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American Association of Individual Investors Presentation Denver, Colorado chapter


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Title: American Association of Individual Investors Presentation Denver, Colorado chapter

American Association of Individual Investors
PresentationDenver, Colorado chapter
  • Retirement Investing Budgeting
  • How Much Can You Spend?
  • Manage Your Wealth Find the Answer!
  • November 8, 2006
  • Joseph Banach, Registered Investment Adviser

Retirement Investing BudgetingPresentation
  • A systematic wealth management approach
  • Life Cycle Wealth Examples
  • Ideal plan contingency plans
  • Build Confidence in your own approach
  • Basis for future detailed wealth management

Retirement means different thingsto different
peopleWhat is Your Vision?
Trail walks
  • Casual exercise with friends

Travel to famous cities
Exploring nature
Presentation GoalA Clear Investment FocusAvoid
out-of-control feeling
Sometimes investing results feel like a Roller
Its easiest to hear, see, and say nothing then
hope for the best
The goal is to focus the Wealth Management
process to achieve your goals
Retirement Investing BudgetingAgenda
  • Develop Wealth Planning Assumptions for examples
  • Investment asset allocation portfolio
  • Tax planning and budgeting
  • Pre Retirement Wealth Accumulation
  • Ideal and contingency examples
  • Post Retirement Wealth Distribution
  • 401K and pension annuity spending plans

The GoalDont be broke when retired
  • .

Retirement Financial Goals
  • Ideal Goal
  • No Financial Risk
  • Automatic Cash Inflows
  • Constant Buying Power for Lifetime Retirement
  • Our Practical Goal
  • Use Investment sources with SSI and possibly a
    pension to meet retirement spending needs

Tax Deferred Savings Assumptions
  • 401K other tax deferred savings plans -
  • Automatic discipline, tax deferral benefits
  • Pay full tax at withdrawal
  • At retirement may transfer assets to an IRA
  • Income tax rates at withdrawal
  • Assets held in tax-deferred accounts?
  • Examples Spend tax-deferred before taxable funds

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
  • 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
  • Investment performance varies and bears the risk
    of loss.

Taxable Investment SavingsRetirement Income
  • Small Businesses, including property owners
  • Control flexibility of property and sale
    timing Liquidity?
  • Non-controlling shareholder investments
  • Stock funds good for taxable accounts
  • Limited partnerships hedge funds - higher risks

Taxable Investment Shareholder Assumptions
  • Low cost diversified funds - core tax-efficient
  • Returns similar to SP 500 index total returns
  • Price Volatility Risk similar to SP 500
  • Cumulative draw downs, such as 2000 2002
  • Higher dividend stocks reduce volatility
  • Bond Funds reduce Total Portfolio Risk
  • Core International Mutual Funds recommended

Retirement Investment PlanningReturns, Risks,
Inflation, Wage, Tax Assumptions
  • 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
  • Asset allocations combine money, bond funds
    large, small, international stock funds to reduce
  • Annual Pension (adj. to 3 inflation) Social
    Security Annuities (adj. to 3.5 inflation)
    assume 0 S.D. 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
  • SUMMARY Ideal examples, 80,000 annual after-tax
    inflation-adjusted disposable income

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

1 S.D.
- 1 S.D.
- 2 S.D.
  • Most people focus on downside 16 risk of a loss
    instead of volatility
  • that also results in 16 risk (opportunity) of
    gt20 annual gains

Asset Allocation WeightsAvoid the 401K to 201K
situationPeople felt in 2002
Tax ManagementAssumptions
  • Stock fund assets for long-term gains
  • Tax-deferred assets (401K ) full income tax
    rates at withdrawal
  • Tax rates determine where assets held
  • AMT reduces cap gain tax differential (group alt.
    year deductions)
  • Regular to Roth IRA transfers?
  • Significant discipline needed

Portfolio Asset AllocationAssumptions
  • Investment Portfolio Asset Allocation
  • Allocation formula 110 age stock fixed
    income asset weights
  • _at_ Age 55 110 55 55 stocks 45 fixed income
  • Asset weights change annually _at_ age 81 100
    fixed income
  • Fund allocations and expected returns
  • Stock funds allocation 60 large cap, 20 small
    cap, 20 Intl. Fixed Inc funds 50 bond, 50 mm
  • Age Stocks Weight () Fixed Income Weight ()
    Expected Return ()
  • 45 65 35 8.77
  • 65 45 55 7.61
  • 80 30 70 6.74
  • 81 0 100 5.00
  • 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 very late in

