivested ad ot allowig the market to dictate your actios. Let s cosider a more proactive way to maage the asset allocatio of a retiremet pla. PNC recommeds that ivestors set a target asset allocatio cosistet with their retiremet goals. The the allocatio should be rebalaced toward the target periodically aually or whe it falls outside of the allocatio by percetage poits or more. This accomplishes a few goals. Chart 6 S&P 500 Price Idex 2,000 2,000 1,800 1,600 1,400 1,200 1, Source: Bloomberg L.P., PNC First, it systematically implemets buy low ad sell high. For example, a ivestor who targeted 50% i stocks ad 50% i bods would sell stocks ad buy bods after a year with very good stock returs ad vice versa. Secod, it keeps the ivestor s targeted risk level cosistet with his or her goal as assessed rather tha allowig it to drift to a sigificatly higher or lower level. 7

8 PNC STAR Chart 7 Portfolio Values 550 With Aual Rebalace 500 No Aual Rebalace Dollars Source: Bloomberg L.P., PNC Third, our aalysis has show that periodic rebalacig ca improve both the absolute ad risk-adjusted retur of a portfolio. 2 Sice a picture is worth a thousad words, we ll coclude this key by illustratig a stylized example of a ivestor with a asset allocatio target of 65% stocks ad 35% bods from the ed of 1994 through November Oe ivestor rebalaced the portfolio back to the target allocatio at the ed of each year, while the other ivestor made o chages durig the period. As oe ca see, the simple, systematic strategy sigificatly outperformed the do-othig strategy (Chart 7). It is worth otig that a more optimized rebalacig strategy could have show eve better results, but i our opiio the power i the idea is that eve a very simple, systematic pla should improve results over time. Coclusio While may of the keys might soud simple ad certaily our goal is to help idividuals take actio to improve their retiremet plaig ad ivestig by simplifyig the steps, the actual implemetatio ca be dautig ad cofusig. This cofusio should ot be shockig, give the vast array of ivestmet products, strategies, ad advice i the marketplace ad the fact that idividuals get oly oe lifetime to pla ad ejoy their retiremet. With PNC s log history of helpig coutless idividuals ivest ad pla for their retiremet goals, you ca feel cofidet that PNC ivestmet professioals have the istitutioal experiece behid them to help you successfully avigate the complex path to a successful retiremet. 2 Please see the PNC white paper Itergrated Ivestmet Approach for more details o this study. The PNC Fiacial Services Group, Ic. ( PNC ) provides ivestmet ad wealth maagemet, fiduciary services, FDIC-isured bakig products ad services ad ledig of fuds through its subsidiary, PNC Bak, Natioal Associatio, which is a Member FDIC, ad provides certai fiduciary ad agecy services through PNC Delaware Trust Compay. This report is furished for the use of PNC ad its cliets ad does ot costitute the provisio of ivestmet advice to ay perso. It is ot prepared with respect to the specific ivestmet objectives, fiacial situatio, or particular eeds of ay specific perso. Use of this report is depedet upo the judgmet ad aalysis applied by duly authorized ivestmet persoel who cosider a cliet s idividual accout circumstaces. Persos readig this report should cosult with their PNC accout represetative regardig the appropriateess of ivestig i ay securities or adoptig ay ivestmet strategies discussed or recommeded i this report ad should uderstad that statemets regardig future prospects may ot be realized. The iformatio cotaied i this report was obtaied from sources deemed reliable. Such iformatio is ot guarateed as to its accuracy, timeliess, or completeess by PNC. The iformatio cotaied i this report ad the opiios expressed herei are subject to chage without otice. Past performace is o guaratee of future results. Neither the iformatio i this report or ay opiio expressed herei costitutes a offer to buy or sell, or a recommedatio to buy or sell, ay security or fiacial istrumet. Accouts maaged by PNC ad its affiliates may take positios from time to time i securities recommeded ad followed by PNC affiliates. Securities are ot bak deposits, or are they backed or guarateed by PNC or ay of its affiliates, ad are ot issued by, isured by, guarateed by, or obligatios of the FDIC or the Federal Reserve Board. Securities ivolve ivestmet risks, icludig possible loss of pricipal. Securities are ot bak deposits, or are they backed or guarateed by PNC or ay of its affiliates, ad are ot issued by, isured by, guarateed by, or obligatios of the FDIC, or the Federal Reserve Board. Securities ivolve ivestmet risks, icludig possible loss of pricipal The PNC Fiacial Services Group, Ic. All rights reserved.