Ep 18: Total Return Portfolio: Retirement Income Planning Series – Part 3

Ep 18: Total Return Portfolio: Retirement Income Planning Series – Part 3

The Smart Take:

If you’re taking a probability-based approach to generating retirement income, as we discussed in the first part of this series, you’ll need to build a strategy for how to invest. That’s where the Total Return Portfolio comes into play.

Prefer to read? See below for the transcript of the show.

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The Host:

Kevin Kroskey – AboutContact

Introduction:                     00:03                     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:                00:15                     Thanks for joining us on the podcast this week. Walter Storholt here alongside Kevin Kroskey President and a Wealth Advisor at True Wealth Design in Northeast Ohio. Offices in Akron and Canfield, so it’s convenient to come,

Walter Storholt:                00:26                     By, say hello and ask questions if you have them. You can also find us 24/7 online at TrueWealthDesign.com. That’s TrueWealthDesign.com. Kevin, it’s part three of our Retirement Income Planning Series. I know that’s got you energized and excited today.

Kevin Kroskey:                  00:42                     Yes sir. I think you’re going to be able to hear it throughout. So today we’re going to be talking about the total return portfolio.

Walter Storholt:                00:51                     I like that. Total return. We need like Total Recall, like Total Recall portfolio, you know, just tie it into some cool movie name.

Kevin Kroskey:                  00:59                     Thank you. My attempted emphasis just fell flat. I thank you for saving me, Walter.

Walter Storholt:                01:08                     We’re just going to play like dramatic music behind you as you describe these things, each episode now just to help, you know, build in like when they pipe in extra applause when the crowd’s not really feeling it at the sporting event and they pipe in some extra applause and sound to make it sound like everybody’s really excited.

Kevin Kroskey:                  01:24                     Yeah, I might have to just do some pushups before we get on the call and get pumped up a little bit, I don’t know. Anyway, let me get back on topic here. Yeah. So I’ll just do a quick recap if you don’t mind, of what we did in one and two so far in this Retirement Income Series. So we started out with a framework and talked about, Hey, you got to start with the financial plan. But as you get through and putting together that financial plan, then you get down to the point where you need to start implementing the plan and making decisions about how you’re going to recreate your retirement income. Are you going to follow a path of using more of a probability-based path and using investments or are you going to completely transfer your risk to an insurance company and by some sort of guaranteed income source from an annuity or something of the sort there?

Kevin Kroskey:                  02:12                     So there are those two frameworks. And then what we talked about in episode two was really to emphasize why this really is important. And there is something called, we call it bad timing risk. A lot of the smart people call return sequence risk. And basically, it’s just, Hey, are you going to retire and have a real tailwind at your back, with real positive market returns. And if you do, that bodes quite well for you and your future throughout retirement. Or are you maybe going to get unlucky, roll the dice and come up snake eyes and go ahead and have a series of negative returns similar to what we had and say, you know, 2007, 2008, 2009 and put a lot of stress on the portfolio? And, while you have a lot of years left ahead of you. So we talked through that in detail and we talked about, and we’re going to talking about it some more in a future episode in the series, but you know, if you want to go ahead and buy the guaranteed income, it’s really expensive.

Kevin Kroskey:                  03:09                     So you can have a high certainty, but you’re probably going to have to work longer. You may have to spend less or you’re going to have to give up a lot less money in terms of you know, what’s going to be left when you’re gone. That’s going to go to your kids, grandkids, charities, what have you, and that may be a fine tradeoff for some, but mathematically we just believe there’s a better way to go about creating this retirement income. And it is that more probability-based investing approach. All of us have are going to have, you know, some guaranteed income already. Social Security, if you have a pension, those are forms of guaranteed income that you already have. And we’ll do another future podcast episode on this. But just with Social Security claiming strategies, doing some planning around that is much more beneficial than introducing some sort of annuity from an insurance company just because of the way that the math works on Social Security system. At least it does today. So if we’re going to go down this path of having more of a probability-based approach and creating our retirement income from savings, then it gets into, well how are we going to invest? And so that’s really what this total return investing is and what we’re going to talk about briefly today.

