American Association of Individual Investors Presentation Albuquerque, New Mexico Chapter

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American Association of Individual Investors
PresentationAlbuquerque, New Mexico Chapter

• Retirement Investing Budgeting
• What Plan Works For You?
• Manage Your Wealth Find Your Spend Rate!
• April 17, 2007
• Joseph Banach, Registered Investment Adviser
• www.BanachWealthManagement.com

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Retirement Investing BudgetingPresentation
Goals

• A systematic wealth management approach
• Retirement Wealth Flow Examples
• Accumulation distribution (retirement) wealth
  plans
• Build Commitment for your own approach

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Retirement life means different thingsWhat is
Your Vision?

• Casual exercise with friends

Part-time work trail walks
Exploring nature
Travel to interesting cities
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Presentation GoalA Clear Investment FocusAvoid
out-of-control feeling
Sometimes investing results feel like a Roller
Coaster
Its easiest to hold current positions and hope
for the best
Our goal is to focus the Wealth Management
process to achieve your goals
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Retirement Investing BudgetingAgenda

• Develop Wealth Planning Example Assumptions
• Investment asset allocation portfolio
  management
• Spending budgets with tax planning
• Review Retirement Wealth Distribution
• Qualified Savings Plan and Pension Annuity
  spending plans

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The GoalDont go broke by outlivingfinancial
resources

• .

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Retirement Financial Goals

• Ideal Goal
• No Financial Risk Complete Financial Security
• Automatic Cash Inflows, as needed
• Constant Purchasing Power for Lifetime Retirement
  Spending
• Our Practical Goal
• Use Investments with Social Security Income (SSI)
  and possibly a pension to meet retirement
  spending needs

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Tax Deferred Savings Assumptions

• 401K Other Qualified Savings Plans
• Good Savings Investment Vehicles
• Tax deferred savings growth benefits
• Pay full income tax at withdrawal
• May transfer qualified plan assets to an IRA
• Full Income tax rates paid at withdrawal
• Plan which assets held in tax-deferred accounts
• Consider Selling (spending) lower cap gain tax
  rate stock funds from taxable accounts before
  withdrawing qualified plan (or IRA) assets

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Tax deferred investment accountsaccumulate value
faster than taxable accounts- T. Rowe Price
website example

• The annual contribution limit to a Traditional or
  Roth IRA is the lesser of your earned income or
  4,000 for 2006 and 2007, and increases to 5,000
  in 2008. After 2008, this limit will be indexed
  for inflation and will increase in 500
  increments.
• Investors who are at least 50 years old in a
  particular year may make "catch up" contributions
  for that tax year to accelerate the accumulation
  of assets in their IRAs. Those eligible are able
  to contribute an additional 1,000.IRAs Give You
  More After-Tax Income
• Assumes contributions of 4,000 a year for 25
  years, then distributions for 20 years in a Roth
  IRA, Traditional IRA, and a taxable account a
  rate of return of 7 while contributing and 6
  during retirement and a tax rate of 27. 
  Contributions are made at the end of the period.
• IRAs Give You More After-Tax Income Assumes
  contributions of 4,000 a year for 25 years, then
  distributions for 20 years in a Roth IRA,
  Traditional IRA, and a taxable account a rate of
  return of 7 while contributing and 6 during
  retirement and a tax rate of 27.  Contributions
  are made at the end of the period.

• Past performance does not forecast future
  performance
• Investment performance varies and bears the risk
  of loss
• Accurate return tax estimates needed for
  analysis

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Taxable Business Financial AssetIncome Issues
Assumptions

• Small Businesses, including income producing
  property owners
• Control flexibility of property cash flows
  taxable event timing
• Liquidity (property sale) Risk
• Non-controlling shareholder investments
• Stock funds - taxable accounts.
• Limited partnerships private equity funds -
  higher risks
• Hedge funds for Qualified HNW clients good
  analysis needed

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Taxable Investment PortfolioReturn Risk
Assumptions

