Christine Benz: Hi. I am Christine Benz for Morningstar.com. Psychological impediments have the potential to derail financial planning during retirement. Joining me to discuss that topic is Mark Balasa from the firm Balasa Dinverno Foltz.
Mark, thank you so much for being here.
Mark Balasa: Thank you.
Benz: I'd like to talk about your retired client base in aggregate and kind of tap into some of the key behavioral pitfalls that you see your clients running into. And one in particular, I would like to hear about is, how they approach getting income out of their portfolio. So, I often encounter people who very much want to just live on the income that their portfolio kicks off and have that be their spending money. Let's talk about how common that is among your clients and how you kind of coach them about thinking about things a little differently and maybe using a total-return approach?
Balasa: You bet. What you described is so true. For so many generations, people would go into retirement with the idea that they would invest in certificates of deposit and bonds and dividend-paying stocks, they'd live off of that to the end of their days, and pass the assets on to their children.
Benz: And that was easier a couple of decades ago, right.
Balasa: So true.
Benz: Where you had CD yields so much higher.
Balasa: Yeah, I mean in 1981 yields on CDs were in the 15%, 16% range. So to your point, inflation was high, but that's another conversation.
Benz: Exactly.
Balasa: But in terms of just a nominal return it was very attractive. And so you fast forward to today where there is no return on a money market and minimum return on bonds and CDs and so forth. And the idea of making a living off your portfolio in retirement is so difficult. And so with that in many cases, not all, but in many cases what it's encouraged people to do is to go out looking for things that just yield high, high-yield bonds, master limited partnerships. Many of the things are fine, but in the end what they don't appreciate is that a lot of risk comes with that.
And so kind of to your point, what we encourage people to do is instead of thinking about just the interest on an investment, think about the total return--the interest, the dividends as I mentioned a second ago, but in many cases what's more important is the capital gain. So, when you look at a portfolio from the perspective of a total return, it's much more balanced in terms of what risks you're taking as opposed to just interest-rate risk when you're looking for a yield.
Benz: So, when you talk through this thesis behind using a total-return strategy, do people start to get a little more comfortable with potentially rebalancing out of certain asset classes and using that as their spending money? Are they able to kind of see the benefits of using the total-return approach?
Balasa: For the most part, yes, because you can show them in pretty convincing fashion, just historical returns by different asset class and you can show them where the return came from. And so for most people that works. The one challenge, of course that comes to mind, is when the market doesn't do well. So you take '08 and '09 with [the Lehman Brothers bankruptcy] and the capital gains part, the equation went through the floor.
Benz: Everything was down almost.
Balasa: Yeah. So there the people, of course they thought, "Gosh, if I would have had my CD even though there was no return, I wouldn't have lost any money." So you can't have your cake and eat it, too. You have to accept some volatility, when you look at the total-return idea. But for a complete lifecycle of a client and for almost all, I can't imagine an exception, that's a better approach than again being just focused on the income.
Benz: Do you use with clients a cash buffer that is kind of a baseline living expenses pool? Do you set that up kind of a bucket system, if you will?
Balasa: Bucket systems are a great approach because people can get their head around that very easily, so, absolutely. In some periods, we will have 12 months and other periods, we'll have as much as 24 months of living expenses set aside and a little bit of cash, but more typically one- and two-year bonds--very liquid and stable, if you will, but a higher return than a money market--for exactly the reasons you're suggesting. So, if there is market volatility, we don't need to touch anything. We can just live off of the buffer and let stuff recover.
Benz: Another thing that you said that you run into a lot with retired clients is a fear of running out of money, which I think is common across the retiree population, but in some cases, you think it's disproportionate. It doesn't square with the actual situation. Let's talk about how common that is and how you work with clients to kind of get through the mental trap?
Balasa: Yes. So, it's kind of to your point, if you go and look at the typical retiree pre-Lehman crisis, there was a sense of more optimism, in general. I'm generalizing now, with people about the market returns, the economy, the political system, they were just people who were going through their life, and it was going to play out as it had for the prior decades. Post that, even people that haven't arguably more than they need, and of course for many who don't have as much as they need, the concern about where the markets are going, where the political system's going in Europe and here, the Middle East, and even the government programs like Social Security and so forth, all of these issues kind of roll up to where people I think in some ways are overly pessimistic about the assumptions they want to make and how much money they think they need to get the job done for themselves. So, there are exceptions. But in general, I think the atmosphere in the country is affecting people's views about how they plan for themselves.
Benz: How do you coach them when they come to you? In some cases maybe it's warranted that "You need to save more, and we really need to buckle down here." But with other people, say they are retired and looking at their withdrawal rate and how much they have; you think they are going to totally fine. How do you work with them on getting comfortable with the financial plan that you've set up?
Balasa: Largely through education. I mean, we are trying to give them some perspective. You look at every generation, you had the Great Depression, you had World War II, you had the Cuban Missile Crisis, and you had Watergate. There are always problems. And the markets have returned 10%; bonds returned 5%. So, it doesn't mean, it's going to happen in any one cycle and then you are on a two- or three-year time frame. But on balance, when people come in and say, "You are showing an expected rate of return of 6% or 5%. I haven't made anything since 2008." That might be true or might not be true, but that is their perception. And so they say, "Well, let's not run the projections at 5%." I don't think that's realistic, if I look at over a 30-year life span or 40-year life span. So in that sense, I think recent history, coming back to the idea of behavioral finance, has anchored people on just what's happened the last few years as opposed to the long view.
Benz: Mark, great insights. Thank you so much for being here.
Balasa: My pleasure.
Benz: Thanks for watching. I'm Christian Benz for Morningstar.com.
