Gillian: Welcome to Asset TV. I’m Gillian Kemmerer. We are witnessing a seismic shift in global demographics today. The number of people leaving the workforce is rising so there is no better time to be thinking about retirement income. Luckily we have three top experts here to talk us through their approach to portfolio construction. Thank you all so much for joining us. So I wanted to kick off our discussion with some interesting data that I saw on Bloomberg just earlier this week which I thought can frame our discussion, which is really about how demographics are shifting in the world right now. So the first one that we’re going to look at breaks down the population of the under 15s versus the over 65s. So if we look at this figure, the over 65s account for approximately 9%, which is a figure that has doubled since the start of the decade. So broad strokes, I just want to hear from each of you, what you’re seeing in the changing landscape of retirement. So, Steve, I’ll start with you, what are you looking for?
Steve Deschenes: [0:00:53] Sure. Yeah, no, you’re absolutely right. The demographic increases in longevity are enormous. When Social Security was started actually 65 was typical mortality table. And today it’s improved 13 years in just the last 50. So retirees are looking for obviously a much longer period of time in retirement, which is a real bonus. But their number one fear is outliving their money. So clearly we have to develop programs that are going to sustain them throughout what can be as long a time living in retirement as they spent working.
Gillian: [0:01:27] And I’m looking forward to hearing more about how you’ve done that and are doing that. Hersh, what about you, what are you thinking about, broad strokes, when you look at how retirement has changed?
Hersh Cohen: [0:01:32] Well, to me the major thing that’s changed, and I think it’s been hugely damaging to the country is the shift from Defined Benefit pension plans to Defined Contribution, because I think it’s undermined the sense of security for people. And until the last 10 or 15 years, many people in the country, working people could depend on a pension – a regular pension that they were predictable when they retired and then they could supplement with whatever savings they had put together in Social Security. With 401(k) plans, I think there’s a lot of evidence that people don’t manage them well, that they get into stocks at the wrong time and money funds at the wrong time. And so I think that’s the major change that I’ve seen. And I think it’s a big problem. The other problem is that unfortunately people as they head into retirement, look back and say, “I should have started saving when I was 25 years old.”
Gillian: [0:02:34] And, Wingee, what about you?
Wingee Sin: [0:02:34] Yes. I think definitely acknowledge that there’s a huge retirement savings gap. According to EBRI, the retirement savings gap at the moment is around $4 trillion, which is just slightly short of the size of the overall DC market. So given that we’re all living longer and that there’s such a gap, there’s a lot of measures that we should take in order to perhaps introduce retirement income as a way to bridge DB to DC.
Gillian: [0:02:59] So let’s talk a little bit about the broader savings rate. And I have another graph from Bloomberg that illustrates this point. So the silver line here is the average savings rate since 1996 and the blue is the savings right now. We see that savings rates are trending well above the average since 1996. And it’s interesting because central banks have done a very good job at keeping interest rates quite low. And a lot of retirees may be looking at this and avoiding spending, which obviously would impact their quality of life. So I’m interested to hear just broad strokes, and Hersh, we’ll start with you on this one, how has the low interest rate environment impacted the attitude or the activities of retirees?
Hersh Cohen: [0:03:38] Oh, brother, where can you start? Well, a couple of things. One, I think that the collapse of 2007/2008 into 2009, to me accounts for the higher savings rate. Now, people are really, really scared. Unfortunately that’s combined with a period when rates are so low that they can’t get what they used to get on savings. People used to buy treasury bill or bank CD or whatever. And so it’s impacted. And then the less interest you get the more you feel you’re going to need to save. So it’s a combination of fear over losing jobs or not getting wage gains that are motivating people to save, plus the idea they think they need to save more to get the same level of income they might have gotten before.
Gillian: [0:04:20] An interesting point, because so much of this activity has been done to stimulate spending, but obviously it’s doing the opposite for retirees.
Hersh Cohen: [0:04:25] It has an opposite, right, have rates gotten too low? Yeah, probably.
Gillian: [0:04:30] So Wingee, how do you view the headwinds in the lower interest rate environment for retirees?