Walter Storholt:                04:17                     I think it’s so helpful to see that there’s more than one way to solve the problem. And so it’s not always in the financial world a conversation of you know, yes and no that we’ve talked about, you know, gray areas before or just there are different ways to get to the solution, but yeah, why wouldn’t you want the more efficient way, the one that might be better for you long term. And I guess it kind of like that suitability versus fiduciary standard. There’s this might be a suitable solution for you, but is it the best thing? Is that the thing that’s truly in your best interest? And that’s the kind of plan that we really want to have in place and the strategies that we truly want to follow.

Kevin Kroskey:                  04:53                     Yeah, I like to say that we do the math first and see what the math says is likely to be best. And then we certainly talk about, you know, how do you feel about that? Is this a solution that you’re going to be able to sleep at night? Because even if it’s, you know, mathematically optimal or whatever, you may want to describe it as if he can’t sleep at night. If you can’t handle some of the ups and downs in the market, then it’s not a path for you to pursue. But just to start with the emotions, frankly. I mean that’s what a lot of insurance people do just to go ahead and sell those high commission products. And I just don’t think that’s a good approach. So this total return approach, it’s been around a long time, and I should probably explain what total return is to start.

Kevin Kroskey:                  05:32                     So you know, whenever you go ahead and you invest in, I’ll just use the S&P 500 you know, call it the stock market by today, who knows what it’s, the return is going to be over the course of the next year in total. However, if we just compartmentalize the return of it into two components, we buy today on average, we’re going to get about a 2% return from dividends paid out from the companies that comprise S&P 500 so the dividend yields about 2% and then we’re going to get another part of the return to go ahead and sum up to the total return. That is going to be some price increase or decrease, you know, or the stock prices are going to go up. This is the market going to go up or is it going to go down? You know, we don’t have the crystal ball, but whatever that price return is.

Kevin Kroskey:                  06:19                     So we have an income return, the dividend yield. And then we are going to have the price return. And that’s just again, did stock prices go up or down? So you have those two together and that’s the total return. The same thing works. If we’re talking about bonds, you’re going to have a higher portion generally speaking in interest payments. So the income returns going to be higher there, but the price of the bonds is going to move around as well. You know, as interest rates move, the prices of the bonds move and as bonds kind of, you know, if you buy a 10-year bond and it goes down to 9 years, you know, not to get too wonky here, but there’s something called a “roll yield” and the price of the bond is going to change as the duration changes. So you’re going to always add those two components together to get the total return.

Kevin Kroskey:                  06:59                     Now one of the mistakes that a lot of people make, and I’ll just mention here but won’t go into, is that income return is very easily observable. You know, it’s something say, Hey, I like dividends. You know, I can see that the money is coming in. And you know, a lot of the funds that we use, we’ll pay out those dividend payments quarterly and we have some call it Super Senior clients that literally they still, they’ve been getting the dividend checks in the mails for a long time. They like getting yet, and it’s just this emotional, behavioral preference that we have for seeing the money work for you. So a lot of people will have kind of a dividend focus strategy. The evidence on doing that is not good. So the total return approach I’m talking about, it’s been proven for the last 50 years.

Kevin Kroskey:                  07:44                     It’s a much better way to go ahead and provide a total return and also ultimately provide your retirement income. So I’ll give you an example of this. Whenever you look at pension plans, I’ve mentioned in some prior episodes, I mentioned Goodyear. We work with a lot of people from Goodyear because Goodyear employees a lot of people in our local area. And Goodyear at the end of 2018 excuse me, in 2016 a had $1.8 billion in assets and the same amount in liabilities and the liabilities for a pension plan are the monthly payments that they have to pay their pensioners, so all the people that worked for Goodyear over the years vested in those pension benefits. Goodyear has the $1.8 billion in assets and has to go ahead and invest that money and provide that monthly income stream to their pensioners for as long as they live and Goodyear actually froze their pension plan in 2008 and what they’ve been doing since then.

