EXECUTIVE
SUMMARY | AS THE BEAR MARKET
CONTINUES, IT’S NO WONDER some
investors, particularly those close to
retirement, fear losing their money in the
stock market. When advising clients age 50
and over, CPAs need to emphasize
fundamental investment strategies more
than ever before.
DESPITE RECENT
MARKET LOSSES, IT’S STILL NOT A
good idea for investors who are
nearing retirement to switch all of
their assets to money market funds or
short-term bonds. Stocks still have a
proven track record of generating
returns that beat inflation by a wide
margin, even after taking taxes into
account.
THE ONLY WAY FOR
ANY INVESTOR TO PROTECT AGAINST
losses is to diversify. The
more diversified a portfolio, the less
any one stock can hurt it. Diversity
means buying stocks in different kinds
of companies as well as including some
bonds in the portfolio.
DOLLAR-COST
AVERAGING IS ANOTHER FORM of
diversification. Instead of spreading
money over different stocks and bonds,
it diversifies investments over time. By
investing the same amount of money at
regular intervals, the goal is for
investors to buy the most stock when
prices are low.
ASSET ALLOCATION
TAKES ADVANTAGE OF THE FACT
that stocks, bonds and money
market accounts behave differently under
different conditions. An asset
allocation strategy determines what
asset mix gives a particular client the
optimal blend of risk and reward.
| PHYLLIS J.
BERNSTEIN, CPA, is president of Phyllis
Bernstein Consulting in New York City
where she provides services to
CPA/financial planners. She previously was
director of the AICPA personal financial
planning division. Her e-mail address is
Phyllis@pbconsults.com .
|
ondering what’s next for the market?
Join the club. Most raging bulls think stocks will
go up, up and away. The bears, on the other hand,
cite a deadly combination of overvalued equities,
moribund earnings growth and the possible onset of
deflation to send the Dow tumbling anywhere from
3,000 to 6,000 points. Regardless of what you
believe, one thing is certain—it will be a bumpy
ride. Three years into the bear market,
it’s certainly understandable that some investors,
particularly those close to retirement, can’t get
over their fear of losing money. With only a few
working years left, they anxiously view equities
as a game of craps: The longer they stay in, the
greater their chance of losing more. In fact,
history shows the opposite is true. The easiest
way to reduce the risk of investing in
equities—and improve the gain—is to increase the
length of time you hold your portfolio. Yet after
age 50, many investors simply are afraid to stay
the course.
A recent AARP (formerly the
American Association of Retired Persons)
report highlighted some major issues
concerning the financial status and
security of those 50 and older. It
concluded the traditional concept of
retirement has changed: The risk of
ensuring sufficient retirement income now
rests increasingly on employees. The
limitations of private pension and 401(k)
plans and of the Social Security safety
net have pushed more people into the stock
market to help them accumulate retirement
capital. That means more Americans need to
know about investing than ever before.
Here are some suggestions for CPAs who
advise clients 50 and over on their
investments to make sure a once-secure
retirement doesn’t disappear in the blink
of an eye. |
Market Downturn
Hits Retirees Hard
In a survey of
people ages 50 to 70,
70% said they had
lost money in the market over
the past two years. Over
one-third lost more than 25%
of their portfolio.
67% said they
were changing their lifestyles
as a result of their losses,
including budgeting daily
expenses more carefully and
taking fewer vacations.
Source: AARP, Washington
D.C.,
www.aarp.org .
| |
SERIOUSLY SPOOKED
Market downturns
typically require investors to pay more attention
than ever to time-tested fundamentals. What makes
good sense in ordinary times is even more
important now. That means CPAs should have clients
focus on leveraging tax-favored accounts, saving
as much as they can, making smart investment
choices and above all, staying the course.
Mary and John Jones both are 50 and plan to
retire in five years. Their 401(k) plans, which
are invested in Standard & Poor’s 500-stock
index funds, are not doing well. In fact the
Joneses lost $180,000 in the last three years.
Concerned that they are taking more risk than is
prudent, they come to you for help. They think
they may need to work more years and are worried
about their investment choices. They aren’t alone.