Wingee Sin: [0:04:34] Yes. I think, especially as this chart show, I think savings rate is a really critical piece. And for us, you know, to sort of bridge the retirement savings gap, you know, you have to save more, work longer and avoid financial fraud. And so we really believe in a lot of auto-enrolment and auto-escalation paths to help plan sponsors with encouraging more savings with [inaudible].
Gillian: [0:04:57] And lastly, Steve, you’ve done some behavioral research on this point on retirees in general, do you have anything to add on how they’re approaching their savings in light of the interest rate environment?
Steve Deschenes: [0:05:06] Sure. No, I mean I think the positive aspect of an increase in the savings rate is great. But that’s not enough to get to full income replacement. So that’s a concern. And people should be saving probably more like 10 or 12% of their income throughout their entire working career to provide the right level of income replacement. And clearly at 1.4% where the 10 year treasury yield is now, and even lower for obviously CDs and other shorter term instruments. It’s very difficult for people to get the level of stability they’re looking for and the level of income that they required. So I think it’s going to have to take a product multiple asset class solution. And dividends have to be an important part of it where they have the growth of both those dividends and the growth of the underlying securities to get to where they want to go to meet their long term needs in retirement.
Gillian: [0:06:05] Absolutely. Wingee, I want to talk a little bit to each of you on how you approach retirement income individually. Because obviously you’re all looking at it from very different perspectives, so starting with you, I want to start with this shift over from Defined Benefit to Defined Contribution. Can you talk us through where retirement income fits in here and what State Street provides?
Wingee Sin: [0:06:28] Sure, yeah. So I think retirement income is sort of the missing piece in the Defined Contribution plan because as Hersh mentioned, traditionally in the Defined Benefit world you would see the stream of pension and that it really helps a participant manage its longevity risk. In Defined Contribution world we have been mostly focused on accumulation vehicle and saving vehicles which has been great in the industry in terms of growing savings. But what the scheme really is missing is the decumulation phase. And this is where we see retirement income is really critical. So we’re in the lab at the moment and developing a retirement income solution. And we feel that one of the key risks a retirement income solution should try to address is longevity risk because that is one piece of the solution that is very critical for participants to manage. And longevity risk, especially in the light of the fact that people are living a lot longer and when we think about a 100 to be potentially the next 65 years old, you know, that becomes even more critical to make sure that everyone is prepared for longevity.
Gillian: [0:07:26] And longevity risk is actually something I want to drill down into next after we speak with each of you on your products, so, Hersh, what are the characteristics of attractive dividend payers? I know this is something that you are thinking about. And what’s your outlook for dividend growth generally?
Hersh Cohen: [0:07:38] Right. Characteristics of attractive dividend payers and the things we look for. Number one, a good business model so that you can pretty much predict what that business will look like 5 or 10 or 20 years down the road, good management teams, proper asset allocation by the companies, adequate free cash flow yield to provide a sustained, and hopefully, rising dividend. I love companies that have the history over the ability to raise dividends on a regular basis. And that’s what we focus on. And we happen to prefer companies that make products that tend to get used up because then you don’t have to reinvent demand every quarter. So we would prefer a consumer staple to an auto company say, as a dividend payer. Although there might be a point at which an auto company is so cheap that it would pay to put in, but it would be small. We prefer companies that have sustainable businesses with recurrent revenues.
Gillian: [0:08:36] So very often this would lend to certain sectors being [inaudible]?
Hersh Cohen: [0:08:38] Yeah.
Gillian: [0:08:39] Okay, interesting.
Hersh Cohen: [0:08:40] But it’s interesting, as an aside, technology which did not used to be a dividend paying sector, you now have some real blue chip technology companies that are dividend raisers. And so we have a few of those as well, that didn’t used to be the case, maybe in the last 5 years that’s become a more popular theme.
Gillian: [0:08:58] Can you talk us through an example of one?
Hersh Cohen: [0:09:00] Well, the big examples would be Microsoft, Intel; Texas Instruments would be three examples of stocks that we own and have owned for a long time and are dividend raisers.
Gillian: [0:09:11] So, Steve, I want to switch gears a little bit with you. American Funds has been very vocal on the benefits of active management. And can you talk us through how an active manager can provide the benefit to a retirement portfolio construction?
