The unused portions of these funds could then be invested in either tax-efficient securities or Roth IRAs, where they will be exempt from future taxes. It may in fact make financial sense for clients with long life expectancies to consider taking a substantial chunk out of their traditional IRAs and converting them into Roths, especially if one expects marginal tax rates to continue rising.
Portfolio Management
Ron Weiner explains that it requires as much talent to efficiently withdraw money from accounts as it does to maintain them. The impact of market downturns are exaggerated when investors remove money. And because the interest, income and capital gains generated aren't usually enough to cover annual withdrawals, managers need to tap into capital. That means selling securities. The current market offers a good example of the challenges in balancing a portfolio during withdrawals.
Many financial planners, including Michael Kitces, director of research at Columbia, Md.-based Pinnacle Advisory, recommends 60% equity exposure and 40% bond exposure. The equity part of an investor's allocation has likely expanded over the past year as stocks have soared and long bond prices soured. Maintaining the balance might mean that withdrawals should be funded initially from the sale of stocks. Yet the near-term growth prospects of stocks are positive as corporate earnings recover, and meanwhile bonds are likely to fall in value as interest rates increase. So it might be, instead, that investors want to raise cash from the sale of bonds rather than stocks.
Another problem is market volatility, which can play havoc with the accounts investors are trying to draw from. In a study that tracked performance of the S&P 500 over a 40-year period between 1966 and 2005 and then recalculated as if the years were sequentially reversed, the American Funds Company found that annualized returns and volatility were exactly the same. However, a person withdrawing 5% starting in 1966 would have run out of money by 2002. When you work backwards and start in 2005, on the other hand, such a withdrawal rate would have left plenty in the portfolio after the 40th year.
The study suggests that advisors must be collectively mindful of how portfolio management, performance and withdrawals interrelate.
A lesson in effective retirement account management comes from Wisconsin-based Appleton Group Wealth Management. With $144 million in assets under management, the firm has done a decent job sustaining growth and limiting risk when markets turn treacherous. According to senior portfolio manager Mark Scheffler, "We target annualized gains of 7% to 9%, which doesn't require us to make high-stakes bets." As a result, when most accounts were getting slammed in 2008, Appleton's account losses were only between 5.1% and 8.7%.
Active management has much to do with this performance. "While we were 89% long equities at the beginning of 2007," recalls Scheffler, "by July we had ratcheted back our net long exposure to just 18%. And by the beginning of 2008, we were 5% net short."
By the middle of 2009, the firm had shifted back to a substantial net long position. As of April 2010, the firm was 93% long equities. While that sounds high for a retirement account, Scheffler explains that in today's environment, to realize even modest growth requires more than what bonds can generate, and the firm is quick to alter its risk profile to meet changing markets.
While Ron Weiner's retirement portfolios are not as heavily equity-weighted, he agrees it makes sense to occasionally look outside traditional boundaries when opportunities present themselves. While many retirement advisors may have avoided investment-grade corporate bonds and preferred stocks when the market bottomed last year, recalls Weiner, these prices presented a unique buying opportunity.
"If one had faith and saw that panic, not fundamentals, were driving securities into the basement," says Weiner, "then those who kept their heads and bought when it was darkest locked into rare yields that will serve retirement needs well."