Kevin Kroskey:                  08:45                     What you’ve seen is that the pension plan has become more well-funded because now it’s not completely open-ended and people are still accruing benefits. Again, it’s kind of winding down because it’s been frozen and where it sits today, it’s actually more than 90% invested in bonds. As of the end of 2016, the report showed it was 94% in bonds and only 6% in stocks. But if you would have gone back and look at any pension plan that is kind of open and still accruing benefits, most of them have a risk that’s approximate to about 60% in stocks and 40% in bonds. And so really what the Goodyear plan kind of shows you is that they’re investing with a purpose and their purpose is to go ahead and meet those monthly obligations that they’ve promised to pay their workers. And they go ahead and say, look, you know, Hey, we got $1.8 billion in assets.

Kevin Kroskey:                  09:35                     We at $1.8 billion in liabilities, we’re going to invest with a purpose and just go ahead and, and meet those obligations. And we don’t have to take a lot of stock market risk anymore. And you know, that may not necessarily be true for somebody entering retirement. But I can say for sure after we do the math, it’s true for some of our clients and we make that very clear to them that, Hey, your plan is not only fully funded, but maybe you even have some excess so we can go and then have a discussion about, you know, do you want to take some additional risk because you can afford to, it’s not going to detract from your lifestyle. If we hit a 2008 kind of speed bump for a period of years and oh, by the way, I mean you’re probably going to end up being able to spend more money if you want to leave more money on to your kids, grandkids or charity or what have you, but we’ve already done the math for that and then we come down and then we kind of stress test the plan and we have this conversation around, Hey, what kind of return do you really need for your plan to work?

Kevin Kroskey:                  10:33                     How much capacity for risk do you have? Because it could go the other way. You could really see after you perform one of these stress tests that, Hey, if John and Jane hit a speed bump at the outset of retirement, they had one of those bad timing events that we talked about in the last episode, they’re going to have to cut back a lot and it’s probably going to be more than what they really can handle. So they can’t take that kind of risk. So you have to measure this stuff, but after you measure it, it comes down to that, you know, this total return approach. So, Goodyear, any pension plan has the advantage of one, it’s a fixed monthly payment. It doesn’t increase with inflation. All of our expenses as human beings pretty much do increase with inflation over time.

Kevin Kroskey:                  11:16                     You know, gas is going to be higher over time. Your car insurance and your property taxes are going to go over time, so on and so forth. Pension plans do not pay taxes. We do pay taxes. So that introduces some more planning and complexity. The people that are managing those pension assets have some objectivity to that. Certainly, we’re all humans and we’re all emotional creatures. However, I can tell you in working with clients for many years that particularly once they’re in retirement and the paycheck spigot has been turned off, a lot of them do get more emotionally attached to their dollars, whether it’s going up or going down. Whereas in the pension example, you know, you kind of have that objectivity of the pension board and the consultants that they’re hiring, making the decisions on behalf of the pensioners. But there is really that, you know, kind of that separation of the two.

Kevin Kroskey:                  12:06                     So in effect, what we do when we’re following this, you know, this probability-based approach, this investing type approach and using a total return approach for the investments are doing the same thing that the pension plans are doing. But just factoring in all those other things. So we just have to go through and we have to go down that path and figure out, you know, what kind of returns do you need? You know, where is it likely to come from? Today you can go out and you can get maybe 2% on cash, maybe get a little bit more from investing in bonds. Stocks are inherently more difficult to forecast, but it’s going through that deliberate approach and practice of figuring out where are we going to derive the returns that we need, that we already measured from your financial plan that you need to achieve over time. And that’s also consistent with how much risk that not only that you can take your capacity for risk, but also your ability or willingness to go ahead and take risks.

