Would you trust a doctor that based his entire treatment regimen on a single question?
Of course not. You’d rightly assume the doctor was being cavalier with your health, and you’d look for a better doctor.
That seems obvious. But somehow, when it comes to the world of financial planners, that’s exactly what they’re getting away with.
Age In The Investment Process
My biggest problem with financial planning today is that it reduces the entire investment process to a single question: age.
When you’re young, your financial plan shoehorns you into stocks. And the older you get, it gets you progressively out of stocks and into bonds.
Most models try to at least pay lip service to risk tolerance by asking you questions about your feelings towards risk. But these questions are inherently subjective, so in the end your portfolio almost always depends on your age.
Because no broker will ever get sued or fined for putting a 20-year-old in stocks or an elderly widow in bonds, no matter what the returns end up being. Sadly, it really comes down to that.
Given how simplistic the industry has become, it’s really no surprise that human advisors are being replaced by robo advisor apps you can download onto your iPhone. Most 401(k) plans now have online questionnaires that choose a portfolio for you based on your age. No human contact needed.
Age and risk attitudes matter. But equally important — and if you ask me, more important — is your expected return. It doesn’t matter if you’re 20 or 80. If an asset class is priced to deliver lousy returns, you shouldn’t be in it. Yet expected returns are completely left out of the planning equation today.
Furthermore, nearly all financial plans ignore specific goals, such as generating a specific level of income or saving a specific dollar amount for a large purchase such as a retirement property or a wedding.
1201(k): A Better Way To Plan
The age-based model can be used as starting point or baseline. But once you have that baseline, you need to make adjustments based on market conditions.
For example, let’s say that your 60 years old and that a standard age-based financial plan gives you a suggested allocation of 60% stocks and 40% bonds. But with stocks now over 10 years into a bull market and looking overpriced by most metrics, perhaps that 60% in stocks should be knocked down to 40% or even 20%.
And what about the 40% in bonds? In a “normal” bond market, this portion of your portfolio should be laddered, or spread more or less evenly across various maturities.
But does that really make sense today, with the yield curve inverted? Short-term T-bills yield considerably more than 10-year Treasury notes. On what planet would it make sense to buy long-term bonds, locking in cruddy rate, when you can earn a higher yield on shorter-term bonds and have your money accessible sooner?
Of course, these are not plug and play decisions. You might actually have to put a little thought into your portfolio, which is more than most financial planners do.
Today, the average stock fund offered by a 401(k) plan yields less than 2% in dividends. And if you’re excluding junk bond funds (and at this stage of the market cycle, it’s wise to exclude them…), you’re not likely to find yields much higher than about 3% in a diversified bond fund.
Blending the two together, a standard 60/40 portfolio might produce a yield of 2% to 2.5% if you’re lucky. Most people can’t live on that, so they depend on capital appreciation as well. But after a solid decade of raging bull markets in both stocks and bonds, are you comfortable making that bet?
A Better Way To Retire
I’ll never complain about making money in the stock market. But I don’t want my retirement to depend on it, as there can be long stretches when the gains simply aren’t there. Most recently, an investor buying at the top in 2000 wouldn’t have seen a return on that investment until 2013.
The good news is that we’re not limited to the cruddy menu of stock and bond mutual funds found in most 401(k) plans.
We have better options, many with cash dividend yields three times higher than what you’ll typically find in your 401(k) plan. I like to joke that these high yielders can turn your 401(k) into a 1201(k).
To get an idea of the kinds of yields on offer, check out my presentation tomorrow in The Rich Investor.