The Smart Take:
If you own a disproportionate amount of cash or bonds in your portfolio, you can be broadly classified as a conservative investor. With today’s low-interest rates, being conservative is a tough investment row to hoe. Starting yields have been shown to explain 90%+ of returns realized from high-quality bonds. Ergo low-interest rates equal low returns. So what can you do?
Tune in to hear Kevin discuss four actions to consider. Bond ladders, Social Security delay, and smartly using annuities (yes even those … but smartly!) are all strategies that may be used to your benefit. And the only way to thoughtfully consider these and other strategies is within the context of your well-crafted financial plan.
Be sure to listen to the end when Kevin gives a warning about the risk many are taking in seeking higher-yielding assets. A higher yield means higher risk. You need to know what risks you are taking. There is no free lunch.
ANNUITY BREAKDOWN EPISODES
Things to Consider before years end
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Speaker Intro: Welcome to Retire Smarter, with Kevin Kroskey. Find answers to your toughest questions, and get educated about the financial world. It’s time to Retire Smarter.
Walter Storholt: It’s another episode of Retire Smarter. Walter Storholt here, alongside Kevin Kroskey, President and Wealth Advisor at True Wealth Design, serving you in Northeast Ohio, Southwest Florida, and the greater Pittsburgh area. You can find us online at truewealthdesign.com, and schedule a time to meet with an experienced advisor on the team. Just click the “Are we right for you?” button. Great show on the way today. Kevin, great to be with you, once again. How’ve you been?
Kevin Kroskey: Well, it’s always my pleasure, and we’re good. We just wrapped up Halloween. When you have young children, particularly, it’s for us anyway, it was quite fun, I think; tons of candy, tons of candy. I don’t know what the heck we’re going to do with it, but I’m making my wife hide it from me. Those Reese’s cups are just addictive; but my girls went trick or treating three times, so it was-
Walter Storholt: You’ll have to explain that. I don’t think, in all of my years of trick-or-treating when I was a young lad, did I ever get to go trick-or-treating more than once. So three times is, wow.
Kevin Kroskey: All right. So, while I’ve shared that we’ve done the… We bought a travel trailer, and we found a campground that we really like about 20 minutes south of us, in Northeast Ohio. It’s called Clay’s Park. The campground had trick-or-treating about a week before actual Halloween. We went down there; that was awesome. It was quite a bit of fun. Then, there was a school event trick-or-treating on Saturday afternoon that I took the kids to. Then, there was trick-or-treating on actually Halloween, on Sunday night, which was particularly enjoyable for me, because that was the day my Steelers beat the Browns. I made sure, as I walked around the neighborhood, that I was dressed head to toe in Steelers garb. It was fun for everybody.
Walter Storholt: And your outfit was probably an easy pick that evening.
Kevin Kroskey: It was. I got a couple of bad looks, if you will, from some of the friendly neighbors that were giving my kids candy. I’d like to think that they didn’t give them any less, just because of how their dad was dressed.
Walter Storholt: Oh man. That is fantastic. Well, no wonder you have copious amounts of candy still remaining.
Kevin Kroskey: Yes. Yes, we do.
Walter Storholt: Very impressive. Very impressive. So, Reese’s is your… That’s your kryptonite? That’s your candy of choice?
Kevin Kroskey: Yeah, that’s my three-year-old. Oh my gosh. It’s like every night. “Oh, my tummy hurts.” And then, she’ll get down and try to stop eating dinner. And then, she goes right over to the candy.
Walter Storholt: Yeah. Yeah.
Kevin Kroskey: I’m like, “Wait a minute. You just said your tummy hurts.”
Walter Storholt: It really hurts. Really hurts.
Kevin Kroskey: She just tries to work the system. It’s so cute and obvious. And our eight-year-old is, she’s like a little angel in comparison, so they keep us on our toes.
Walter Storholt: Oh, that’s nice. That is good stuff. Settle this debate, and then we’ll jump into today’s episode because everybody seems to have a different opinion of candy corn. Take it or leave it?
Kevin Kroskey: I’m a leave it guy. It’s a little, I would say, a little too sweet; but yeah, I’m not a big candy person; I try to be healthy. But if I’m going to pile on some calories, yeah, it’s going for Reese’s cups for sure.