A survey conducted last year by financial software
provider Intuit found 13% of those surveyed
anticipate delaying their retirement because of
stock losses. A full quarter of these said they
will have to work an extra five to seven years to
retire comfortably. As the Joneses move closer to
retirement, they want to be safe rather than
sorry. How can investors who have saved
all their working lives only to choose a losing
investment strategy replace the missing funds? We
can take some comfort in history: Since the Great
Depression, there never have been four straight
years of losses in the broad stock market. It’s
important for both CPAs and clients to realize
that from an investing perspective, we’ve faced
uncertainty before and triumphed. As a financial
planner you can help clients cope with investing
in uncertain markets by getting them to spread
their money among different types of assets that
don’t all move in sync. For clients
approaching retirement, some advisers mistakenly
recommend a portfolio heavy on short-term bonds or
money market funds—the least risky investments.
Historically, the long-term return from stocks has
been about 11% annually, while bonds—which are
less risky—return just 5.2%. Over time that spread
can make a huge difference in the earning power of
savings. A client who follows the safer strategy
will thus miss out on a significant amount of
asset accumulation. In advising the
Joneses, it’s important to remember that the
longer clients have to invest the more the clock
will make up for inevitable short-term losses. The
couple’s investing horizon isn’t 5 years, but more
likely 30 to 40 years. A 65-year-old man has a 50%
chance of living to age 85 and a 13% chance of
living to age 95. The chances that either Mary or
John will be alive at age 85 or 90 are even
higher. They need to invest their 401(k)s as if
the funds had to last them at least 30 years and
perhaps much longer. If clients put all
their money in a very liquid, safe stash such as
money market funds or short-term bonds, the return
they likely would earn over the long term won’t
exceed inflation by very much. And that margin
will get even thinner, if it doesn’t disappear
entirely, after taxes on withdrawals. Stocks, on
the other hand, have a proven track record of
generating returns that beat inflation by a wide
margin—indeed, enough of a margin so a client
actually can have a positive return even after
accounting for inflation and taxes. The conflict
for investors over 50 is how to achieve high
return and low risk at the same time. The
solution: Invest in an efficient market, which
lessens risk and increases the likelihood of
return. Another thing CPA/financial
planners should remember is that, unless the
economy is about to go through an unprecedented
20- to 30-year stretch where prices don’t rise,
inflation will push up the costs of the goods and
services Mary and John buy during retirement. That
means they need at least some of their savings in
the stock market earning a return that grows
faster than inflation. At age 50 and
beyond, a good investment strategy takes into
account a client’s specific retirement needs. It’s
a good idea for CPAs to sit down with clients and
help them evaluate their retirement goals. Start
by collecting information on existing retirement
plans including 401(k)s, IRAs and Keogh accounts.
This is also a good time to assess the client’s
risk tolerance and factor in variables such as
inflation, interest rates and prevailing market
returns. CPAs must actively help clients decide
what assumptions they want to make in their
retirement projections—for example, how much
longer they will work or how much income they will
need at retirement. One key assumption
clients and CPAs should look at together is the
client’s expected Social Security retirement
benefit. Because the individual benefit
projections the Social Security Administration
provides are based on future wage increases of 4%
to 6% annually, the projections may not be
realistic for many clients. The Social Security
Administration makes a calculator available on its
Web site at
www.ssa.gov/planners that allows users to
change these assumptions and come up with more
realistic estimates. As CPAs and clients
approaching retirement work together to develop
the best investment strategy to meet the client’s
retirement needs, they often must perform a
difficult balancing act to meet the client’s
current lifestyle objectives while he or she also
is saving for retirement. In doing so, CPAs will
find the three classic defensive
strategies—diversification, dollar-cost averaging
and asset allocation—described below to be crucial
in helping older clients maximize their gains
while limiting their risk.
DIVERSIFICATION
The only way to
really protect a client is to diversify,
diversify, diversify. While this strategy is
important for all investors, it is particularly
crucial for those over 50 because they have a
shorter investment horizon than those in their
30s. The single best way for investors to protect
themselves from a meltdown in one stock or
industry is to spread the risk across several
different investments. The more diversified a
portfolio is, the less any one stock can hurt it.
A balanced portfolio should include
small-company exposure. Typically, large- vs.
small-cap performance runs in cycles, with the big
companies leading the pack for a few years and
then the smaller companies taking their turn.
