When interest rates are high, bonds are great to own because they’ll pay out a healthy amount. However, is there a better alternative in a low-interest environment?
Make It Last with Victor Medina is hosted by Victor J. Medina, an estate planning and certified elder law attorney and Certified Financial Planner™. Through his law firm and independent registered investment advisory company, Victor provides 360º Wealth Protection Strategies for individuals in or nearing retirement.
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Victor Medina: Everybody, welcome back to Make It Last. I’m your host, Victor Medina. I’m so glad that you could join us here this Saturday morning for a rip‑rousing, another episode of Make It Last where we help you keep your legal ducks in a row, and your financial nest egg secure.
I’ve got three topics for you here today. I’m really excited to share them with you. We’re going to talk a little bit about why this next generation of millennials is counting on you, their parents, dying in order to help them solve their debt.
We’re also going to go over why in this low interest rate environment it might be a good idea to own an alternative to bonds, and some of the research behind what makes that so. Finally, we’re going to talk to you a bit about why you should hire a financial planner even if you are not rich, especially if you’re not rich.
Before we get started with that, I do want to issue a little bit of an apology, I suppose. I listened back to last week’s show. I think I was way disconnected to what was going on, in terms of the episode.
I shared with you that I am still going through a major health crisis with a family member, and I think that has me largely distracted. Still has me distracted, but I feel a little bit more involved in today’s show than I was last week.
Listening back to it, I might have rambled for a little bit. Anyway, thanks for listening. Thanks for coming back. [laughs] We’re going to do a little bit better this time around for this week. Interesting research coming out. There’s this host of millennials. These millennials are basically the people aged 20 to 34 right about now.
Those are the millennials, and there is all kinds of craziness going on with them. One in four of them are still living with their parents, that’s up to the age of 34. This job market is very, very challenging. People are coming out with four‑year degrees and tons of debt.
There is even an article that came out in “The New York Times” about a dentist that had amassed over a million dollars in student debt and it was increasing by $130 per day. Even though the gentleman was earning $130,000 a year, he essentially wasn’t going to make paying this back.
Between student loan debt and the sort of craziness that’s going on with either the housing market or how people are coming out with jobs and whatnot, situation is such that the millennials are really counting on one thing to help them eliminate their debt, and that is essentially you, their parents, dying.
This research came out. It basically said that two‑thirds of millennials ‑‑ two‑thirds ‑‑ expect to inherit something financially from their parents. They’re banking on this windfall to help pay off the debts, according to the student loans company that basically did this study.
They think that the average inheritance is going to be around $80,000. I’m not really sure what they’re basing that on. What I mean by that is that, they’re projections about how much people will have but that is all tied to what stock market might look like when people die, actuarials. It’s just not a number to rely on.
What I think is really interesting that is, first, they’re relying on their parents dying to settle their debt as opposed to handling that somehow on their own. Second, about a fifth of them are actually concerned about their parents spending habits and how they’re going to damage the total.
They’re watching over what their parents are spending as though it’s going to affect their inheritance. This drives me crazy. Well, my family dynamic’s a little strange.
We’ve got parents that divorced and remarried. They get along with each other. My wife couldn’t quite figure that out when we were dating. It sounded a little abnormal. Still sounds abnormal, but anyway I’ve got two sets of parents. I expect to inherit nothing from them.
I’m not waiting on anything in terms of inheritance. I’m certainly not concerned with what their spending habits are. If anything, I’m approaching this with the idea like, “I want you to enjoy life. You all have sacrificed so much raising multiple kids and putting them through college and all this craziness. Enjoy. Go out and do life while you have the chance.”
Certainly, spending the money is an OK thing to do, but it speaks to the culture and the mindset that is there. We’ve seen this manifest its way itself across a couple different ways.
The first is we see people not saving for the future. There’s not a habit of saving. I understand that there are these tremendous pressures that are coming in from the outside. They were pressures in that the cost of living has outstripped our ability to be able to afford it using mechanisms that were there in the past.
There’s a book that came out that basically talked about the idea that we went from single income to dual income and from dual income to leveraging housing and equity. We basically squeezed the maximum out. As costs continue to increase, there’s really nothing else for us to draw on in order to make it through keeping pace with the cost of living.
