A popular characterization of the baby boomers is that they've saved little and will therefore draw on home equity to meet retirement income needs. But what happens when neither stocks nor residential real estate holds its value? Retirement plans must be rethought, modified and, hopefully, salvaged.
According to the research report released by Tiburon Strategic Advisors in May 2008 entitled Consumer Wealth, Liquidation & the Retirement Income Challenge: The Impact on the Decline in Home Equity, various trends confirm retirees' dilemma:
Consumer households' personal assets are dominated by residential real estate, which
accounts for more than 80% of assets;
Consumer households have $9.6 trillion in real estate equity, which reflects a 10% decrease since 2006;
Baby boomers' savings crisis will be, in part, remedied by their liquidation of residential real estate;
The number of new and existing home sales is falling; and
Ultimately, baby boomers' need to liquidate their homes could cause U.S. home prices to collapse by 2015.
What's an advisor to do? We asked our sources to divulge their strategies and found that, while many have been successful in protecting clients' investment portfolios, housing is another story.
Michael Martin, a principal in the firm of Financial Advantage Inc. in Columbia, Md., has always taken a conservative approach to both retirement investing and retirement income planning and finds it is paying off in the current environment. "We're getting an unusual number of happy e-mails from clients thanking us for keeping their portfolios productive and on an even keel. We've always thought that retirement portfolios should be managed actively for absolute returns because sustaining withdrawals is a huge part of the retirement challenge," Martin explains.
His message is that static allocations and passive diversification across the style boxes is "not appropriate to the goals of retirees, and if the investment manager is attentive to big-picture market signals (such as the fact that a high P/E for the broad indexes portends low future returns, especially when business profit margins are at all-time highs) it is possible to achieve absolute returns, but this also requires a temperate view of return potential." Financial Advantage has had no down years since January 1, 2000. In this year's first quarter, Martin says "our portfolios earned 0.0% versus the S&P's 10% decline." In other words, his existing retired clients are being very well served.
But then, Martin is a talented portfolio manager with a strong Wall Street background. What about new clients who've been sold what Rob Schmansky of Sound Capital LLC in Southfield, Mich., calls "new and untested investments," namely, "variable annuities and/or managed accounts based on untested" risk-mitigation techniques. "Clients are attracted to the belief that they are investing while cutting their downside risk," Schmansky says. "However, they are unaware that they may also be cutting their upside potential, and they're certainly unaware of the costs involved and how those might affect their long-term plan."
Schmansky says he recently met with a prospect who believed his portfolio had a loss limit of -10%. "This was an all-equity portfolio with a company marketing 'put options' as bond substitutes," he notes. "Meant to achieve returns equivalent to a 60/40 portfolio, this client's portfolio trailed a blended benchmark by 12% in 2007, while total costs were somewhere around 8% to 12% per year for the options and another 2.4% for manager fees-all in the name of 'protecting' his account."
And then there are the investors who undermine what would otherwise be solid plans-had they worked with a reputable advisor. "I saw a prospect the other day who claims he's lost nearly 20% since October 2007 and has put off retirement," says Tom Orecchio of Greenbaum and Orecchio Inc. in Old Tappan, N.J. "He is becoming a client and we are setting up a more diversified portfolio and an automatic savings plan to beef up his retirement savings in addition to maxing out [contributions to] his company's retirement plan."
Should advisors look to housing to bail out clients like Orecchio's? No, says John Sestina of John E. Sestina and Company in Columbus, Ohio. "I've always argued that a home is not an investment. In my book Managing to be Wealthy [Kaplan Business, 2000], I build a case for the fact that a house is an expense much like an automobile, not an investment," he declares. "My research shows a house sells for approximately the amount of money you have put into it. Often overlooked are the non-mortgage costs of home ownership. If one plans to use the house as part of their retirement portfolio, then they put themselves in great jeopardy. It usually means they have overbought and their actual investment portfolio is underfunded."
True, but nonetheless home equity is already a done deal for many boomers and other would-be retirees. So what are advisors doing to make the best of it in the face of declining home values?