Walter Storholt: Yeah. That’s a good choice. That’s very adult, and just universally loved candy. You just can’t go wrong with the Reese’s in any situation, really.
Kevin Kroskey: There you go.
Walter Storholt: They’re just always good. All right. Well, on today’s show, we’re talking about what’s a “conservative” investor to do these days? And it’s probably a good question, Kevin, because it’s really hard to describe what happens in today’s financial world as conservative, in any stretch of the imagination. I don’t know. I just think about seeing the headlines over the last couple of months, whenever you have this new hot stock, or meme coin, or something that goes up 300 billion percent, only to fall 300 billion percent. Well, I guess that’s impossible; fall a hundred percent, the very next day.
Kevin Kroskey: There you go, the very next day. That’s awesome that you caught that, by the way.
Walter Storholt: I caught it. I caught it.
Kevin Kroskey: I’m proud of you.
Walter Storholt: The very next day, then goes down a hundred percent. That’s not anywhere near the conservative investment. That’s what gets all the attention and the drama and the intrigue in today’s world. I can see why this is a good question to ask on today’s show, so I can’t wait to see what you have in store for us.
Kevin Kroskey: Sure. So, it’s tough. In our last podcast, we talked about, at least in part, the investment allocation, and maybe some things to be thinking about, and expectations that we should have for returns from these investments, looking out over the next decade. And we talked about how many assets, stocks, and bonds included, are quite rosy in their price, meaning that we can expect fairly muted returns, as the couple expected return forecasts that we mentioned from Vanguard and Schwab outline.
And when you look at our clients here, on average, there’s about a little bit more than 60% that’s within stocks, generally speaking. It’s been a good time to be a risk-on type investor, but not everybody’s obviously there. We have several clients, and I’m sure there’s a lot of people that are listening to this, that if they were to look into their portfolio, there’s quite a bit more bonds and cash, and not nearly as much in stocks. Maybe there’s 20%, 30%, maybe up to 50% or so.
And one of the things to keep in mind, and we talked about this in Episode 77, is these sort of qualitative terms, conservative, aggressive; they’re just qualitative. You really need to measure a little bit differently. We always talk about measuring, and this is really why this is important. But really measuring the required return that you need from your investments to make your financial life plan work. We talk about measuring your risk capacity, or your ability to go ahead and take risks. And even if things go awry, that you don’t have excessive lifestyle risk, where you’re really going to have to cut back, and not have your needs and other important goals met. Then thirdly, then we talk about more of the qualitative side, or your risk tolerance, or your willingness to take risks.
One of the things over the years that I’ve found, is when people do not have a plan, and they don’t see how everything is integrated and aligned, they don’t have that clarity, they don’t have the confidence that they’re going to be okay, it’s easy, and I think it’s just brain science; it’s that fight-or-flight mechanism, where you just revert back to a stage of fear, and maybe even inaction. And it’s easier just to keep money in cash or something safe or perceived to be safe.
But also, I found when you do bring everything together, you can walk people through, show them, “Here’s how much you’re spending. Let’s go through, and rank your higher priority goals, your needs, then things that are going down to more discretionary, where if you did have to cut back, those are the discretionary buckets where you cut back from. You define that, not us.” Everybody’s a little bit different in that regard.
So when you’re looking at that, and you’re looking at this plan, and you’re seeing how the pieces and parts fit together; and then we can go in stress test, and show that “Hey, even if the stock market sells off by 50%, similar to what it did in ’08 and ’09, you’re still going to be okay, and maybe even more than okay.” Well, that’s one of the ways that we go ahead and measure this capacity for risk.
What I found in some, not all occasions, but in many, is that when you pull everything together, that fear, that sense of inaction, that desire to just be a really conservative investor, when you can go ahead and clearly show somebody that, “Hey, you’re going to be fine, and you can afford to take a little bit more risk.” Then oftentimes, they can make a smarter allocation decision, and maybe own a little bit more in stocks, in real estate, and other things that have higher return expectations than cash or high-quality bonds.