I totally understand. I totally understand where that’s coming from, but the mindset is not necessary to try to keep up with what the cost of living is. Maybe, we get off of the train. If you see, people are very comfortable being cash flow livers.
What they’ll do is as long as it fits within their monthly cash flow, they will spend what is necessary in order for them to keep up with whatever the costs of life are.
We see this at cell phone plans. What your cable costs, then add Netflix. After that, there’s a data charge for this. Then there’s a monthly charge for that. People are just adding all of these these monthly charges up. They’re not in the culture of savings.
The idea that the generation behind them, you, their parents, or grandparents, actually went ahead and made the sacrifices to be able to have a nest egg to leave behind, is teaching them that they can wait for that nest egg.
Their savings is going to be you dying. Not them actually producing anything or making any choices. That is a really scary environment to be in.
Not only because they’re not being trained to be self‑sufficient going forward, but there’s this incredible risk that what you leave behind will end up being squandered, not saved. They’re going to keep their spending habits.
All of their behavioral influences and instincts are suggesting that they’re going to go take that inheritance, and they’re going to just increase their lifestyle. They’re not going to actually save it for their retirement.
I don’t know what is causing them to think that, because at some point in time, they’re going to run out of the ability to work. When that happens, they’re can’t generate any more money. Where is that going to come from?
There are going to be people holding these eBay sales of their stuff. Since most of their money is spent on technology gadgets that are depreciating faster than their worth. They’re just replacing iPhones one after another.
Oh my goodness. There’s not going to be anything of value to leave behind. What can we do with this? One of the primary things we can do is continue to educate. There are smart people out there doing smart things. We just have to spread the information wider.
What might be a good resource? This radio show, or podcast, is a good resource for them. Them reading books on the nature of investing, saving, and lifestyle choices. There are all kinds of great, great resources for people to understand why they don’t necessarily need to keep up with their neighbor in order for them to feel whatever is the joy of life.
We want them to get to that point in time. Again, we want them very comfortable moving forward. A lot of that is an internal discussion, not necessarily an external discussion.
When we come back, I’m going to share a little bit about what might be a good alternative to bonds in an environment where interest rates are super low. Why you might want to hire a financial planner even if you’re not rich. Stick with us. We’ll be right back on Make It Last.
Victor: Welcome back to Make It Last. We’ve been talking a little bit about how we are going to deal with this next generation of millennials. Them waiting for you to die in order to get then an inheritance, so they can satisfy their debt and increase their living style. All of that’s not good news.
I’m making light of that fact, but really what I want to highlight here, is that a lot of people in retirement are under‑spending on their resources. They feel this continuing obligation to leave something behind for the next generation.
The best stewardship that you can live through for these individuals is in teaching them how to manage what you are leaving them behind. It seems like this generation isn’t ready.
I meet families in our estate planning practice. We’re talking about who might be a good executor. Who might be somebody good to manage the stuff when they’re gone. It always seems to be in a multiple child family, one or two people that are highlighted. They get it. The other people never did.
The question comes up, what are we doing to educate those people that are not there? What kind of controls are we putting in place because we don’t want them to injure themselves with the money that they’re inheriting? Not necessarily by drinking and drugging their way to some problem, but just the idea that these resources are precious.
There are things that you can do in order to be a good financial steward to set yourself up for the next generation, the next life afterwards. Even you in your own retirement. We are in a fairly low interest rate environment. Within that, what it means is that bonds are not paying out what people expect them to pay out in retirement.
New research has come out by a gentleman named Robert Ibbotson. He is a founder of Ibbotson Associates. It’s an asset allocation research firm. He’s published new research championing this idea of fixed‑index annuities as alternatives for bonds for retirement for investors that are approaching retirement.
In order for you to understand this, we need to set it up because you need to understand why you put bonds in a retirement portfolio and why the fixed‑index annuities might be a better alternative. Investors in retirement typically increase their bond holdings to reduce the amount of risk in their portfolios.
Bonds tend to be safer unless volatile then owning equities. In doing so, especially in a low yield environment, means that they might not have enough income in retirement plus their capital may not appreciate. The fact that they’re not in the stock market means they may not grow.