Steve Deschenes: [0:09:22] We did some significant research on what made a good active manager an important part of a portfolio when you’re taking money out of the portfolio. And when you think about it, withdrawals themselves accentuate the volatility of a portfolio. So you’re looking for low volatility, managers that have done well in terms of downside capture, other characteristics that were important were low expenses and a high degree of manager ownership. When we combined those three factors we found a subset, a cohort of active managers that dramatically outperformed other active managers. And the broad benchmark index when you were taking money out of a portfolio and left residual portfolio outcomes at 50, 80, and even 100% above where the index was over the same timeframe over the last 20 years. So those are meaningful differences, life changing differences, because at the end of the 20 years, to have that significant asset base even after all the withdrawals available means that you can help the next generation and not worry about outliving your money, and that’s what people are looking for.
Gillian: [0:10:29] And it’s an interesting point because active management has been a bit under fire recently. But it appears that it’s very much focused on the manager selection process and choosing the right managers as opposed to active management broadly. So I’m curious to know a bit more how you choose those managers.
Steve Deschenes: [0:10:43] Sure. Well, the process of, as you think about it, and you’re absolutely right, most of the critical analysis look at active management as a whole, sort of assumes that you’re investing and all managers are the average of all managers. And obviously no one does that. And so when you look at manager selection we actually boiled down about 3,000 funds to a little bit over a 100 and looking at those 100 as a cohort and was able to produce those dramatically, you know beneficial results for retirees and really producing a low volatility, more sustainable income stream. And part of it was based on dividends. I mean one of the correlating factors of these strong managers was that their yield tended to be much higher than the broad market as a whole.
Gillian: [0:11:27] Wingee, let’s start with you on this point, you just alluded to it. Obviously longevity is a huge opportunity in the moment but it also leads to new ways of planning. And from a product development perspective, how do you start to plan for that extra 30 years that might be getting tacked on?
Wingee Sin: [0:11:41] Yeah, so we are. I think this is why thinking about longevity was such a critical piece of our retirement income solution thinking, we actually ran a focus group last year, interviewing various participants and learning about how they envision retirement security. And what we really learned is that actually when someone thinks about their retirement in their 60s, what financial security means for them in 60s, 70s and 80, it means very different things to them. In their 60s, retirement security means being able to find another job and being able to still work. In their 70s, they’re thinking, well, I hope that what I’ve saved in my 401(k) plan or my DB or my Social Security will pay me to sustain me until later on in life. And in my 80s, retirement security means to me that actually someone has taken care of my finances and tells me sort of how much I can spend. And so these characteristics really tells us sort of like in the 60s and 70 age ranges, a participant is really actually keen on achieving retirement security, perhaps through an investment approach that has a lot of flexibility. But starting at 80, this is where actually having an annuity where, that the fixed payout of the annuity and managing that longevity risk it really has a lot of value to them.
Gillian: [0:12:52] It’s an interesting point from the product development standpoint. And I’m also curious too, when you are designing these products, are you looking at a risk appetite in mind, is it individualized or can you generalize broadly across the 60s, 70s and 80s?
Wingee Sin: [0:13:05] Yeah, that’s a great question. I think you know there is such a trend of mass customization, with rogue advisory and managed accounts going on, and this idea of being able to customize your peoples’ need during their life stages is very compelling. But I think it really depends on individualized, you know, what their needs are. I think for the average American, you know, having a generalized solution is better than having nothing. And overall I think having an overall solution can help and make a big difference in retirement and the savings gap.
Gillian: [0:13:35] Steve, moving on to you, the biggest financial challenge you just said is outliving your assets. So talk me through a little bit about how American Funds has designed solutions to help clients and advisors get past this.
Steve Deschenes: [0:13:44] Sure, yeah. That’s certainly the number one fear of retirees, it’s even more than perhaps not living as long as they expected. In our experience too, there’s a lot of behavioral sort of issues around this. It’s not just the math; it’s also the emotions of retirement. One of the things that we found is that people classify their money in retirement in different buckets, different categories. So there’s an emergency bucket because you don’t want to create a plan and the first thing you have to do when something changes, you’ve got to revise the plan. So they’ve got an emergency, they’ve got living expenses, kind of the day-to-day household expenses, lifestyle, which is the brochures for retirement, the golf and sailing etc. And then the legacy, I mean particularly as retirees get older they begin to think about, they’ve worked all this time, created this pool of assets and they want to think about, well, what can I do with this? What’s available for the next generation or for some charitable bequest? And so what you’re looking for perhaps is not one silver bullet product, but a comprehensive plan that can be adapted over time and can address all four of those goals. One of the things we found in talking to retirees too is that they would like to have their principal intact at the end. They’d like to be able to maintain it if they could. Now, they realize they may not be able to. But be able to transfer that to the next generation would be a worthwhile goal. So one of the things that we did was we built a range of portfolios, these are actually fund to funds that are designed around different withdrawal strategies to help retirees achieve those multiple goals.
