The Need for Conservatism and Discipline in Retirement Planning

The Need for Conservatism and Discipline in Retirement Planning
by Leo F. Wells III

For those in or approaching retirement, what does the unpredictability of the financial markets mean for their future financial health? Right now, it's difficult to speculate about or forecast tomorrow's economic climate with any degree of certainty.

According to a February 2008 article in Money magazine, an increasing number of economists worry that the country is rapidly sliding toward, and may already be in, a recession.¹ The author cites record-low consumer confidence, a weakening job market, and the continued housing slump as contributing factors.

Regardless of what the forecasters say, it's important to remember the basics. Many may be wondering, "How can I plan effectively for my retirement given all the uncertainty in the world today?" The best course of action usually calls for prudence and a disciplined approach to investing. A focus on high-quality investments, broad diversification, and a long-term investing strategy may help investors better weather market fluctuations. Let's take a look at some considerations for those nearing or in retirement.

The changing investment needs of seniors
If the country does slide into recession, some Americans will feel it more acutely, because they're facing the prospect of living on a fixed income. And a growing number of people are poised to leave the workforce - according to the U.S. Census Bureau's Special Study, 65+ in the United States: 2005, the first U.S. baby boomers will turn 65 in 2011. By 2030, the number of older Americans is projected to be double that of 2000, growing from 35 million to 72 million. In fact, between 2010 and 2030, the growth rate of the senior population is expected to be more than four times that of the total population! That means that, while approximately 1 in 8 Americans will be 65 and older in 2010, this ratio will increase to nearly 1 in 5 by 2030.²

Inadequate savings / limited income streams

As the older population grows larger, their financial resources appear to be shrinking. Many Americans have little money put away in savings or investments, according to the annual Retirement Confidence Survey (RCS) sponsored by the Employee Benefit Research Institute.³ With home values (and, therefore, home equity) declining in a cooling housing market and mortgage debt increasing, many older Americans will have less money in retirement than anticipated.⁴ Perhaps David Rosenberg, North American economist at Merrill Lynch, put it best when he said, "There is a looming shortage on the retiree balance sheet that needs addressing, and it is spelled I-N-C-O-M-E."⁵

Mounting debt

In addition to insufficient savings, Americans are plagued by debt, even as they near retirement age. An Employee Benefit Research Institute study found that 61% of American families with heads of household aged 55 or older carried debt as of 2004. Perhaps even more surprising was that, among households headed by someone aged 75 or older, the average debt increased 160% from 1992 to 2004. Approximately 2 out of 5 Americans aged 75 and older carried debt as of 2004.⁶ Credit cards are part of the problem. The average credit card debt among households headed by someone aged 65 to 74 has more than doubled just since 2001, from $1,012 to $2,200 in 2004.⁷ The study concluded that increasing levels of family debt have obvious implications for the future retirement situation of many Americans.

Avoiding extremes as retirement nears
In light of these concerns, how does this expanding wave of older Americans approach investing? According to research by the Investment Company Institute (ICI), older equity investors who have short-term financial goals are often more risk-averse than younger investors. Approximately 29% of equity investors aged 65 or older describe themselves as willing to take below-average or no financial risk. Only 18% of equity owners aged 65 or older are willing to take substantial or above-average risk with their equity investments, leaving the majority of those surveyed squarely in the moderate risk category.⁸

Not surprisingly, the ICI found that investors typically shift some of their equity holdings to other types of investments as they age. For example, an older equity investor with a shorter investment horizon and lower risk tolerance is more likely than a younger equity investor to own bond investments and money market mutual funds.⁹ While some might be tempted to flee to cash and fixed investments, they should be aware of the role that inflation plays in eating away at retirement savings. Because today's retirees are living longer than those of previous generations, it may be critical that an investment portfolio not be too conservative, as otherwise it may not provide enough assets to support retirement long-term. There may be times where it makes sense to consider balancing these more conservative investments with other, somewhat riskier investment opportunities within the investor's risk tolerance.

