TINA Is Dead. Cash Is King For Affluent Retirees

Includes: DBD, GE, SPY, VTWNX
by: Steve Condie

When you are retired, you need to minimize the risk of outliving your money.

For the past decade, low returns on ultra-safe, fixed-rate investments have driven retirees to investing in riskier alternatives such as ETFs and individual stocks.

While interest rates have not returned to the levels of the 80s or 90s, they have risen significantly over the past year and look to continue that trend.

At the same time, multiple indicators are signaling that returns from equities will be muted over the next 10 years.

Accordingly, affluent retirees should be looking to allocate a larger portion of their savings to "cash" in the form of the old stand-by, federally-insured Certificates of Deposit.

Once a person retires, their appetite for financial risk should decrease. If you retired in 2000 with all of your life savings invested in the go-go stock of Pets.com, you would now regret that decision. But most people didn't do that, of course. Decades ago the conventional wisdom for retirees was to invest their life savings in a "ladder" of federally-insured CDs to provide steady, risk-free income in their golden years (That's what I always assumed I'd be doing when I retired).

Then came the financial crisis of 2007-2009, and the years of low interest rates created by the Federal Reserve's policies instituted to help boost the economy back to health. CD rates fell to less than 1%, generating little to no income for retirees.

Suddenly that CD ladder wasn't even a stepstool. The interest generated by that traditional, 100% safe investment strategy wasn't sufficient to support any kind of retirement spending, resulting in consumption of principal and destruction of nest eggs.

That created a need to look to other riskier sources of retirement income and begat TINA - "There Is No Alternative" - to buying riskier investments such as ETFs and common stocks. From 2009 to 2017, it was a great strategy to have been invested in equities, with annual returns averaging double digits accruing from a simple strategy of investing in index funds like the SPDR S&P 500 ETF (NYSEARCA:SPY) or mixed stock/bond funds like target date retirement funds like the Vanguard Target Retirement 2020 Fund (MUTF:VTWNX). But that cannot go on forever. Literally. Absent runaway inflation, it is impossible to have investment growth of 10%+ per year forever with index funds in the real world.

The risk of poor returns from equities over the next 10 years is high

I have argued (as have many others) that the nation's demographics dictate economic growth averaging about 2% per year for the coming decade (or more.) See Don't Get Conned! That simply won't support the kind of profit growth needed to drive equity returns at their recent pace over the coming years.

Whether you refer to the Shiller CAPE index...

CAPE Index

...the "Buffet" ratio...

Buffet Ratio

...or any other respectable measure of stock market pricing, equities are expensive right now. And that means that over the next decade, chances are that returns from the kind of investments which have been great for the past decade will be... not great. In fact, this chart suggests that the returns from the stock market over the next 10 years will look a lot like the returns from those CD ladders over the past ten years - or worse:

Goldman forward returns chart

Ned Davis Research has generated this chart showing how the percentage of household financial assets, which are invested in equities, predicts poor future returns from the market (note the returns curve is inverted, so higher equity percentage corresponds to lower future returns):

Ned Davis chart

TINA is dead for affluent retirees

None of that looks good for equity returns over the next 10 years - a key time frame for retirees. And as of this writing, both SPY and VTWNX are in the red over the past year, including dividends.

So where does that leave us?

Well, the Fed is now gradually reversing course on interest rates. When I looked at the CDs offered at Schwab, I saw that 5-year CDs are paying up to 3.6%; I have seen longer-term CDs paying more than that. For affluent Americans who have recently retired, I would argue that even that level of CD interest is sufficient to put an end to TINA - there is an alternative now, and it's one that affluent retirees should be looking closely at.

What do I mean by "affluent retirees?" Well, that depends on where you live to a great extent, and you can adjust based on the cost of living and prevailing incomes in your state or community. But generally, we're talking about people who have savings, IRAs, 401(k)s, etc. in the high six- to low-seven figure range - enough retirement savings to be interested in optimizing their use of them during their "golden years," but not so much that they are primarily concerned with leaving a substantial inheritance. Affluent retirees have different concerns than folks who simply never saved a lot of money before retiring on the one hand and the filthy rich on the other. Affluent retirees want to be able to enjoy life in retirement, but are deathly afraid of "outliving their money" and need to develop a strategy to maximize their prospects of doing the former and avoiding the latter.

There are two parts to the analysis of how affluent retirees should allocate their savings investments: the amount of money they will need/want to spend at different points in their lives, and the level of risk of running out of money at that spending level with the investments chosen to generate that income.

Conventional wisdom of post retirement income needs and investment strategies

Back in the day the conventional wisdom with regard to retirement planning was that once you retire, your spending drops by 10% (no more commuting and other work-related expenses) and then rises with inflation over time. You start drawing your pension and social security the day you got your gold watch. You invested your retirement portfolio 60% in equities and 40% in bonds (or some other similar proportion) and started withdrawing your savings at the rate of 4% per year, adjusted annually by 2% (or variably in line with inflation). That was based on studies that found that, historically, that mix of investments would support that withdrawal rate with very little risk of running out of money over a 30-year period. The more recent conventional wisdom has leaned towards DGI - invest 100% of your savings into dividend growth stocks and just spend the dividends which, as the name indicates, should grow over time, but are typically limited to about 3% of the value of your portfolio at any point in time.

There are two problems with that conventional wisdom: it doesn't generate the right amounts of cash at the right times, and it may be riskier than retirees are comfortable with.

Let's look at cash flow first.