• Low cost diversified stock funds - core,
  tax-efficient holdings
• Returns similar to SP 500 index
• Price Volatility Risk similar to SP 500
• Cumulative draw downs, as 2000 2002 possible
• Higher dividend stocks reduce volatility (risk)
• Bond funds reduce total portfolio volatility
• Core international small company funds
  recommended
• Diversification should add returns reduce total
  portfolio volatility

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Asset Allocation (Diversified Portfolio)avoids
401K to 201K scenario in 2002
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Retirement Investment Portfolio
AssumptionsReturns, Risks, Inflation, Wages,
Taxes

• Fund Annual Annual Severe Market
• Category Return S.D. Risk Downside Risk
• Money Market 4 0 0
• Government Bonds 6 5 10
• Large Stocks 10 10 30
• Small Stocks 12 12 40
• International Stocks 12 12 40
• Investment performance varies and may result in
  losses
• Asset allocations combine money, bond funds
  large, small, international stock funds to reduce
  risk
• Annual Pension (adj. to 3 inflation) Social
  Security Annuities (adj. to 3.5 inflation)
  assume no volatility risk
• Annual Long Term Inflation 3.5 Annual Wage
  Income Change 3.5
• Annual Combined State Federal Marginal Tax
  Rates Income 33 Capital Gains 18
• All examples total combined taxes 20 of
  100,000 total income 20,000

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Normal Quantitative Risk Assumption

• Example Large Stock Fund Risk Expected Return
  10
• Normal Return Distribution
• One Standard Deviation (S.D.) volatility 10
• 1/3 sample years return 0 to 10
• 1/3 samples return 10 to 20
• 2/3 (most) returns 0 to 20
• 13.5 samples return -1 S.D. and -2 S.D.
• (-10 to 0)
• 2.4 samples return -2 S.D. to -3 S.D.
• (-20 to -10)

1 S.D.
- 1 S.D.
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16
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- 2 S.D.

• Most investors focus on downside 16 risk of a
  loss
• Volatility also results in 16 risk (opportunity)
  for gt20 gains
• Thoughtful risk participation needed for higher
  potential gains

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Portfolio Risk ManagementKey Points

• Low Risk, Low Return Portfolio Asset Class Funds
• Money market and short duration bond funds
  (Strategic)
• Portfolio heavily weighted in low risk asset
  classes (Strategic)
• Portfolio Diversification with relatively
  non-correlated asset classes
• i.e. Bond commodity returns correlate 0.5 0.1
  with stock returns, etc
• Note asset classes correlate in market downturns
  (Strategic)
• Rebalance portfolio to normal level, when asset
  class weight changes more than 10, e.g. Large
  Cap fund from 36 to 40 (Strategic)
• Sell portfolio positions based on negative trends
  or deteriorated relative strength (Technical
  Analysis required) (Tactical)

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Tax Management Assumptions

• Hold stock funds (low cap gain rate) in taxable
  accounts
• Consider selling low taxed assets before 401K
  assets
• Tax-deferred assets (401K ) full income tax
  rates at withdrawal
• IRA RMD tax rates - where assets (Bonds
  REITs) held ?
• AMT higher taxes (group alternative year
  deductions?)
• Regular to Roth IRA conversions?
• Depends on conversion vs. regular IRA withdrawal
  tax rates
• Good analysis and planning needed

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Retirement PortfolioAsset Allocation Assumptions

• Retirement Portfolio asset allocation general
  formula
• 110 current age portfolio stocks weight
  (fixed income remainder)
• _at_ Age 65 110 65 45 stocks 55 fixed income
  assets
• Asset weights change annually _at_ age 81 100
  fixed income
• Conservative very low risk judgment at age 81 to
  reduce risk
• Fund allocations and expected returns
• Stock funds allocation 60 large cap, 20 small
  cap, 20 Intl. Fixed Income funds 50 bond, 50
  money market
• Age Stock Wt () Bond Wt ()
  Expect Rtn () S.D. Risk ()
• 45 65 35 8.77 6.66
• 65 45 55 7.61 5.41
• 80 30 70 6.74 5.29
• 81 0 100 5.00
  2.50
• Note at Age 81 it is rational and wise to hold
  some stock funds for inflation protection.
• The Examples assume 0 stock weight based on
  normal feelings to reduce all risks late in life.
  