That’s not universal; some people are truly just very risk-averse. And even though they have very high-risk capacity, or the ability to take risks, they’re just not going to feel comfortable with it. But we have successfully worked with several people over the years, that once they have that clarity of the financial plan, once they have that confidence, once we stress test their plan and walk them through really their worst fear, and showed them that they’re still going to be okay, we were able to nudge them to make smarter decisions to their benefit. So that’s one of the reasons why this is really important.
But even if you are taking, say a balanced approach to your portfolio, maybe half in stocks or half in bonds, or even less than that; I would probably say that’s where you’re starting to get into, I’ll use the qualitative term here, a little bit more of a conservative investor. The more bonds you have in the portfolio, the higher quality bonds you have in the portfolio, the lower return you can expect, and the more conservative, I would say that you are.
If that is you, and you haven’t had a plan, so what I’m going to do, is just offer some potential solutions here. Then also, maybe a bit of a warning. Step one, I’ve already talked to about this, about why it’s important, but if you don’t have a plan, that’s really step one. That lack of clarity, lack of understanding, often defaults to that fear and safety mindset, fight-or-flight. And if you can get that clarity, and you can get that confidence, and we find that you have that risk capacity, and we can educate you a little bit more, to get you to a new level of comfortability, then maybe it would make sense to go ahead and take a little bit more risk than those preservation assets, than those high-quality bonds really would allow you to do otherwise. So that’s step one.
And even if you are just going to remain a conservative investor, staying away from stocks or what have you, a plan still helps. Because of the other side of that short-term volatility, the market decline risk that we think goes along with stocks, where things could sell off 20%, 30%, 50% maybe, is the slow way to go broke on the other side. If you’re so conservative and everything is in cash, or low yielding bonds or annuities or something like that, that people are perceiving as safe.
Well, there’s a lot more risk in that case, that you can go broke slowly over time, because like today, inflation is fairly high. Interest rates are low. You are losing money after inflation, or what we call a purchasing power basis. You do that consistently for a decade, and you don’t have a ton of money relative to your spending; it’s going to be a very slow way to go broke. You’re at risk of probably realizing it too late when there’s not much to do about it. So you’re taking risk, even if you’re conservative; you’re just exchanging that short-term volatility risk for long-term purchasing power risk, long-term interest rate risk. I think that is really, really important to remember; know the risks that you’re taking.
Walter Storholt: Makes sense. Know the risks that you’re taking. Good starting point. And that’s all part of that getting a plan in place. What else?
Kevin Kroskey: Sure. So another simple one, I think a lot of people have probably heard, you can build a bond ladder; so rather than keeping your money in just shorter-term investment. The example I always give is the interest rate charged to somebody on a 30-year mortgage is almost always higher than a 15 or 10-year mortgage. So the longer you go out in time, the higher the yields are. You have to be careful when you do this.
In the prior episode, we talked about that duration risk, and what happens to those longer-dated bonds if interest rates go up, and what happens if the price goes down. But if you’re holding these bonds all the way to maturity, I would argue that you can probably ignore any price movement in between, because if you’re buying, say you need $100,000 and 10 years for spending, and you buy a $100,000 bond today, that’s maturing in 10 years. Yes, the price of the bond will move around over that 10-year period until maturity. But what you’re going to get in year 10. So, there is certainty within the cash flow.
So you can go ahead, and build a bond ladder. And again, that’s just laddering bonds out over time; maybe keeping your shorter-term money in cash, but then maybe buying a 3, 5, 7, 10-year bond, so on and so forth, and just really dedicating those to meet your spending goals over time. So that’s something that’s been around quite a long time; there’s different ways to do it. You have to decide what bonds you want to buy; that’s a whole other conversation. But nonetheless, if you’re buying the bonds and holding them all the way until maturity, then you do have a lot more certainty in that cash flow. And because you are buying those longer-dated bonds in general, you should be able to get a higher yield from your bond portfolio.
Walter Storholt: Okay. Makes sense. I like that when we start with the easy stuff, Kevin.
Kevin Kroskey: All right. Yeah. Easy is good. I’ll go to annuities next. So, we’ve done some episodes fairly early on, probably back maybe like episode I don’t know, I would say in the tens, 10-20 or so, we did a few. Generally, not a fan of most annuities, how they are sold, but there are some that can be used properly. The important thing to remember is there’s really two broad types of annuities, and I would say: accumulation annuities, which is mostly what you find being sold and purchased in the marketplace. These could be the fixed indexed annuities, the variable annuities, things like that that tend to be higher cost. And I’m not a fan of so much, particularly for how they are sold.