Following a tried-and-true strategy
Yet, as the nation faces the prospect of another downward cycle, how can those nearing retirement better balance their investment portfolios to prepare for retirement in times of significant volatility?

While it's nearly impossible to predict the direction of the stock market or the next political or social crisis, the best course of action is generally to follow tried-and-true principles of asset allocation, healthy conservatism, and discipline when it comes to investing. As investors get closer to retirement, it's important for them to evaluate if their investment strategies are on track with their age and retirement goals, taking into account both the highs and lows.

One of the keys to successful investing is diversification. It's perhaps the single most important strategy an investor can follow, because gains from some investments usually offset the losses of other investments. Because there are never any guarantees with investing, diversification may help to prepare for both the good years and the not-so-good years. A prudent approach is to build a solid, no-nonsense strategy that incorporates a variety of equity and nonequity assets, including growth-oriented investments that offer income possibilities.

Here are some other practical tips:

Pay down debt

Common sense dictates that it's difficult to achieve any measure of financial stability if you're drowning in debt. As retirement approaches, Americans should strive to pay off credit cards, focusing first on those with the highest interest rates. Consolidating balances into one lower-interest credit card can be a good start, while a financial professional can help set up a plan for paying that card off.

Align risk with actual tolerance

As the stock market and economy approach the end of a prolonged growth period, some near-retirees may be tempted to play with market timing in an attempt to boost returns. However, such a strategy is usually doomed to fail, and, because they may need access to their funds, those who are nearing retirement should avoid taking on too much risk. Money magazine suggests that a safer strategy in times of recession is to move toward a more conservative portfolio, which may likely return less than an aggressive one but will probably give better results than an attempt to time the stock market.¹⁰

Keep expectations realistic

Back in the heyday of the late '90s, many investors and financial professionals were tempted to use returns of 10% or more when creating portfolio illustrations. When working with a financial representative, it's prudent to rely on a retirement model that's a little more realistic, using a more modest target of 6%-8% total return, before deducting fees and expenses.

Build a balanced portfolio

A conservative strategy with the potential for some growth is a good bet for many investors considering retirement. Potential stock market volatility, uncertainty about the future of Social Security, and unsettling world events all point to investment approaches aimed at long-term capital appreciation with lower risk. One way to employ this type of strategy is by selecting investments that offer potential income. There are a number of income-oriented investments, including certain real estate products, that may be suitable for investors whose primary portfolio objective is retirement planning.

Look for investments that seek to preserve capital and provide supplemental income

For those contemplating retirement, market instability is a major concern. Seeking out investments that strive to preserve capital and provide supplemental income (income not needed for everyday living expenses) - such as bonds, Treasury bills, and certificates of deposit - may help meet income needs after retirement.

Real Estate Investment
Though much of last year's volatility in the broader financial markets centered on the real estate market, commercial real estate remains one long-term investment category that investors may wish to consider as they seek complementary supplemental income investments. Although some investors are now shying away from real estate in general, many financial professionals continue to recommend investment in certain real estate sectors to help provide further portfolio diversification, as well as some measure of opportunity to preserve and build capital over the long term.¹¹

Real estate investment trusts (REITs) typically offer diversified investment opportunities in commercial real estate because they invest in a portfolio of properties. REITs have varying investment objectives, such as providing current income, capital appreciation, or long-term total return, and therefore cannot categorically be classified as "conservative" investments. However, some REITs do have characteristics that are in line with more conservative and income-oriented investment objectives. For example, an investment in high-quality office properties - those that are well-leased and located in leading 24-hour markets - may be especially attractive to long-term investors for a couple of reasons. First, these types of properties tend to ride out temporary unrest better, since they typically benefit from longer lease terms and continuing demand. Second, corporations have an obligation to pay rent as long as they are in business. Therefore, though there's no guarantee that corporate tenants will completely satisfy their contracts, most will prioritize paying operating expenses (including rent) over other expenses.