Asset Allocation Weights ChangeReduce risks (and
returns) with age
Retirement Savings Wealth AccumulationExample
Start _at_ Age 45 Assumptions
  • Household Income
  • 100,000 (2006) annual 3.5 inflation adjusted
  • Tax deferred 401K Savings Example
  • 400,000 tax deferred 100,000 taxable savings
  • 10 401K savings rate, 4 company match
  • Pension and Savings Example
  • 50,000 annual (2006 equiv. 3 limit inflation
  • 200,000 IRA 5,000 inflation adjusted annual
  • Annual contributions to defined benefit pension

Stock and Fixed IncomeAsset Allocations Change
with Ageapproaching Retirement
Stock and Fixed IncomeAsset Allocations change
during retirementExpected Returns and Risk
reduced with Age
Asset Allocation atAge 81 and BeyondMoney
Market Funds and Laddered Fixed Income Assets
NOTE In practical terms only about 2 years of
spending needs to be held in near risk-less money
market funds. The remainder can be held in
laddered 2, 3, 5 yr. etc. bonds CDs to
increase income during normal yield curve periods
and achieve 5 total return. The example is an
over simplification.
Expected Annual Returns decreasewith lower risks
Charity Spending Investment BufferAssumptions
  • Charity spending rate same as pre-retirement
  • 5 to 10 charitable giving
  • Total investment buffers in any given year varies
    during life cycle.
  • Examples are ideal. No simulations or confidence
    levels shown.
  • Real annual returns and path to accumulated
    wealth will vary.
  • Asset allocations, which impact returns, in
    examples is always based on age

Ideal Accumulated 401Kand other investment
wealth appreciates to3.5M Total Wealth Value _at_
Ideal Real (Inflation Adjusted) 401Kand other
appreciated investment wealthDollar buying power
decreased 50 in 20 yrs. to 1.7M _at_ 65
Retirement401K Plan Portfolio Spending
  • 95 years old at death sets spending period
  • Investments and returns starting _at_ 65 (2006
    inflation adjusted)
  • 1,450,000 tax-deferred and 250,000 taxable
  • 45 stock 55 fixed 7.61 expected total
  • Social Security Income, Spending Rate, Total
    Annual Spending
  • SSI 20 of pre-tax spending
  • Initial portfolio spending rate 4.75
  • SSI 20,000 Portfolio 80,000 100,000 before
  • Assumed 20,000 taxes yields 80,000 disposable

Currently RetiredWealth Distribution (Investment
  • Investment spending allows 100 pre-retirement
  • Asset allocation shown is needed to earn returns
    maintain spending
  • Returns and investment account vary yearly
    however, in the long-run (20 yrs.) based on past
    60 years they should average to those shown
  • The constant inflation adjusted investment
    spending amount (80,000) determines the annually
    increasing spending rate

Relax, ask questions for clarifications
Ideal Scenario 401K PortfolioSpending Amount and
Increasing RateConstant Real Income
Ideal Portfolio Value, Spending Amount (Nominal
Real)and Spending Rate
  • Goal Keep the real
  • (inflation adjusted)
  • portfolio spending
  • amount constant.
  • The spending rate
  • increases each year
  • to achieve the goal
  • The real portfolio is
  • essentially spent by
  • age 95 to meet the
  • goal

Portfolio Value, Spending AmountSimplified
Spending Rate Changes, Variable Portfolio Spending
  • Spending Rate constant during early retirement
  • Note Real Spending decreases significantly with
  • More frequent spending rate adjustments needed
  • in later retirement for reasonable real spending

Ideal Scenario Life Cycle Wealth ChangesAnnual
Wealth Spendingnot including SSI Income
Ideal Wealth Accumulation Spending(401K and
Ideal Scenario (401K Other Sources)Inflation
Adjusted Constant After-Tax 80,000 IncomeReal
total portfolio wealth decreases beginning _at_ 65
Ideal 401K Plan ScenarioGood Planning Constant
Annual Retirement Income
  • Beginning at 45, 401K taxable portfolios,
    savings, and returns required
  • Retire at Age 65 birthday
  • Investment Asset Allocation critical
  • Returns risks decrease with age
  • Investment account spending rate rises with age
  • YES, planning, discipline, and steady investments
    allow a couple to maintain their current spending
    level through a long retirement

Retirement Spending categorieschange with age
  • Simplified overview examples shown.
  • Everyones circumstances are different.
  • Spending categories change with age.
  • For example, less travel expenses and more doctor
    visits or assisted living expenses as we grow
    very elderly.