Walter Storholt:                13:00                     It’s interesting hearing your conversation about kind of this total return investing, but also that comparison of the pension plan for you know, Goodyear and that stock and bond mix being so heavily weighted toward the bond side. And I guess although that sounds like a great strategy and one way to again accomplish the goal that we’re seeking here of kind of weighing all these different opportunities and options, there are major differences then I guess between a pension plan and an individual person. And you kind of outline, you know, so there are advantages that a large pension plan has versus us as an individual and that’s why we maybe we need to be a little bit more nuanced and be a little bit more flexible through some of these things.

Kevin Kroskey:                  13:41                     Yeah, completely. So I think the biggest thing for people to take away is that you know, there are these two components of return. It’s the income and then it’s going to be some growth. And again that growth over time is going to occur. But certainly in the shorter periods of time that growth may detract from the returns. So when we actually go ahead and start creating the income, not only have we measured and potentially planned for those bad timing risks that we talked about previously, but it really comes down to you. You can think about it over time, you know Goodyear is investing that money and the cash that they have in their portfolio is paying out monthly benefits for the next, you know, one to 10 months. So on and so forth. The 6% stocks that they have in their portfolio are really for the much longer-term dollars for people that are vested and, maybe they’re going to be paying out 30 years from now.

Kevin Kroskey:                  14:31                     The same sort of thing applies to our clients. When we went through 2008 and we were looking and updating our clients’ financial plans, one of the things that we did that was really helpful was, Hey, we just looked at their portfolio. We said, look, you’re about 50% stocks, 50% in bonds, maybe your 60% stocks, and you know, it’s kind of went down because stocks went down and so now you’re more balanced. If we don’t do anything, you know we have 50% of your money in bonds and all we did was spend the bonds first. So we just bought some time for the risky stuff, the stocks to go ahead and bounce back. How much time do you have? And for most of our clients it was at least even in 2008 it was at least about three years. It was on average is a little bit more than that.

Kevin Kroskey:                  15:14                     Several clients that have well-funded plans, you know, we’re 10 or 20 years before they would have to touch, you know, the stocks. I talked about, you know, decomposing the returns into this income and growth component. And you can do the same thing for the portfolio. You know, you can say like safer assets, we call them more preservation assets or more growth or appreciation assets. So you can kind of think of it in that time segmentation as well. Your money tomorrow, particularly in retirement, it better be in something very safe, very liquid, you know, cash at the bank sort of thing. And then as you go out in terms of time, you know, it’s, as you get further and further out, you can afford to start taking more and more risks with the portfolio. It’s all one big pot if you will.

Kevin Kroskey:                  15:58                     It’s one big pot of money. It’s this total return approach. But what we have to do if we’re following this investing based approach, this probability-based approach to creating somebody’s income rather than going out and spending, you know, a lot of money on these expensive guarantees for insurance. We have to use these ways about kind of segregating things and showing them, say, look if we just spent on ourselves first, you have five years, you have 10 years. And in my practice in doing that over the course of time, it allows people to have the mindset and have a little bit more comfortability to go ahead and stay disciplined and stay invested and let the market kind of work itself out like it did in 2008, 2009. Something else that we do is, you know, when you do have multiple goals in your retirement plan if you have a single goal and say you’re spending, you know, $80,000 a year before you enter retirement and say, okay, well I got to go ahead and maintain that lifestyle in retirement.

Kevin Kroskey:                  16:54                     So you have one goal and it’s $80,000 a year each and every year through retirement. Well, we’ve talked about this early on in the podcast and kind of the myth of that 80% replacement rate it’s probably episode three or four, but spending does change over time. So, if you have kind of a, you know, simplistically, it’s kind of like the go-go, this slow-go and the no-go years as we get through those sixties, seventies, eighties, and nineties. So when you model how spending actually changes, and then you have this not one goal but a multi-goal approach, and then you stress test somebody’s retirement plan that’s reflective of their lifestyle, not only today but how it’s likely to change over time as they age. Then even when you do that bad timing stress test, what you’re going to find is that there needs, the things that are most critical to them, their health insurance, you know, just heating the house food and the belly sort of thing.