Fixed‑index annuities can actually offset some of the shortcomings if they’re used correctly and if they’re used smartly. In addition to earnings that grow on a tax‑deferred basis, it allows it to compound without the payment of taxes.
They guarantee a set interest rate and provide some exposure to the stock market which tends to be a higher return than bonds and what they’re paying. This is according to Ibbotson’s white paper that he published.
The way fixed‑index annuities work is they link their performance with stock market index which can be something like the S&P 500. There are more sophisticated indices that are out there, but I don’t want to lose you as the audience to go through them.
Let’s go ahead and take the S&P 500 just as our understanding what indices it performs. It highlights what the value of various underlying securities are. The gains aren’t limited because the insurance company bears the risk and losses are not a factor.
The way that that happens is that these fixed‑index annuities rather than actually putting your money in the stock market, what they do is they end up purchasing options to participate in the index.
If I lost you with that statement, understand that all I’m doing is taking an interest rate that the insurance company might have paid you and we’re going to put it on a bet that the index is going to increase. Now, it’s not a dumb bet in the sense that it could harm you. But it is a bet.
If the bet works out, we’re going to get some of the gains. If the bet doesn’t work out, all we lose is what we put on the table. In this case, what we lost was the interest we could have otherwise earned on our money for that period of time.
Now, these indices tend to be drafted or constructed in a way that will perform typically not as well as capital markets. They won’t go as high as stock markets in being in the stock market. But they will perform based on the way that they diversify their risks. What it means is that there’s a good chance that the money that you put in there will increase.
What we have is essentially downside protection. Since we didn’t put the money in the market itself, we can’t lose it. All we did was take the interest that was going to be credited to us, the money that the insurance company was going to give to us, and we bought options in the index.
That could be very, very attractive for people in retirement, specifically, people that need to time a horizon, their investments. They need to be able to look at their investments and say, “I’m gonna use this money in the short‑term, this money in the mid‑term, and this money in the long‑term.” What we want is downside protection for that.
Ibbotson did the research on it. He simulated the performance of a dollar invested in a uncapped, large cap equity index like the S&P compared to the performance of long‑term government bonds over the same period. He modeled it from 1927 to 2016 net of expenses.
He assumed that the annual expense was basically 10 basis points for a passive stock market. That’s .10 for that and 10 basis points for a passive bond portfolio. What we found was the maximum annualized return, by the way, in his model was about 5.8 percent for the fixed‑index annuities versus 9 or 10 percent for the large cap stocks and 5.3 percent for long term government bonds.
What he was able to find was that in the average return for a portfolio that had 60/40, 60 percent stocks and 40 percent fixed‑index annuity, it returned 8.77 percent versus 60/40 for a bond portfolio, stocks and bonds that only returned 8.5 percent.
There was a marginal increase in the fixed‑index annuities. It is, in fact, outperforming bonds even over a 30 year period. There’s also, by the way, an in‑between where they do 60/20/20 where they do 60 percent stocks, 20 percent bonds, and 20 percent fixed‑index annuities. That performed 8.66. It was a pretty good number there as well.
Within our portfolio, we end up recommending a 50/40/10, 50 percent in stocks, 40 percent in fixed‑index annuities, and 10 percent in bonds for short periods. We figured out that’s a good model for retirement.
Here’s the idea. They took the performance. They went with all kinds of sequence of returns. 10 percent up, 10 percent down, 20 percent up, whatever it was. When rates increased over that period of time, you basically had better performance when equities fell and gained more when equities…
The way that these portfolios worked out is that they either gained more or lost less, compared to their alternatives of just stocks and bonds over a three‑year period. Here’s the point. At the end of the day, what it means is that you can construct a portfolio and it’s a sound one using a fixed‑index annuity.
The trick is you need to be working with someone that understands both of them. If you’re just working with an insurance agent, then what you will get is an insurance solution that’s all fixed‑index annuities with no smart management on the rest of the money that’s not in the annuity.