Gillian: [0:15:18] And again, on the personalization question, is this a retiree by retiree decision or are you able to broadly bucket based on the research that you’ve done?
Steve Deschenes: [0:15:27] Well, we’ve talked about a lot of risks, right, withdrawal risk, healthcare risk, inflation, longevity, and then we have a lot of products that are available, market based products, insurance products, solutions that are out there. So there’s a lot of complexity in those two risks and the product needs. So when you have a lot of complexity and you only get to do it once, I think it’s good to have someone to help you. And working with an advisor to build a specific personal plan that makes sense for you and pulls an array of solutions together to manage your needs is more likely to create a sustainable and adaptable plan that’ll work well throughout retirement.
Gillian: [0:16:04] And how each of your solutions fit into an advisor’s larger plan is something I want to drill on at the end as well. Hersh, bringing the question back to you, how do you approach the longevity question, perhaps in terms of capital preservation?
Hersh Cohen: [0:16:16] You know, I don’t … I don’t agree with the notion that retirees’ biggest fear, if I’m hearing what you’re saying properly is will I outlive my money. The only people I … I manage a lot of money for a lot of different kinds of accounts, including many retirees. The only people who worry about outliving their money are the people that haven’t saved enough. And so people today have a big advantage in that we didn’t have back in the 1970s, we didn’t have deferred savings programs. People have the opportunity now to start to save. And so if they save enough money, arguably is incredibly difficult in today’s world, if they save enough money they’re not going to worry about will I outlive my money. So the sustainability of income, I mean you need … so you need as much excess savings, I do agree with the idea, I don’t know whether 10 or 12% is the right number of what you need to save out of your income. You need to save enough and you need to start early and have the power of compounding working for you. My father-in-law, may he rest in peace, used to have these tables, showed all the grandkids, to everybody, if you put away $2 a week and you have, you know, you’ll have x dollars by the time you’re 65, if you do 4%, 6%, 8, it was great.
The power of compounding was, people understood it, I’m not sure people today really have grasped onto that, generally speaking. So the sustainability will come from having saved enough, number one. And number two, I would say investing properly, not getting killed during difficult periods. I agree, people who get … the people who get crushed in 2008 or 2000 or 2002 or 1974, you know, if you lose half your assets, you have a big problem. If you lose 10% or 15% of your assets it’s a lot easier to come back. And there are times you just can’t avoid losing something. But the power of compounding, and I can tell you stocks, when I first came into the business, 1969, I saw portfolios where the dividends each year were more than people had paid for the stock. And I said, “No, too bad that’ll never happen again.” You know, and then stocks that we bought in the 1970s, I mean I can’t name names, but I can tell you, blue chip companies, it’s happened again. The dividends each year are as much or more than what was paid for the stock in the first, real life examples, it works. But people need to be patient, need to understand compounding and it will happen again from this point over the next 30 years.
Gillian: [0:18:51] So there’s slight agreement, slight disagreement here about what the number one issue is in a retiree’s mind. Wingee, what do you think is the number one issue in a retiree’s mind?
Wingee Sin: [0:18:58] Yeah, I think Hersh makes a good point because it’s for people who have saved and perhaps the longevity risk is much less of a concern. But for us what we find is that access to workplace saving covers about half of America. So the other half which do not have access to workplace savings are people who have not saved. And then the other point that I would like to make is for the people who have workplace saving and have started saving, when we look at Generation X and we look at the EBRI data for Generation X, 40% of them have not saved sufficiently. So I think it’s actually, it’s a large population for people who either haven’t had access to workplace savings or who have not saved enough.