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Retirement Asset AllocationReduce risks and
returns with ageLess Stock, More Fixed Income
Funds
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Retirement returns decreasewith increased fixed
income allocation
Return
Std. Dev. (Risk)
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Retirement Portfolio SpendingExample _at_ Age 65
Assumptions

• 100,000 household income annual 3.5 inflation
  adjusted wages and savings during wealth
  accumulation Age 45 to 65 period
• 401K plan savings rate 10 4 (employer
  match)
• 401K (or rollover IRA) Example
• Savings, allocation, and expected return _at_ 65
  (2007)
• 1,450,000 tax-deferred and 250,000 taxable
  portfolio
• 45 stock 55 fixed 7.61 expected total
  returns
• Pension Annuity at Age 65 Example
• 50,000 annual (3 limit inflation adjusted)
• SSI 20,000 annual (inflation adjusted)
• Secondary IRA value 650,000 (same above
  allocation returns)

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Stock and Fixed IncomeAsset Allocation Changes
with age
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Stock and Fixed IncomeAsset Allocation changes
during retirement
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Asset Allocation at Age 81 and BeyondAll Fixed
Income Assets
NOTE In practical terms only 2 years of spending
needs to be held in low risk money market funds.
Remainder can be held in 2, 3, 5 yr. etc. bonds
CDs. Example is an over simplification.
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Example AssumptionsCharity Spending Investment
Buffer

• Charity spending rate same as pre-retirement
• 5 to 10 charitable giving
• Wealth buffers accumulate and deplete
• based on actual annual return paths above or
  below plans
• Asset allocations always based on age

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Retirement401K Plan Savings Spending
Assumptions(continued)

• 95 years old at death sets 30 year spending
  period duration
• Social Security Income, Spending Rate, Total
  Annual Spending
• SSI 20 of pre-tax spending
• Initial portfolio spending rate 4.9 (_at_ Age 65)
• SSI 20,000 Portfolio 80,000 100,000 before
  taxes
• Assumed 20,000 taxes yields 80,000 disposable
  income

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Retired _at_ Age 65Wealth Distribution (Investment
Spending)Assumptions

• Investment spending allows 100 pre-retirement
  spending
• Asset allocation needed to earn returns
  maintain spending
• Returns and investment account vary yearly in
  the long-run (30 yrs.) based on past 60 years
  they should be near the returns shown
• Worst case periods impacted past long term
  returns by about 2
• Constant purchasing power investment spending
  (real 80,000) goal determines annual spending
  rate

? Relax, ask questions ? for
clarifications
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Portfolio Spending beginning retirement in 20
yrs.Increasing Annual Spending RateIncreasing
Nominal Spending Constant Purchasing Power
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Ideal Investment Portfolio ValueNominal Real
Spending beginning in 20 yrs.and Spending Rate

• Goal Maintain real
• spending constant
• Spending rate
• increases annually
• to achieve the goal.
• Portfolio nearly spent
• _at_ age 95
• (small cushion planned)

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Reduced Number of Spending Rate ChangesVariable
Real Spending

• Early retirement constant spending rate
• Real Spending decreases with age
• Later retirement many spending rate changes
• needed for near constant purchasing power
• 15 Rule Spending Rate, where lt 5 yrs. assets
  available for expected spending

Real Inflation Adjusted Spending
Spending Rates
Simple Spend Rate
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Wealth (Ideal Portfolio) Changes Distributions
begin at retirement in 20 yearsNominal spending
(not including SSI Income)
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Ideal Wealth Accumulation andNominal Retirement
Spending - All Sources
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Ideal Inflation Adjusted Portfolio Valueand
Retirement Spending
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Ideal Retirement ScenarioGood Planning
Constant Retirement Income