And then the decumulation annuities; and these are those types that are more pension-like, where you’re giving money to an insurance company, and converting that asset into an income stream. The general principle here is when you take a whole group of people as an insurance company does, and pools that risk; while some people are going to die prematurely, some people are going to live longer than average. But when you get a sufficiently large number of people, the insurance company can afford to offer a higher payout to those people within that pool, than what somebody could sustain on their own when there’s just a sample size of one; just you or you and your spouse. So it’s very rare that these things are bought. I think 1% to 2% of the annuity sales are these decumulation products. They could be of the variety where they could be an immediate annuity, that you say you give $100,000 to the insurance company today, and they’ll start paying you a monthly amount that you cannot outlive next month. So that’s one.
There’s others; like everything, there’s all these acronyms, but a QLAC stands for Qualified Longevity Annuity Contract. What it is, is say you give $100,000 in your IRA to the insurance company, and you say, “Hey, if and when I reach age 80, or age 85, start paying me a monthly amount, or an annual amount, for as long as I live thereafter, that I cannot outlive.” So it’s really insurance against living too long and running out of money. And it’s similar to another one called a Deferred Income Annuity. So, the QLAC is just inside of an IRA; a Deferred Income Annuity could just be outside of the IRA. But in principle, they’re really the same. So, rather than starting immediately, they start at a future date; and generally, I’d say 80, 85, 90. There’s not a lot of these that are sold. There’s a lot of good economic sense why they could make sense, particularly if you are a conservative investor that owns a lot more cash and lower-yielding bonds.
And then lastly, in the annuity bucket, and this is really in the accumulation bucket, but there’s something called a Multi-Year Guaranteed Annuity. So, we’ve used these to a limited extent over the years for our more conservative clients. But it really acts more CD-like; the rates are higher than CDs, and the rates are actually fairly attractive, relative to similar duration bonds that you can buy. And the benefit too is in a rising rate environment, you’re just going to get the stated interest rate for the Multi-Year Guaranteed Annuity or MYGA for short. So they’re not bad to use. I’m not exactly a huge fan of them; I think there’s better ways to do it. But if somebody’s truly conservative, and wants to keep things very, very simple MIGAs can be a good part of that solution.
Walter Storholt: I believe it was Episodes 12 and 13, or 11 and 12, had our annuity discussions in-depth on them. So yes, 12 and 13 had some pretty decent annuity breakdowns in them. If anybody wants to get more information or check those out, go back to the early days of the podcast.
Kevin Kroskey: There you go. Yeah, just don’t judge if I… Hopefully, I’ve gotten better at my speaking abilities over the years. Or judge, but just focus on today. There you go. Progress, not perfection, right Walt?
Walter Storholt: That’s right. Exactly.
Kevin Kroskey: Next, I’ll go into Social Security. And we’ve talked about the benefits of Social Security deferral in the past, and this is something… I just mentioned these annuities and annuitization; I would say that if you’re going down this path, Social Security is really the best annuity that you can get out there. We’ve talked about that in just a recent episode, about how Social Security is priced from an annuity perspective. And you just can’t get that deal out in the marketplace today. If you’re going to do anything, before you buy an annuity, you should be deferring Social Security. And if you’re not doing that, then candidly, it just doesn’t make mathematical sense.
I’m not saying that people don’t do it; I think they do it all the time. I just don’t think they understand the math behind those decisions. So, you can defer Social Security to as late as age 70, and it keeps increasing every year in value. And again, that’s lifelong inflation-adjusted income stream as well. So a nice big 6% increase next year for Social Security.
One thing I will mention from a warning perspective; so we talked… I’ll just recap, maybe the positives, and then I’ll go into a warning. But again, step one is get a plan. There’s just so much benefit that I’ve seen over the years for everyone, really, regardless of income. I just had a call with a gentleman last week with a very significant net worth, but he doesn’t have any clarity. And so I could tell in just talking with him, that he doesn’t have to worry about money, but he doesn’t see how it’s all going to fit together; how they’re going to be able to afford their lifestyle, so on and so forth. He’s selling a business. He doesn’t know what he needs from the business.