Gillian: [0:19:43] So it’s an interesting conversation that perhaps should be starting a lot earlier than when you are accessing each of these retirees. It’s an interesting point. So let’s talk a little bit about the solutions that each of you are providing and how they fit into a larger portfolio. So, Steve, starting with you, are you finding advisors that are receptive to your active management approach? And how are they building portfolios around it?
Steve Deschenes: [0:20:03] And when we released the research about a year ago, there was a lot of receptivity to people better understanding what were the key factors that made the difference when you were taking money out of a portfolio. And actually several of our broker dealer partners and Investnet and LPL and others, have actually built portfolios using this research to drive model portfolios for their clients. So that’s been a terrific outcome and we’re talking to several others as well who are planning similar use of the research. And then as I mentioned, we’ve also built on similar and related research, a whole range of fund to funds to help individual investors, you know, dial in on the kinds of withdrawal strategies that are sustainable. Because again, we found that people wanted to plan for a longer period of time, wanted to know that their income was going to grow, and they would like to keep their principal intact if they could. So we built some portfolios that can help them guide to achieve those outcomes.
Gillian: [0:21:01] Do you think that the increased savings, even in light of the low interest rate environment will continue to promote that legacy preservation? Do you think it’s adding to it? Maybe we’ll see another generation coming through that has more to start with, so to speak, the children of these retirees, moving forward, do you think that’s the case?
Steve Deschenes: [0:21:16] Yeah. I do think so, because I do think that, you know, when I came into the business 25 years ago, half the people were covered by a DB plan and today it’s one out of six. But what’s also interesting is that the 40(k) environment has actually moved from a similar number, one out of six people had a Defined Contribution plan, now it’s about one out of two. So I do think there’s a broad recognition that people are on their own, they need to save more and they need to make this a lifetime commitment to have enough sustainable income. And they’re going to cycle probably in and out of retirement as well. One of the things we found in our lifestyle study is that people were downshifting but still working. So they’re retired but they had a job. So kind of an interesting situation because they would say they’re retired. But then you’d say, “Well, what are you doing on Tuesday?” “Well, I’m going to work at this place and I’m going to help out over here. I’m opening a small shop.” So, people are thinking about this much more as lifestyle management throughout a 30 year retirement of not drawing a paycheck, but maybe recreating a paycheck from their assets and from their human capital to live over a long period of time.
Gillian: [0:22:22] So you find that retirees are working longer?
Steve Deschenes: [0:22:24] Yeah. Maybe in a different job, I talked to an associate not too long ago, who’s a lawyer, he’s leaving the law and wants to teach at a prep school. Now, he’s working but in his mind he’s retiring, you know.
Gillian: [0:22:38] Sure. Yeah, less stress, still lecturing, but less stress.
Steve Deschenes: [0:22:39] Yeah, still lecturing but in a different way, to maybe more receptive audiences.
Gillian: [0:22:43] Sure. And Wingee, what about you, how do your products fit into a portfolio? And how do you explain to advisors how to use them?
Wingee Sin: [0:22:50] Yeah. So, yeah, so our products they’ll love. But certainly for advisors who work with plans and advising how a Defined Contribution plan should be designed, I think what they find is a lot of selection in the accumulation phase, and many, many different products out there. And in the decumulation phase we’re trying to come up with a solution that helps them decumulate their assets, that has both an investment and an annuity approach within it. So I think it has a special place.
Gillian: [0:23:14] Great. And Hersh, what about you, how do you?
Hersh Cohen: [0:23:16] Yeah. I agree with what Wingee is saying. My favorite kind of relationship is when an advisor, the client and I can sit down and work together and figure out what, depending on the age, depending on how fast the track the person wants to travel on, at a young age I grasped that accumulation, you might want some mid cap and small cap and maybe a growth to your portfolio as you get older. Maybe you want to switch it more towards core and dividend, dividend growth products. And so that’s how we handle it. And also I’ve always managed accounts with a combination of fixed income and equities. Now, the fixed income side is really tough now and so you’re forced, and I have municipal bonds and government bonds that were bought many years ago, as they mature I scratch my head as to do with it. So we may take 5 or 10% of what matures, not 5 or 10% of the portfolio, 5 or 10% of what matures and put it in something, you have to, a little riskier to get a higher yield. So an MLP, closed end MLP fund or a higher yield fund, which I don’t happen to love. But to get more income you have to take a little more risk now, or in some cases a lot more risk, with some of it. And then others just put in treasury. But that’s why you want people, and people have to understand they need to save more. If one message I want to leave here, people better start saving early and a lot. And as hard as that is, you make sacrifices. There were times in the 1970s we didn’t go out on Saturday nights because I would have rather saved the money than pay the babysitter, it’s not, you know, it’s like, okay, we got through it.