Trying to forecast which will lead the way and for
how long is a waste of time. But by owning both
types of securities, a portfolio benefits no
matter which does better. However, clients should
not go overboard when buying small companies.
Basically, small-caps should represent only 10% or
so of their stock holdings—about the same
percentage they represent in the value of the U.S.
market. Many investment advisers suggest clients
get that exposure by buying a small-cap index fund
or one or more broadly diversified, actively
managed small-cap funds. S ince stocks
generate the best returns over the long run,
people just entering retirement generally need to
keep the bulk of their assets in equities. Given
that most of us probably will spend 20 to 40 years
in retirement, CPAs need to recommend clients
allocate a good percentage to stocks to prevent
the purchasing power of a portfolio from being
whittled away by inflation. Clients may
want to hedge their bets even more by adding an
international fund to their portfolio. Even in
today’s global economy, not all stock markets
around the world move in sync. Purchasing a fund
that invests outside of the United States
increases the odds that part of the portfolio will
continue to grow even when the U.S. market is
struggling.
Bonds. CPAs should make
sure clients include bonds or bond funds in their
portfolios. As the past three years have shown,
stocks go through periodic downdrafts. At times
like these, having a position in bonds can add
stability to a portfolio. Many advisers generally
recommend short- to intermediate-term bonds or
bond funds so the portfolio doesn’t sustain too
much damage if interest rates rise. Core holdings
might include a mix of quality municipal,
government and agency bonds. How much
money should be in bonds? The answer depends on a
variety of factors, including how comfortable the
client is seeing a portfolio’s value drop during
market downturns, what size annual withdrawals he
or she plans to make during retirement and how
much he or she can reduce withdrawals during
periods when returns are low. For many clients a
bond allocation of 25% to 40% of a total portfolio
is a good starting point. CPAs should
consider personal factors when recommending a
client’s stock and bond allocations, including
current and future income needs, tax bracket and
what return the client expects. Sometimes a
client’s expectations are unrealistic given his or
her risk tolerance. Stocks are good for growth
when clients need to increase their assets, but
they need to be ready to ride out market
fluctuations. Bonds are for income when clients
need money to live on and for diversification. For
risk-averse clients money market funds and bonds
lessen the vulnerability of a 100% stock
portfolio. Diversification is as important
in bond investing as in stocks. Some advisers say
it’s best to spread risk over a series of
different maturities while maintaining an average
maturity of the client’s liking in the portfolio.
The best way to do this is to set up a bond
ladder—essentially a series of bonds with a range
of maturities. H ere’s an example of how
it works. A client buys equal amounts of Treasury
securities due to mature in one, three, five,
seven and nine years. That portfolio has an
average maturity of five years (1+3+5+7+9=25
divided by 5). The next year, when the first bonds
come due, the ladder is reset by having the client
put the money into new 10-year notes. The
portfolio then has an average maturity of six
years. Two years after that, when the
3-year notes mature, the client buys more 10-year
bonds and continues to do so whenever a note
matures. That keeps the average maturity in the 5-
to 6-year range. The advantage of such a
strategy is that there is no worry about interest
rates—especially if the ladder has notes coming
due every few years. If rates do rise soon after
the client buys a bond, he or she can take comfort
in the fact money soon will be available to take
advantage of the change. Similarly, if rates
decline, the client has managed to lock in the
higher rates for that portion of the portfolio.
The bottom line is that clients don’t get stuck
one way or the other. CPAs can help
clients build a bond portfolio with any kind of
bond, but Treasurys are commonly used since they
have relatively little risk and are widely
available either on the secondary market (from
another investor) or directly from the government
through a program called Treasury Direct. The
beauty of buying from Treasury Direct is that
there are no transaction costs. The minimum
investment also is a low $1,000. To open an
account, just download an application from
Treasury Direct’s Web site,
www.treasurydirect.gov/ and mail the
completed paperwork to the nearest Treasury Direct
office. You can also obtain general information
and maintain an account by calling Treasury
Direct’s toll-free number (800-722-2678).
Unfortunately, there’s a catch. Since an
investor can buy only new issues from Treasury
Direct, creating a neat ladder is pretty much
impossible. That’s because Treasurys have
maturities of 6 months and 2, 5 and 10 years. So
if you create a ladder with these durations you
could miss some big interest-rate swings between
the times the 5- and 10-year Treasurys come due.