Kevin Kroskey:                  17:44                     You know, that stuff has to go ahead and be met with an extremely high degree of confidence regardless of what investment market returns are. As you start moving down the totem pole and get into more discretionary items, like, Hey, you know, I’d like to have a second home down in Florida. I’d like to do this, or I like to do that. And you know, it’s not in the needs bucket, but it’s more than the wants or maybe in even the wishes bucket and, actually, I’ll give a good example. We just went through this with a client recently. They retired in their late fifties which is, you know, quite young by, by most standards, they’re healthy. You know, they might have 40 years in retirement and it wasn’t in their retirement plan, but they said, you know, we’ve been going down and visiting some friends and we have some family down outside of Bradenton, Florida.

Kevin Kroskey:                  18:29                     We’d really like to get this second home down there. I’m like, well, you know, hey guys, we didn’t plan for that in advance, so let’s go back and see how we can work this. And as we kind of worked it in their financial plan and we found that look, you know, if you guys downsize your big home that you’re in now in Northeast Ohio and it doesn’t have to be today, but at some point in the future where that money’s going to become available for, for spending, for retirement spending. And you go ahead and you buy something around $300,000-$350,000 down in Florida, we feel comfortable recommending that you can do that. And you know, what are you going to do if it’s a worst-case, if things don’t pan out well maybe not doing it for 20 years, you can probably do for about 10 years and then you’re going to have to sell it.

Kevin Kroskey:                  19:10                     So this is really what, to me, it’s about, it’s, you know, Hey we got all these moving pieces and parts. We have investments, we have taxes, we have Social Security, we have pensions, we have bad timing risk. But it’s our job to go ahead and make it clear, do the math, explain it in plain English to our clients. Talk about, you know, kind of the emotional side as well and some of the tradeoffs, but then make it very concrete to them about, Hey, if you go down this path, yes or no, you can or can’t do it. And if this happens, this is the potential ramification. And for them, frankly, I haven’t gotten the answer yet, this was just something that happened a couple of weeks ago, but I think it’s a tradeoff that they’re willing to make. I think there’ll be willing to go ahead and pursue that path and find a place down in Florida. And if things, you know, maybe they’re going to have to sell their home in Ohio and say, you know, their mid-seventies or so, which probably makes sense anyway because there’s a big home, they’re more difficult to maintain and the older you get the less you want to do it. So that’s a practical example of some of the things we’re talking about here, but you know, their plan and the returns are going to get met by the total return from their investments over time.

Walter Storholt:                20:18                     Well, it’s so important to get a good perspective on these moving parts and that’s why we’re taking some time over the course of several episodes that talk about retirement income and making sure that you understand the ins and outs of those different moving parts and some of the elements that go into the philosophy that’s used at True Wealth Design. It’s not just a, you know, following a saying, you know Kevin of Oh yeah, well as you get closer to retirement, you get out of stocks and you get into bonds. It’s not that simple. It’s not easy. There’s a much more complex methodology behind making sure that you’re truly prepared for your retirement future. The great news is you don’t have to, you know, go at it on your own. You’ve got somebody there helping you along the way and pointing out the pitfalls, the twists and turns of the road as you go through.

Walter Storholt:                21:05                     And that’s what we’re trying to do here on the podcast each time is take you down that path to understanding kind of some of the moving parts that are going on behind the scenes in your portfolios that you can be well prepared for your financial future and if you’d like to meet with the True Wealth Design team, you can start by scheduling a 15-minute call with an experienced financial advisor on the team. Just go to TrueWealthDesign.com and click on the “are we right for you” button, typically down at the bottom of the page but in a couple of different spots. Again, just go to TrueWealthDesign.com and click the “are we right for you” button or you can call the team directly at (855)-TWD-PLAN that’s (855) 893-7526 and Kevin, we are going to be continuing this series into the next podcast. Can you give us a little preview? What direction are you taking us in for the next one?