Gillian: [0:24:53] And when you look at that saving strategy for someone who’s a bit younger, but is planning ahead, what do you suggest to them, what’s the best move? Interest rates are low, so what should they do with this pile that they’re…
Hersh Cohen: [0:25:03] What should a retiree do?
Gillian: [0:25:05] What should the younger generation that you’re saying is starting earlier?
Hersh Cohen: [0:25:07] The younger generation should own 100% equities. I mean under the age of 50, I think everyone ought to own, because the math is, if the return on equity is not greater than the return on debt, companies should just lend their money into the government and walk away. So below the age of 50, all equities, but not getting in and out. I mean buying and holding really good things, well managed companies for long periods that of time. That’s what I did. That’s what I believe should happen and then you slowly shift away from that, but that’s just my view based on experience and the math of it.
Gillian: [0:25:37] Steve, what do you think about that?
Steve Deschenes: [0:25:38] Yeah. I would concur, I mean I think you think of, you know, what Hersh is talking about is really in some ways a targeted strategy. You start largely equities and in many cases, certainly in our fund, with growth equities. And then as you decline in terms of the risk in the portfolio as you approach retirement, you know, we shift in two ways, we shift the amount of equities. But we also shift the characteristics of the kind of equities, we move to more dividend payers as you’re approaching retirement to reduce volatility knowing that you’re going to be starting to take money out of the portfolio.
Gillian: [0:26:10] And, Wingee, lastly, what about you, how do you look at the younger generation that needs to be saving more?
Wingee Sin: [0:26:14] Yes. I think employers have a lot to do with that which is ensuring that they have auto-enrolment into the workplace saving plan so that everyone is captured when they join a company to be in the 401(k) plan. Auto-escalation, which is a default investment, is also really important so that their savings rate increase over time without them having to sort of consciously make sure, let me save more, save more, save more. And then also tax credit for small businesses I think is also really critical because so many businesses, small businesses are hindered by the idea of offering a 401(k) plan because of administrative expenses and etc. So tax credit for small businesses is also critical. And then last but not least is this idea that given the workforce is increasingly more fluid, multi employer plan and for the government to remove barriers for multi employer plans will also make a big difference in terms of enabling greater access of workplace savings to more people. And that definitely will benefit the future generation more.
Gillian: [0:27:08] So you’re looking at the workplaces as something that needs to start a little bit of a revolution in this case. So they need to be approaching their younger employers or, excuse me, employees in a different way.
Steve Deschenes: [0:27:17] And I think the enlightened companies are definitely doing, yeah.
Gillian: [0:27:20] Yeah. So let’s talk a little bit about risk management. Obviously this is very important to retirees. And you know, Wingee, I’ll start with you, what would you say is the greatest risk facing retirees right now, it could be macro, it could be behavioral and how do you mitigate it?
Wingee Sin: [0:27:34] Wow! There’s many risks. But one thing that I think about when you think about risk on a more broader context is a lot of discussion about retirement has been very framed around building wealth. But actually if you reframe the conversation to building retirement income, that sort of introduces whole different areas of risk to think about, right. So when people are thinking about the objective of savings in a retirement vehicle, is actually for retirement income as opposed to just building wealth. Then all of a sudden the way they think about how the portfolio should be built will be different.
Gillian: [0:28:07] And is there a particular macro risk that you’re looking at right now?
Wingee Sin: [0:28:10] Not specifically, I would say yeah, I would say definitely we’re framing the conversation from wealth to retirement income. I think we’ll make a big difference in how people are thinking about their portfolio construction.
Gillian: [0:28:21] Got it, Hersh, what do you think?