If you work with somebody that’s purely a stock manager, an investment manager, and doesn’t believe in annuities, they won’t understand how to use that either. You need somebody with feet in both of those worlds and somebody that is comfortable because ‑‑ here’s the thing ‑‑ those fixed‑index annuities, those FIAs, they are complicated instruments.
Working with somebody that’s looking out for your best interest, you need to have somebody that’s doing that because they’re going to need to manage that.
They’re going to need to have experience in that in order for you to get the gains of this kind of strategy which dovetails so nicely into our next segment, why you should hire a financial planner even if you’re not rich. Especially if you’re not rich.
The lesson to take from this segment is consider using a fixed‑index annuity as an alternative to a bond section in your portfolio in retirement because your gains are going to be better and your losses are going to be less according to Roger Ibbotson and his white paper.
When we come back, I’ll tell you how a financial planner can help you do that and why you may need one, especially if you’re not rich. Stick with us. We’ll be right back on Make It Last.
Victor: Hey, welcome back Make It Last. I’m so glad you can join us here today. In the last segment, we talked about why fixed‑index annuities might be an alternative to bonds in your retirement portfolio.
It’s all based on research by a gentleman named Roger Ibbotson who has, basically, proven with the math that’s involved that you can get more money or lose less money, including these fixed‑index annuities in your retirement portfolio.
I was making the point before the break that in order to make this work, you actually need a financial planner that knows what they’re doing in both of those areas for you to be able to reap the benefits of that. Let’s talk a little bit about why that’s the case.
Here’s the thing. [laughs] There’s another study that came out that said your perceived financial well‑being, the feeling that you’re secure not only about your state of your current situation but how you’ve planned for the future, is a key to your overall well‑being. I can’t stress this enough.
It’s happened in my own life. When the law firm was just getting off the ground and I didn’t know where the next dollar was going to be coming from, I was super stressed. Getting to a point of maturity where not worrying about money, much better. I’m overall healthier. I lost a bunch of weight. I’m in good shape now.
Your financial security can’t affect you as much as job satisfaction, relationship stability, physical health. It’s interesting because money is the most concrete expression of every neurosis that we have. Every neurosis that we carry we express that about money. Somebody dealing with your finances can be transformative, especially if they can take some of the worry out.
Why should you be considering a financial planner? Well, first of all, you have to know yourself. Regardless of whatever financial state that you’re in, you can take benefit from taking stock in what stability means for you.
If you know how uncomfortable it feels, it can be hard. For instance, to sit down and look at numbers if you know that you’re in amounts of debt and you’re not sure how bad it is or if you’re worried about whether or not what you have is enough to last for the rest of your life, yeah, it can be difficult.
You’re saving yourself unpleasantness in the future if you start to work with somebody that can move you from the sense of being unpleasant to some place that is more stable. You can start doing it by tracking your own habits.
T’s an eye‑opening exercise to know what you’re spending a little bit more. Try to figure out what you want from that, especially on a financial planner in retirement.
Many times, people, what they’re looking for is they’re looking for answers and guidance so that when they are in retirement that they know that they have somebody who’s watching over their back. They can get security from the idea that this person’s going to help them manage that through the last days that they have.
People want to be debt free. They want to have an emergency reserve fund, and they want to maximize their retirement account.
When you get to a point in time where you’re in that retirement spending, you really want to be working with somebody that can help you assure yourself that what you have is enough or, at least, give you guidance on how to change your habits if what you currently have isn’t going to be enough the way that you’re spending it.
Financially planners help clarify that process. They help you realize what you have and what it takes to get to the end. They’re dispassionate about things that you are passionate about, in terms of the things that you spend money on. They can look at a situation and more easily figure out, geez, this is what it’s going to take for you to get to the finish.
Some of that is just behavior, right? We do that in the legal sphere as well. I’m dispassionate about my client’s legal situation. All I’m doing is thinking about how to solve it. I am not invested in which family relationships are going on where, who might be hurt.
I can just give you an objective view that this person out to be an executor. This is the way you ought to protect assets for the next generation. I can do that dispassionately because I’m serving as a counselor.
In the financial world, I’m doing that also for my clients. I’m doing that in combination many times with the legal planning because I sit there and say, “Not only did we create a cast to help you protect your assets, but now I’m managing stuff in the cast to make sure that what’s in there is worth protecting in the first place.
