It amounts to simple math, he says. Starting with the 20-year projection of Robert Ibbotson of an annualized rate of return of 8.1%, Evensky says the real return to the client is 2.7% once you whittle away investment management fees and taxes, and figure in an inflation rate of 3%. By comparison, when you figure the 15% average growth that was seen in the S&P 500 the past 20 years, the real return was 8.2%.
Evensky has been touting a "core and satellite" portfolio model, which stresses tax efficiency, fewer overall positions, heavy use of index funds and a less aggressive pursuit of alpha. Under this model, 80% of Evensky's portfolio, the "core," is mostly sitting in index funds, chiefly the Russell 3000, with some allocations in large- mid- and small-cap funds. The intent here is to simply capture market returns in stable, middle-of-the-road investment vehicles. The other 20%, the "tactical satellite" portion of the portfolio, is designed to add alpha.
"The criteria is simply investments that, net of fees and expenses, we think will do better than the core," he says. The tactical portion is usually split up between three managers. The split had been among commodities, micro-cap growth and emerging markets. The commodities portion was recently taken out, he says, and replaced with a position in short and long Treasuries. "If we are wrong, and everything does great, we may be giving up a marginal amount of alpha, maybe 13.5% versus 15%," he says. "If we are right, our clients will do a lot better and keep 20% to 30% they would otherwise lose."
Other advisors are using tactics of their own for dealing with the uncertainty of today and tomorrow. Advisor Bernie Kiely of Kiely Capital Management in Morristown, N.J., says providing fee-only advice in times like these is a help because it's easier to promise less and deliver more. "One of the reasons I got out of the commission side is I didn't want to have to promise astronomical returns in order to get business," he says.
For his clients, many of whom are at or nearing retirement age, he prefers a conservative portfolio allocation that splits equities and fixed income 50-50. "It's the best allocation you can have-no bear market can hurt you," he says.
The style does cost him clients. One woman left him recently because she considered the plan too aggressive. "Her point of reference was CDs," he says. Then there was a Ph.D. who wanted him to be "conservatively aggressive," as he put it. "He basically wanted a genie-someone who makes money when the market is up and doesn't lose when the market goes down," Kiely says.
Kiely, however, continues to use an assumption of about 7% in annual returns for planning purposes, based on annualized market gains covering the past 33 years. "That period has a lot of history, and it's not unreasonable the next third of a century is going to have the same ups and downs," he says.
Yet he likes to remind clients that no matter how uncertain the current times appear, conditions are not nearly as frightening as the 1970s, when the nation took a decade to recover from a down economy and market. As Kiely sees it, it took that amount of time for the nation's economy to digest the price of oil going from $3 to $30 per barrel. "We are dealing with a normal economic recession," he says. "This is a completely different animal."
George Kinder of Kinder Institute of Life Planning in Littleton, Mass., uses a different type of historical reference to help clients deal with all the unknowns. He basically takes their portfolio back in time, to the late 1920s and to the early 1970s, and tests how their investments would have performed during the two worst economic periods in the nation's history. He notes that the market collapses of both periods were similar, when you account for the deflation that occurred in the Great Depression and the inflation of the 1970s.
"What I'm interested in is what's going to calm my clients' nerves," Kinder says. "What's going to calm them much more than a statistical study is the simple question of what would have happened in 1929-would I have made it through?" What he found by analyzing the statistical data was that the best allocation to get through those difficult times was an allocation of 30% to 40% in a mix of cash and bonds, and the rest in stock. For a retiree, annual withdrawals are limited to 4%. "The idea is to make sure the money does not get wiped out at any point going forward," he says.