Go-go, slow-go, no-go years

Here's the problem: Your post retirement spending probably won't follow the "conventional wisdom" pattern. What you will really (want to) do soon after retiring is enjoy those long-deferred activities you've been talking about doing once you were no longer tied down by your job: traveling, buying a boat, RV or second home, seeing ballgames in every major league ballpark - that sort of thing. In fact, most affluent retirees' spending actually goes up in what is referred to as the "go-go" years of retirement compared to their final years of employment, not down. To be realistic, you should plan on wanting to spend 110% of your pre-retirement budget in the first couple of years after retiring (if you have the money to do so).

But that tends to level off after a few years as you enter the slow-go years. In this period you're still enjoying a lot of those activities, but at a slower (and slowing) pace. Your expenses in this period are actually lower than they were when you were working, because you're just not doing as much.

And last, the no-go years. At the very end of life, you may need assistance in your day-to-day living, either with home care or by moving to an assisted living facility. Here, again, your spending may increase. Generally speaking, however, you are less concerned about outliving your savings at this point. Chances are, in their final years, affluent Americans are spending their children's inheritance, not money they will need to pay bills in their own future.

Typically each of those phases gradually evolves into the next; the exact pace of that evolution varies with individuals' health and engagement with life.

But what about inflation? Unlike people who are living Social Security check to Social Security check, for most affluent retirees, general costs of living increases (excluding medical) are not as much a factor for as they are for younger folks. Affluent retirees are likely to own their own homes, moderating the impact of housing cost inflation. Diminished driving and eating out reduces the impact of those cost increases being a factor. And the wardrobe turnover is usually less at that point as well. Since most affluent Americans have above-average Social Security income, which carries an annual COLA, the modest increase in that income over time will offset at least some portion of the inflation these retirees are likely to have to deal with.

The actual marginal financial need for affluent retirees

So what is the optimal cash flow from retirement savings if it isn't set at 90% of pre-retirement spending with annual 2% increases forever?

Well, you start with the income you will see from social security and any other sources (pensions, real estate holdings, etc.). Whatever you generate from your retirement savings on top of that today is your marginal investment income - and I would suggest planning for it to start at that number and be roughly flat thereafter. If you spend less than that - fine. But no COLA for your savings withdrawals. Plan on the same number in year 10 post retirement as you spend in year 1.

Obviously - that could be wrong. We could have hyper-inflation. We could have deflation. We could have a zombie apocalypse. But chances are if you retire in your 60s, you won't be spending a lot more in current dollars on top of your income from Social Security and other income year 10 post retirement than you are in year 1, and if you set your withdrawals at a dollar figure year 1 and budget to that number thereafter, you'll be okay. And that makes budgeting pretty simple.

So how does that match up with conventional investment strategies?

Not well.

With 60/40, you get to spend 4% of your retirement savings in year 1 post retirement. With DGI, your dividends are probably less than 3%. Both should increase over time, but you may have squandered your most "golden" golden years by not giving yourself a big enough cash allowance in years 1-5 when you have the most interest and energy to use those funds for the things you have been anticipating doing in retirement.

The 60/40 allocation was based on studies which showed that in the past, there was little risk of running out of money over a time frame of 30 years if you followed that allocation and withdrawal schedule. But there's still risk there. Low risk, yes, but we have seen enough "black swan" financial events in the past twenty years that one has to be a little uneasy about "conventional wisdom." The correlation between stocks and bonds which underlies the "60/40" approach has not held true in recent years, leading many financial advisers to "tweak" that formula in various ways. And is 30 years long enough? One member of a retired affluent couple may well live longer than that.

DGI stocks start by paying less than 3% on average and can and have cut and even eliminated their dividends, generally at the worst possible time (See General Electric (NYSE:GE), Diebold Nixdorf (NYSE:DBD), etc.).

You may reasonably want to spend more in the early years than the conventional wisdom dictates. But both conventional strategies suffer from the same significant problem which dictates that you can't: sequence of return risk (See this article for an explanation of sequence of return risk).

This chart from Senior Planning Advisors shows the difference sequence of return risk can make for an equity-heavy portfolio with just one year between retirement dates:

Sequence of return

Risk of poor returns from equities is high right now

So anyone retiring with a significant exposure to equities in the early years of a bear market can end up in a difficult position. Given the multiple factors discussed above which predict below-average returns from the market over the next 10 years, sequence of return risk weighs heavily against withdrawing as much from one's retirement account over the next few years as a recently retired "go-go" retiree would like to be able to enjoy.

And then there's the psychological wear and tear of having to worry about rebalancing your portfolio, and whether you've made the right allocations, at a point in your life where your enthusiasm for taking on such tasks is waning.

What has virtually no risk? Federally insured CDs

How much should you allocate to CDs?

Over the long term, a diversified portfolio of stocks and bonds will have a better return than CDs - if you don't fall victim to a sequence of withdrawal trap, which is a heightened risk today due to the overbought nature of the market (Remember, the return from an investment in SPY has been negative over the past 12 months). And affluent Americans who have retired are no longer investing for "the long term" - their future is now.

If you invested 100% of your retirement portfolio in CDs today at current rates, with staggered maturities to ensure liquid funds each month sufficient to fund your withdrawals, you could set your withdrawals at a rate of 4.5% of the value of the portfolio year 1 and continued withdrawing the same amount each year for 15 years (the longest maturity CDs I have found recently). If you did that, you'd still have over 80% of your initial portfolio intact after withdrawing 4.5% of your funds each year for 15 years - guaranteed.

If the market has reverted to the mean and is no longer trading at the levels it sees today, you could consider converting to a 60/40 or DGI approach then. If interest rates remain the same going forward, your funds could last for over 40 years if invested in CDs before they ran out at current rates. For most retirees in their 60s, that would be a pretty safe bet.

Of course, you don't need to adopt that sort of "all or nothing" approach. But if you're certain you won't live past 100 and you want to maximize your enjoyment of life now while living free of worry that your savings will run out before you die, you now have an alternative.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.