Hersh Cohen: [0:28:22] The biggest risk clearly is some 2008 type of event, that where there’s no safe haven. And then people get panicked and sell near the bottom or they’ve been withdrawing too much and they have to withdraw, as Steve pointed earlier, sometimes the withdrawal comes at a bad time. So those are the greatest risks. But some black swan type event is the biggest risk. Other than that, you know, like stay with the program, you have to. And unfortunately a lot of people don’t have the stomach for that. So that’s where a good advisor can really keep it, you know, some … a broker on the West Coast, I’ll never forget, she told me, she said, “Your job is to manage the money.” She said, “My job is to get people on the train and keep them on the train.” You know, so it’s a good way of thinking about it.
Gillian: [0:29:11] Is there some way to construct the portfolio with a solution that allows people to behave in a way that would be more advantageous to them in a 2008 type situation? So is there some way to incentivize them not to have the massive sell or anything that would have, you know, obviously these types of events trigger panic, so how do you prevent it?
Hersh Cohen: [0:29:31] Well, that’s where a little bit of balance comes in for, you know, that’s why, you know, having … treasury yields were the only things that didn’t go down. But now, you know now people don’t want them. They’re yielding too little. No, there’s going to be times when you’re just going to lose money and you just have to grin and bear it and it’s not easy. I’m not saying it’s fun. I’m not saying it’s easy. We all make dumb mistakes, portfolio managers are subject to the same emotions as their clients. And so I think that’s where experience and judgment comes in. Maybe you’ve seen enough of these things that you become a buyer as opposed to a seller and that’s when you hope you’re doing that the right way. You know, Warren Buffett said, “It’s tough to bet against America.” It’s pretty good, pretty good and we’ve done a good job of … companies do a good job of earning a proper return on equity. And if you look at 10/20, I like to tell people when they’re nervous, I said, “In any one year dividends can go up, earnings can go up, the market can go down like 2008. But over 20/30 years, those graphs of dividends earnings and stock prices, they’re going to probably superimpose.”
And then I say, I think I’ll throw this question out and you’re free to use this, and I say, “In 1974 this country was in total mess. The country was torn apart by the war, you had interest rates at 9%, you had oil prices tripled, you had a president and vice-president that resigned and disgraced from the White House, you had New York City effectively bankrupt, the bonds were selling at 50 cents in the dollar, had to be bailed out.” And then I say, “Where do you think … and then think of all the things that have happened since then, 9/11, interest rates at 20%.” I said, “Guess what the Dow Jones average was then?” And if they don’t know they’ll guess, 5,000, whatever it is. And then they’re surprised, you say, “580, that’s where it bottomed in December, 580. So it’s up 30 times or so, plus dividends, and look at all that’s happened since then.”
Gillian: [0:31:26] Betting on America as the strategy.
Hersh Cohen: [0:31:26] And people listen and they say, “Yeah, that’s great. But if I tell my client that and they go in, you know, if the market goes down 4% they’re calling me, like what am I doing?” You know, so it’s really hard. The advisor really needs to hold hands, be proactive. Listen, it’s hard. It’s hard.
Gillian: [0:31:43] Sure. Steve, what about you, what is the greatest risk facing retirees right now in your opinion?
Steve Deschenes: [0:31:47] I think I would agree that market risks is one of the largest ones. But I think one of the things that retirees face is that they’ve gotten multiple risks that they haven’t faced before. They’re not just accumulating their portfolio, I mean healthcare, that’s a massive expense and may even have a healthcare impact to their ability to do what they want to do in retirement.” Assisted living is incredibly expensive. You know, inflation, it has been pretty benign over the last 25 years. But as you just pointed out, in the 70s we had stagflation and very high inflation. So it’s handling these multiple risks
Gillian: [0:33:12] And how do you approach diversification?
Steve Deschenes: [0:33:14] We think of it from a client centric view in terms of their objectives. Certainly we look at asset classes and the risks inherent in those asset classes. But we’re really building it from their utilization of the portfolio itself, how much income do they need? What’s their stated goal around principal preservation? And we’re building that from the client back and not just from the sort of risk and mean variance optimization from a top down. We’re really thinking about it from an objectives based, in terms of meeting their goals.
Gillian: [0:33:46] And from a product development standpoint, how do you think about diversifying for your clients?
Wingee Sin: [0:33:50] Yeah. I think he made a great point with the multiple risks that a sort of a retiree faces. And so when we think about it, you know, there’s different investment instruments and a financial instrument that can help you mitigate different types of risk. And you know annuity certainly serves a key role for helping manage longevity risk. And then some of the shortfall risk, market risk, inflation risk, we manage here a sort of an investment approach, if you will, yeah.