So, it doesn’t matter if you have a very high net worth, or if you’re just our typical client that has done well, saved, lived below their means, worked hard, and just wants to make sure that they make the most out of what they have, and they don’t outlive their money. It’s important for everybody. So, definitely get a plan.
Then the others that we mentioned, you could build a bond ladder. It’s a very simple way to go about and do this, I would argue. And I’ve seen examples where actually considering the annuities and the Social Security delay for, particularly if you’re healthy, is better than doing a bond ladder. So again, all these things, there’s sort of, a rank priority that could be applied to people differently. But a bond ladder could make sense. Delay Social Security, consider annuities, particularly, MIGAs on the accumulation side; there’s Multi-Guaranteed Annuities, or on the decumulation side, which from an income standpoint and from a retirement income standpoint, could be quite favorable, particularly for these conservative investors that we’re talking to today. So again, that’s more pension-like. It could start right away, or could start down the road, when you get quite a bit older, maybe age 80 or 85.
Those are some of the things that I thought of, what the conservative investor can do. The warning that I will make, as we wrap up, is you don’t simply reach for yield. We talked about this in the last podcast episode, but there’s no free lunch that’s out there. When it comes to bonds the higher the yield, the higher the risk, generally speaking. So that could be in the form of that duration risk, where you’re buying longer-dated bonds, which I mentioned under the build the bond ladder. Slight difference for the bond ladder is if you’re holding the bond to maturity, then what the cash flow is. You don’t really care about the price movement in between. Bond funds will maybe be a little bit different.
And then on credit risk, the credit risk is anything that you’re taking of lower credit quality, relative to government bond; that’s typically the way it’s thought of. So, high yield bond sounds great; they’re yielding a lot more than high-quality bonds, than treasury bonds; but you’re taking a lot more credit risk to do that. And in these types of higher yield bonds, generally speaking, their volatility or their wiggle factor, how much they bounce around, often appears fairly low until an event happens, like the financial crisis, like March of 2021, when COVID happened, and things got locked down. Even the fourth quarter of 2018, there was a bit of a credit gap down, if you will. And then everything is just going along, hunky-dory, and then all of a sudden, you lose 10% or 15% or 20%, or maybe even more. 2008 was quite a bad year for these credit-sensitive investments.
So you have to be careful. Higher yield equals higher risk; no free lunch. And you need to know what risk that you’re taking there. But these are all things that I think a conservative investor can do. But again, it all starts with that financial plan, for sure.
Walter Storholt: I just love the fact that something that sounds so positive as high yield, is another name for, it is junk; so that juxtaposition between the two names never gets old for me.
Kevin Kroskey: Good marketing.
Walter Storholt: It’s good marketing. Absolutely. Well, there you have it. And hopefully, that helps you out if you are looking for a synopsis of where to be these days as a conservative investor, there’s a bit of the landscape. And if you want to talk to Kevin a little bit more in-depth about some of these things, in regards to your particular situation, you can do that by going to truewealthdesign.com, click on the “Are we right for you?” button, and schedule your 15-minute call with an experienced financial advisor on the team. That’s truewealthdesign.com, and click the “Are we right for you?” button.
And, still got the old fashioned telephone as well, so pick up the phone, give us a call, if you prefer that method. 855-TWD-PLAN. That’s 855-TWD, for True Wealth Design. Or that’s 855-893-7526.
Kevin, thanks for the help. I enjoyed the conversations with you this week, and I will look forward to two new episodes next month.
Kevin Kroskey: Thanks, Walt.
Walter Storholt: All right. We appreciate it. That’s Kevin Kroskey. I’m Walter Storholt. We’ll talk to you next time, right back here, on Retire Smarter.
Disclaimer: Information provided is for informational purposes only, and does not constitute investment, tax, or legal advice. Information is obtained from sources that are deemed to be reliable, but their accurateness and completeness cannot be guaranteed. All performance reference is historical, and not an indication of future results. Benchmark indices are hypothetical and do not include any investment fees.