To avoid that, investors have to use the
secondary market to buy at least some bonds to
fill in the needed durations. Any large, reputable
broker with a trading desk dedicated to Treasury
bonds should be able to get the desired maturities
at a competitive price. Unfortunately, due to the
extra transaction costs the client will pay (plus
commissions, in many cases), this method might not
be worthwhile for Treasury purchases of $1,000 or
less. Clients also can build a ladder of
municipal bonds, but that typically would require
a minimum of $100,000 in capital to buy a
diversified group of issues. Trading in munis
through most brokerage firms or specialized money
managers also creates higher transaction costs,
but if the client’s tax rate is above 27% the tax
savings likely will make the costs worthwhile.
If these bond transactions seem a bit more
complicated (or costly) than many investors
anticipate, a low-fee bond fund is a fine
alternative. While no bond fund usually will come
out and say it has set up a laddered portfolio,
money managers stagger bonds within their funds so
different maturities come due at various times.
One bond fund that mimics the ladder example above
is the Vanguard Intermediate Term U.S. Treasury
Fund. In addition Thornberg Investment Management
manages nine pure bond funds. Within each,
Thornburg ladders the maturities of the securities
it holds. And all Thornburg bond funds invest in
short- to intermediate-term investment grade bonds
(municipal, corporate or U.S. government) to earn
“attractive yields without incurring excessive
market price risk.” Vanguard funds have very low
expenses and an average maturity of 5.4 years. But
because the fund holds approximately 65 bonds with
maturities of 3 to 27 years, it’s a bond ladder.
DOLLAR-COST AVERAGING
Another classic
strategy, dollar-cost averaging, also is a form of
diversification. Instead of spreading money over
different stocks or bonds, it diversifies
investments over time. The natural human tendency
is to buy stock when prices are rising and to stop
buying when prices are on the downswing.
Dollar-cost averaging forces investors to do the
opposite—buy the most stock when prices are low.
It’s a strategy that over-50 investors saving for
retirement will find useful. Here’s how it
works: Suppose a client decides to put $400 a
month into a mutual fund that invests in the
stocks of large companies. CPAs can help the
client set up an automatic investment account, and
the client’s money is pulled straight from his or
her paycheck on the same day each month.
If a share of the fund costs $40 in October,
$400 will buy 10 shares. If the price rises to $80
in November, the client will buy 5 shares. If the
price drops to $20 in December he or she will buy
20 shares. The idea is that money buys more shares
when the price is low and fewer when the price is
high. That lowers the total cost and, if the
fund’s overall trend line is upward, your client
captures more of the upside potential.
That’s not to say dollar-cost averaging
protects your client from a falling market. If a
fund’s value declines, so does the overall
investment. But the strategy does ensure the
client invests new money when prices are low so he
or she can enjoy the run-up when the market
recovers—as it always does in time. Many
advisers recommend dollar-cost averaging for
clients who want to move a big chunk of money into
the market—perhaps from an inheritance or yearend
bonus. The idea is to protect them from putting
everything in at once and having the market crash
days or weeks later. It’s true that if the market
moves sharply higher, the clients have missed an
opportunity, but in volatile times that risk can
be worth it.
ASSET ALLOCATION
Asset allocation is
yet another classic strategy that is a good idea
for all investors. For those over 50, the
difference is in how CPAs implement it based on
the client’s personal needs. Asset allocation
takes advantage of the fact that when it comes to
risk and reward, financial vehicles such as
stocks, bonds and money market accounts all behave
quite differently. Stocks, for instance,
offer the highest returns among the three asset
classes, but also carry the highest risk of loss.