Kevin Kroskey:                  21:53                     Yeah, sure thing. Let me mention one other thing. So if you went down the guaranteed approach, it is simpler. If all your money was in guaranteed, you know, accounts or insurance products, you know, you don’t need somebody like me or like one of the CFPs on our team at True Wealth. However, you know, again, those guarantees are expensive. You’re probably going to have to work longer. You’re probably going to have to spend less or you’re going to have less when your plan is all said and done, you know, for your kids, grandkids, for charity and those tradeoffs may be fine. But if you’re following this more and it is that, it’s a little bit more of a complex approach. I mean we can have some simple ways about doing it, for example. I mean we buy mutual funds and things like that. We’re not doing anything, you know, everything is transparent and low cost, what have you, but there is a little bit more inherent complexity in it.

Kevin Kroskey:                  22:42                     So I think that’s a reasonable trade-off to keep in mind. I mean, all of the clients that work with us, they’ve already made that decision in their mind. And that’s one of the reasons why they’re working with us. They feel like they found somebody that can go ahead and guide them down that path. They can go ahead and kind of do the work but keep them informed and help them make smarter decisions and keep them on the path. What we’re going to talk about next time is now that we have these principles in place of having more of a probability-based investing approach, you know probably is going to end up better for most people. Certainly, that’s what history shows the math shows and then we start getting into really mitigating and planning for and stress testing our plan.

Kevin Kroskey:                  23:23                     So in case there’s a bad timing risk that pops its head in the early years of retirement and then we say, okay, you know, Hey, how are we going to go ahead and start investing in? We have to be mindful of the liabilities of our retirement spending, similar to what the pension plan has to be mindful other than paying out the monthly benefits. And we’re going to follow this more total return approach and have a well-diversified component to it. But then we’re going to talk about some of the things that need to be dynamic. And what I mean by that is, well I think you might have to tune in next time, but it’s not a set it and forget it type of approach. You know, returns, change, return expectations change, your portfolio is probably going to need to change a little bit over time in light of those changes and some other things that may pop up. So that’s where we’re going next. And then the final episode we’re going to talk about how expensive those guarantees really are. I’ll use some examples there.

Walter Storholt:                24:16                     All of that on the agenda for future episodes as we continue our Retirement Income Planning Series. If you want to listen to the first two episodes of the series, just go back two episodes. And that’s where we began the series. This was number three in line, so just go back a little bit before this and you’ll be able to follow along as we go through this series. Just look for part one and part two in the title name and that’ll lead you to the right place. Kevin, thanks as always for the help and we’ll look forward to continuing this series with you next time.

Kevin Kroskey:                  24:43                     Thanks, Walter.

Walter Storholt:                24:44                     Alright, for Kevin Kroskey, I’m Walter Storeholt, remember, check us out on TrueWealthDesign.com if you need any help or guidance or want to listen to past episodes of the show, don’t forget to subscribe on Google, iTunes, Apple Podcasts, Spotify now, we are on Spotify, so that’s exciting as well.

Walter Storholt:                25:00                     And you can subscribe to us really on any app that you like. By the way, if you ever find an app, you have your favorite that you don’t see us listed in it, maybe you have one that’s not one of the more popular ones that you enjoy and you’d like to get us on your favorite app. Let us know and we’ll be able to certainly do that for you. We’ll go ahead and get it submitted on there. Just let us know. Thanks for joining us. We’ll talk to you next time right back here on Retire Smarter.

Disclaimer:                          25:30                     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 references are historical and not an indication of future results. Benchmark indices are hypothetical and do not include any investment fees.