Sunday, August 14, 2005

Summer Stroll #17 -- Retirement Roulette II

You've just been notified that you have a million dollars in retirement benefits. As we said in our last edition, that seems like a lot of money, but it will produce surprising little income in simple investments, maybe $35,000 - $40,000. With stocks having produced over 10% per annum over many years, it is natural in this low interest rate environment, that you would turn to stocks in hopes of producing a higher level of annual income. This seems simple enough, and from an expected return perspective, it is recommended for most people. But there are problems. The first problem is what stocks should you buy and who should you buy them from. You have a broker, a banker, a CPA, and an insurance agent. All of them claim to be financial advisors, specializing in retirement planning. They are all good people, and you have known them for many years. Which one should you chose to work with on your retirement questions? In my experience, it won't make much difference which one you choose because they will all offer you programs that will look very similar: 40% in US large cap mutual funds, 15% in international stock funds, 15% US small cap stock funds, and 30% in bond funds. The reason they will do this is because that is what everyone's asset allocation software says. My biggest problem with this "classical" asset allocation approach is not the stock-bond mix. My problem is that the fees almost everyone will charge you to construct and supervise your retirement plan are sky high. You could pay as much as 5% ($50,000) of your assets in front-end loads, and as much as 2-3% in annual administrative and investment management fees. The retirement planning crowd are not portfolio managers in the strict sense of the term. The have little experience in individual stock selection; indeed, many would not know where to begin to analyze the value of a stock or bond. They leave the investment management up to the mutual funds. Their primary role is the selection of the mutual funds for the various categories. I don't want to minimize the skills and training required to do this, but in the end, it gets down to picking funds that have done well over a long period. It is not rocket science, but they are paid better than most rocket scientists to do it. On a million dollars, excluding the front end sales charge, the total annual fees may range from $20,000 to $30,000. That will just about wipe out the income from the "classical" asset allocation. That means, you will be living entirely off of capital gains as I described in the last blog. Now you can go to bed each night and wake up each more morning thinking about almost every kind of stock under the sun: big stocks, little stocks, and foreign stocks and experience their respective volatilities, which is the case of small stocks is over 30% per annum. Our firm has seen a steady inflow of clients who previously did business with a "friend" or neighbor in the investment business (and it seems everyone has a friend in the investment business). What they understood dimly when they began, they completely understand today: To bet their retirement comfort entirely on capital gains is nuts, especially if the reason they are doing it is to subsidize their friend's lifestyle. As a man in Terre Haute told us: "My friend is a great guy, but he has cost me a lot of money and if I hit the wall, he is not going to come over to my house and offer to support my way of life. He has no plan; he can't explain what's going on. I think he hopes I will move on so we can salvage our friendship." It ain't brain surgery and it ain't rocket science are two phrases that attempt to say investing is just not that tough. It's--you know--go with the flow. It'll be OK in the end. The rising tide lifts all boats. But there is another equally pithy phrase, "It ain't necessarily so." In this case, having your friend manage your retirement plan might be akin to having your friend perform brain surgery on you, or build a rocket that will safely send your to the moon. Not!!!!!!!!!! Get an expert. Get someone who charges a modest annual fee(no front-end loads), which will allow some of the income that your portfolio produces to make it to you, so you won't be living entirely off of volatile capital gains. Get someone who knows value. Get someone who is in the business of building and managing individual stocks and bonds. They are tough to find. They are a bit old fashioned, but they are out there and you need them much more than you know. Additionally, there are brokers we know who can construct a mutual fund portfolio using no-load funds with low annual fees. You are betting your life on your money manager. Think about it.