• At age 65 retirement, adequate portfolios ideal
  returns required
• Savings investment asset allocation critical
  for required returns
• Returns risks decrease with age
• Actual annual returns will vary from ideal path
• Spending rate rises with age
• YES Planning and steady investment returns
  allow a household to maintain real spending level
  throughout retirement years

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Retired _at_ Age 65 with previous example 1.7M
PortfolioConservative Asset Allocation Example
Fixed Income Weight
Asset Allocation Weights
Stock Fund Weight
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Conservative Asset Allocationat Age 65
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Retired ConservativeAsset Allocation at Age 80
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Retired ConservativeAsset Allocation Annual
Returns
Total Return
Std. Dev. (Risk)
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Conservative Asset AllocationCurrent Nominal
Amount and Spending Rate
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Retired Conservative Investing(Wealth _at_ Age 65
100 Purchasing Power)with Nominal Dollar
Spending
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Retired Conservative Inflation Adjusted
Investingresults in 4,000 (5) less
availablefrom Investment Portfolio for Spending
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Example Asset Allocation is criticalConservativ
e Investing Lower ReturnsLess available
retirement spending resources

• Reducing the Age 65 asset allocation to stock
  funds from 45 to 30 and annual 1 stock
  reductions results in an estimated 4,000
  (inflation adjusted) or 5 less available for the
  next 30 yrs. spending
• Understand your risk tolerances.
• Prudent Risk Taking (higher stock allocation)
  should be considered and is often necessary to
  achieve retirement spending goals

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Retire _at_ Age 65 Examplewith a Pension and an IRA

• An Annuity Example includes both a pension and
  IRA
• 50,000 pension inflation adjustment 3 annual
  limit
• 650,000 IRA investment portfolio
• Long term inflation rate 3.5
• SSI 20,000 fully 3.5 inflation adjusted
• Scenario Question
• Can you continue to maintain your current
  100,000 household income (before taxes) from Age
  65 through 95?

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Retired with Pension and IRASame asset
allocation and returnsas Ideal 401K investments
example
Total Return
Risk Volatility
Std. Dev. (Risk)
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Pension Annuitywith Nominal IRA Spending
Amountand Spending Rate
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Pension Annuity and Wealth DistributionAll
Inflation Adjusted Spending Sources
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Retirement Example with a 50,000 (2007) Annuity
and an IRA

• Returns risks decrease with age
• Notice impact of 3.5 inflation and pension 3.0
  adjustment limit
• From Age 93 through 95, total income drops below
  our 100,000
• Planning, a pension, and an IRA should be
  sufficient to maintain spending rate through
  retirement.
• But, at 93 decreasing IRA value limits spending
• SSI and pension are very low risk income sources
• Increasing Age 65 IRA Stock Allocation from 45
  to 60 with 1 stock annual allocation reduction
  meets full 30 year spending goal

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Retirement Investment SpendingSource
Information

• www.socialsecurity.gov
• www.medicare.gov
• www.sec.gov/investor/seniors.shtml
• good calculator for investment planning and
  retirement spending on website left stripe
• www.finance.yahoo.com/
• www.vanguard.com
• www.fidelity.com
• select My Plan an easy retirement plan
  calculator on website middle stripe
• www.troweprice.com
• select Individual Investor various retirement
  and IRA plan calculators on website

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Retirement Investing BudgetingConclusion

• Keep savings, asset allocation, and investment
  return assumptions simple.
• Long-term cash flow results are sensitive to
  mediocre investment results be aware of
  conservative asset allocation expected results.
• Adjust spending or retirement plans, as soon as
  poor results occur (2 successive years) along the
  way.
• Reduced spending or postponed retirement
  adjustments not shown
• All calculation spreadsheets are available per
  e-mail request. jabanach_at_gmail.com