Bonds aren’t as lucrative, but offer much more
stability than stocks. Money market returns are
small, but clients will never lose their initial
investment. An asset-allocation strategy looks at
a client’s particular goals and circumstances and
determines what asset mix gives the optimal blend
of risk and reward. The key here is for clients to
have the appropriate mix of investments based on
age and other factors. As they draw closer to
retirement, most will want to become more
conservative and add more cash and bonds to their
investments. A llocation models also help
clients buy low and sell high. For instance, if
small-company stocks are on fire one year, but
large-company stocks are merely standing still and
the stock portion of the allocation model calls
for a 50/50 mix between the two, this sudden surge
in small-company values upsets the balance. To
“rebalance,” the client would have to sell some
expensive small-company stock and buy some cheaper
large companies. If clients did this each year,
they always would be trading expensive assets for
those with more growth potential. Once a
CPA gets a client’s asset mix to where both feel
comfortable with it based on the client’s goals
and life expectancy, he or she shouldn’t “muck
things up” by changing it around each time the
market hiccups. The CPA should rebalance just
occasionally—say, once a year—to bring the
proportions back to their target allocations. But
given most clients’ resistance to change,
overmanaging the portfolio won’t be a problem.
ENSURING A COMFORTABLE RETIREMENT
Planning for
retirement can be a daunting task, especially for
clients over 50. Their nest eggs have taken some
big hits in the last three years, their investment
returns look smaller and the clock is ticking.
With a growing number of people putting retirement
on hold while their portfolio catches up with
their needs, planning has gotten trickier for
everyone. CPAs may need to help clients adjust
their assumptions about things such as how long
they will work (to age 60, 65 or even beyond) or
where they will live (in the same home or a
retirement destination such as Florida or
Arizona). According to the AARP, nearly 28 million
older Americans rely on their investments for at
least some of their retirement income. The right
advice from CPAs and an improving economy will
ensure the term “retirement planning” doesn’t
become an oxymoron and that more Americans will be
able to live out their golden years in peace and
comfort.
Resources for
Investing Over 50
|
Books
Investment Advisory Relationships:
Managing Client Expectations in an
Uncertain Market, Robert Doyle
and Phyllis Bernstein, AICPA, New York,
2002.
J.K. Lasser’s Strategic Investing
After 50, Julie Jason, John Wiley
& Sons, New York, 2001.
Straight Talk on Investing: What You
Need to Know, Jack Brennan, John
Wiley & Sons, New York, 2002.
The SmartMoney Guide to Long-Term
Investing: How to Build Real Wealth
for Retirement and Other Future Goals,
Peter Finch and Nellie S. Huang,
John Wiley & Sons, New York, 2002.
The Ultimate Safe Money Guide: How
Everyone 50 and Over Can Protect, Save
and Grow Their Money, Martin D.
Weiss, John Wiley & Sons, New York,
2002.
Wealthy & Wise (Secrets About
Money), Heidi L. Steiger, John
Wiley & Sons, New York, 2002.
You’re Fifty—Now What? Investing for
the Second Half of Your Life,
Charles R. Schwab, Three Rivers
Press, New York, 2002.
Miscellaneous Resources
Investing for your retirement.
The National Association of
Investors Corp., a nonprofit educational
group, helps people learn more about
investing with a free information kit
about investing in stocks. Get the kit
by calling 877-275-6242 or going online
to
www.better-investing.org . NAIC
offers members investment tools,
resources and online publications.
Nonmembers can subscribe online to the
group’s magazine Better Investing.
E-mail newsletters.
Follow this URL and find
newsletter offerings from the
self-billed “leader in e-mail
discussions and publishing solutions”:
www.topica.com/dir/?cid=4968 .
(The newsletter Segunda Juventud
has free financial information of
interest to Hispanics 50 and over.)
Web Sites
www.aicpa.org/members/div/pfp/memb.htm
. AICPA members can join the PFP
membership section and subscribe to
publications such as the PFP
Practice Handbook,
The PFP Library of Technical
Practice Guides and PFP
Pointers.
www.bankrate.com/dls/news/money-matters/20020813a.asp
. This page includes links to
Bankrate’s retirement calculator.
www.drummondmoores.com/issue7/investing
. Drummond Moores, an independent
financial consulting firm, offers an
overview of what investors of various
ages should know—“Investing for the 20-
to 50-Somethings.”
www.ssa.gov . The Social Security
Administration Web site provides
retirement planning information as well
as links to statistical research and
congressional testimony CPAs might find
useful in helping clients plan their
retirement.
www.aarp.org . The AARP Web site
offers a money and work section with
links to information on credit and debt,
creating a financial plan and retirement
income. | |