While there is no guarantee against loss or consistency of income, REITs may help provide a portion of the income that many investors seek by combining the potential for gains through property value appreciation with the potential opportunity for income through regular distributions. To retain REIT status, REITs by law must pass on at least 90% of their net taxable income from their real estate holdings to shareholders in the form of distributions. An investment in REITs also may provide investors an opportunity to receive some tax advantages due to a "return of capital" component that allows for tax-deferral to the investor. Consequently, REITs may be a good complement to an established portfolio that consists largely of equities.

REITs typically have a low correlation to stocks and bonds and therefore may help to both lower an investment portfolio's long-term volatility and bring balance to certain portfolios. In fact, a comparison of historical, long-term results reveals that including REITs may help certain portfolios of domestic stocks and bonds improve bottom-line performance while incurring less overall risk.¹² Also, in times of credit turmoil, REITs that employ lower leverage investment strategies and seek to attract creditworthy tenants may be better positioned to ride out the unrest.

In short, Americans will be looking for investment vehicles that may help them reduce long-term volatility in their portfolios and provide potential to both preserve capital and generate income as they mature. Longer life spans, increased health care costs, higher debt levels, and an overall uncertainty about their financial futures have many Americans rethinking their retirement plans and wondering if they can afford "The Golden Years." A long-term investment in real estate may help them further down the path toward financial independence by potentially providing a more balanced and diversified investment portfolio and additional income opportunity.

Leo F. Wells III founded Wells Real Estate Funds, which has served almost 250,000 investors and has managed over $11.6 billion in assets (as of 1/31/08). Contact him at leo.wells@wellsref.com.

¹ "Consumer confidence sinks lower," Money, February 8, 2008.
² 65+ in the United States: 2005, Current Population Reports, Special Studies, U.S. Census Bureau. Wan He, Manisha Sengupta, Victoria A. Velkoff, and Kimberly A. DeBarros, December 2005.
³ 2007 Retirement Confidence Survey, Employee Benefit Research Institute and Mathew Greenwald & Associates, Inc.
⁴ Glenn Ruffenach, "Don't Count on Your House to Fund Your Retirement," Real Estate Journal.com, September 5, 2007.
⁵ Mark Hogan, "Don't Let Housing Haunt Your Retirement," Business Week Online, September 28, 2006.
⁶ "Debt of the Elderly and Near Elderly, 1992-2004," Employee Benefit Research Institute, September 2006.
⁷ Ibid.
⁸ Equity Ownership in America, Investment Company Institute, 2005.
⁹ Ibid.
¹⁰ Stephen Gandel, "Survival strategies: Recession-proof your life," Money, February 12, 2008.
¹¹ David Hoffman, "Investors yank cash from REITs, but advisers urge stay-and-hold strategy despite lower returns," Investment News, December 17, 2007.
¹² Source: Ibbotson & Associates.

Disclosures
Wells encourages investors to start investing for retirement at an early age. Before investing, senior citizens and all other investors should completely read a prospectus and should ask thorough questions about all aspects of an investment, including guarantees, risks, expenses, fees, time horizons, and liquidity options.

Real estate diversification cannot eliminate the risk of investment loss. Investing in real estate involves special risks such as illiquidity and possible declines in profits, revenues, and property values; therefore, it is not suitable for all investors. Past performance does not guarantee future performance. You should consider the investment objectives, risks, and charges and expenses carefully. This and other information is contained in the real estate product's prospectus. You may obtain a prospectus from your financial representative or by visiting www.wellsref.com. Investments in real estate may be affected by adverse economic and regulatory changes. When investing in real estate, ask questions about distributions, capital appreciation, the impact of vacancies, potential for advisor conflicts and their compensation, and redemptions. Please consult your tax advisor or your financial representative for more information on how real estate products pertain to your particular investment strategy. Wells products are not FDIC or NCUA/NCUSIF insured, not bank or credit union guaranteed, and may lose value.

Wells Real Estate Funds, Inc., is affiliated with Wells Investment Securities, Inc. - Distributor - Member FINRA/SIPC.

Article