Investment Returns Shortfall ExampleAge 50, 51,
52 Stock Allocation Returns 0
Wealth Accumulation - 3 years poor mid-year stock
returns2.8 yrs. more work, savings, and returns
forplanned retirement spending
Inflation Adjusted Wealth Accumulation - 3 yrs.
poor returns2.8 yrs added work
Need to postpone retirement for 3 years an
incentive to invest thoughtfully
  • More work years in an uninteresting
    job is not inspiring

Added Work to make up for poor mid-year
Investment ReturnsRetirement postponed until 68
Life Cycle Wealth and Spendingat planned rate in
retirementAdded work to adjust for poor
investment returns
Inflation Adjusted Life Cycle Wealth
Accumulationwith added work to maintain planned
retirement spending
Example 3 yrs Poor Results ScenarioWork to age
67.8 (2.8 more years) to maintain disposable
  • Asset allocation, savings, income assumptions
  • At 65 Short Fall in needed retirement savings
  • Total 401K and Taxable Accounts 2.8M (1.46M
    inflation adjusted)
  • At 68 approximately same total accounts value as
    ideal scenario
  • Total Accts 3.80M (1.64M inflation adjusted)
  • Same disposable income through retirement
  • Social Security Annuity payments not recalculated
  • 2.8 years of added work to compensate for 3 yrs.
    poor returns.
  • A Major Incentive to Invest Carefully!

Example 3 yrs poor investment returns
scenarioDecision Retire at 65, but less
retirement spending
  • Same 3 years of 0 stock returns _at_ Ages 50, 51,
    and 52
  • All other asset allocation, savings income
    assumptions unchanged
  • Retire _at_ 65
  • Total Investment Accounts 2.8 M (1.46M
    inflation adjusted)
  • Annual Constant Level Investment Spending through
    Age 95
  • Inflation Adjusted 69,000 not Planned Ideal
  • After Tax Income with SSI 71,200, not 80,000
  • 3 poor years of returns may reduce retirement
    income 11
  • Small difference in investment returns can have
    significant impact

Example Ideal Retirement Scenario with a
50,000 (2006 Inflation Adjusted) Pension and an
  • At 45, income, returns, and inflation adjustment
    same as others
  • Pension 5,000 inflation adjusted IRA
    contributions (savings)
  • _at_ 45 IRA 200,000 _at_ 65 Pension (first year)
    real 50,000
  • Pension inflation adjustment annual limit 3.0
  • Returns risks decrease with age
  • Taking more stock risk than in the example should
    be considered
  • Pension is effectively a low risk asset (like
    money market fund)

Pension Annuity ExampleLife Cycle Investment
Pension Annuity ExampleOther Investments Amount
and Spending Rate
Pension Annuity ExampleRetirement Spending All
Pension Annuity Example All Income
SourcesInflation Adjusted Spending
Ideal Retirement Scenario 50,000 (2006
Inflation Adjusted) Annuity and an IRA
  • At 45, income, returns, and inflation adjustment
    same as others
  • Pension 5,000 inflation annual adjusted IRA
  • Returns risks decrease with age added stock
    risk should be taken to increase IRA value
    pension is low risk income source
  • Retire at Age 65 birthday
  • IRA Value 1.27M (0.65M inflation adjust)
  • IRA spending rate rises with age
  • Note relationship between pension and IRA value
  • Planning, a pension, and an IRA should allow a
    household to maintain their current spending rate
    through a long retirement. Yet, at 92 decreasing
    IRA account limits remaining spending. Added IRA
    allocated stock returns allow ideal spending.

Retirement Investment SpendingSource
  • good calculator for investment planning and
    retirement spending on website left stripe

Retirement Investing Budgeting Presentation
  • Savings, asset allocation, and investment return
    assumptions were ideally simplified. Long term
    discipline is needed.
  • Long-term real cash flow results are very
    sensitive to mediocre investment results
    especially during accumulation phase
  • Best to adjust spending or retirement plans, if
    poor results occur along the way
  • Presentation available at www.BanachWealthManageme
  • email at for excel
  • A risk management presentation may be a good
    sequel review for real world scenario risk