Somebody that’s helping you do that can remove themselves from being in the middle of everything and give you an objective view on how to get there. They can do that on a very basic level, just nderstanding something about finances.
People that are CFPs, like I am, have gone through the training. They’ve gone through the education. They’ve taken the test. They’ve created the plans. They can get you there.
What you actually need if you are someone listening to this in retirement is somebody that specializes in the retirement area because within that world what you have when you retire is basically it. There’s very little opportunity to generate more. By definition in retirement, you’re not working any longer.
Now, sure you can pick up a part‑time job. You can do other things to help you generate some, but you’re never going to generate as much as you were generating when you were a full member of the working society. In that scenario, it becomes crucial to make sure that what you have you help make it last, all right? Because that’s all that you’ve got in order to get to the end.
That means that working with somebody that essentially is focused in the retirement sphere so that they can know what strategies are helpful, specifically, in a scenario where you can’t make it up by saving some more or getting lucky on a particular investment horizon or whatever’s going on in your investments.
You want to be working with somebody that is tight in that world understanding exactly what you need in order to get to the end.
Now, I referenced before in the last segment some strategies that we use here. We use some time segmenting investment strategies that are broken apart by need of that money. The money has to serve a particular purpose in order for us to be using it smartly. Our investment strategy is going to necessarily change.
It has largely been disproven that a systematic withdrawal is the best retirement strategy. Systematic withdrawal being just I’m going to take out four percent every year, every year, every year.
Hold on a second because that will run the risk that in an environment where your returns are not consistent or not always going up, you might actually run out of money. You want to be a little bit smarter about that. We don’t want to put things at risk that don’t have to be at risk.
Specifically, we only want to expose them to the risk necessary for the horizon that we are looking at for that money.
That’s why in that last segment when we talked about breaking things up between stocks, bonds, and fixed‑index annuities, we used the fixed‑index annuities as a tool to get us through that midterm.
It works out well when we run the numbers because it helps secure that money for the limited period that we need it, seven, eight, nine years, somewhere in that midterm for a retirement that might last 25 years or later.
That means that we can take the other money that is set to go and be used in the last segment of the retirement, that 20, 25 year segment, that horizon that’s later. Now, we can subject that to greater risk because we don’t need to draw down on that money in the short‑term.
If it’s up or down, it doesn’t really matter. It will keep itself going. It will keep the engine going because we have keyed that to a different horizon.
That’s just a long way of saying that somebody who’s focused in retirement as a planner can help you get the assurances that you need that what you have will last as long as what you need it or, at least, will help you key that to whatever spending that you have for that money. It becomes super important.
It becomes super important to make sure that you get the comfort that this is being watched over, so you can go do other things. You don’t want to spend your retirement worried about your retirement. That is a miserable, miserable way to be spending those last 20, 25 years is worrying, worrying, worrying.
It is worth your investment in a financial planner and in an advisor that focuses in retirement in order to get some comfort that what you have is safe, is being well managed, working with somebody that is looking out for you and your best interest.
Reference every fiduciary conversation that I’ve had in this podcast in the past. You want to make sure that you have that person in your life so that when you are in retirement or as you’re living through retirement you can enjoy it.
Speaking back to my own personal stuff right now. The family member that’s facing this health crisis is facing a compromised retirement. The time that they’re going to have left isn’t necessarily going to be stuff that they’re going to be able to spend as richly and as long as they would have otherwise planned.
The time to enjoy this stuff is in the present. That can be achieved by making sure that you are working with somebody, a professional. That you have set up your life in a way that working with somebody to take care of it is worth the investment. You see that. You invest in that. You know that you’re getting something back from it.
Certainly, if you’d like to talk to us about it, you can reach out, Victor Medina at the Medina Law Group or Private Client Capital Group and we can talk to you about it. If it’s not us, find somebody. You deserve to be living a life where you are enjoying what you’ve got.
That’s the lesson for today. I hope you have enjoyed today’s show. This has been Make It Last where we help you keep your legal ducks in a row and your financial nest egg secure. We will catch you next Saturday. Till next time. Bye, bye.