Gillian: [0:34:16] And what about you when you’re looking at your dividend strategy, how do you diversify?
Hersh Cohen: [0:34:22] How do I diversify?
Gillian: [0:34:23] How do you diversify?
Hersh Cohen: [0:34:23] By owning a package of companies diversified by sector, diversified by company and with companies that I believe have sustainable enough dividends. So no one stock at entry will ever be more than 3%. No matter how much we might like energy or pharma, whatever, we’re not going to have 30% on that; it’s going to be well diversified. So you might sacrifice a little bit of upside but you also diversify. Now, you can diversify away success when you own these great dividend companies, there are times you’re going to lag a benchmark. But your dividends keep going up. I get calls sometimes when the markets are getting killed and “Like what do we?” And I say, “Not one of your companies cut their dividends today.” And it’s true. I mean I don’t mean to be glib about it but it’s great. So you’re diversified by stock, by sector, by … and the main thing, the ability to maintain and raise those dividends. So it’s just hard work of finding those companies, there aren’t as many as one would think.
Gillian: [0:35:30] What’s your strategy for searching through them, is it a bottom up approach? How do you look at it?
Hersh Cohen: [0:35:35] for the most part, the companies I’ve followed for long periods of time and every so often a new one will break in as I said, in technology, that all of a sudden you start thinking, well you know, maybe there’s some hope for dividends there. But there are screens and it is bottoms up. I try to be top down approach to the overall market. And so there’ll be times when I’ll be really bearish, or times when I’ll be really, really bullish, and hopefully those will be right. But even then, making extreme bets is really hard. So we were fortunate in 2007 to have gotten out of the financial sector. But in 2009, we were … I mean we were pounding the table on dividend paying stock, and stocks in general, I mean they were throwing them out of the window – throwing them out of the window.
So I still saved a New York Post page from December. I actually thought the market was bottoming in 2008 and they showed graphs of how the bear market of 2007/2008 was similar with the waterfall decline at the end to 1974, 1929-32, 2000, to 2000, the great bear markets of the past. And it was 8 or 10% too early. And I was the only one willing, it’s not patting myself on the back, it just was stocks were so cheap, I said … they said, “Well, what about the market next year?” I said, “Aye, it’ll be up 15%.” I was throwing out a number, you know, was like, I just directionally, it’s just stocks were too cheap to sell and you should be buying them, that’s all. And that comes … I think that comes from experience, you know, 1962 when the market bottomed. The market bottomed in May of that year with the selling climax and then it bottomed again, hit that bottom again in October coincident with the Cuban missile crisis. So sometimes the worst news is the time, you know, you want to buy on the worst news.
Gillian: [0:37:50] Well, as the old saying goes, when the blood’s running in the street and some of it’s yours, is the general [0:37:53].
Hersh Cohen: [0:37:54] Yeah, you hope it’s not your own.
Gillian: [0:37:55] Of course. And then, Steve, when you’re looking at a multi manager approach, are you diversifying across individual positions of the managers or are you looking at what collectively they have in each sector? How do you manage it when you have multiple people who are trading on math?
Steve Deschenes: [0:38:08] Sure. Well, we started at two levels as you know the American Funds are based on a multiple manager system. So any individual fund may be comprised of 8 or 10 managers and they’re working independently. But there’s obviously some look overall at how we’re allocating to those managers and how they come together at the fund level. And then we have an entire team portfolio oversight committee that works at the asset class level and the fund level, pulling together these individual fund building blocks and building retirement income portfolios. And in those cases we’re looking for diversification across asset classes. We’re looking for how the funds have operated together. We do back testing. We have the benefit of some incredibly strong building blocks. I mean Capital Income Builder’s a great example. It was launched nearly 30 years ago and has a $100 billion in assets. And it was dedicated to finding above average income and growing income at dividend payers. And that fund is a mainstay in all of our retirement income portfolios. It’s 20 or 25% of the portfolios itself and then multiple managers within Capital Income Builder. So it’s sort of layers of diversification, each of which are designed to reduce volatility.
Gillian: [0:39:25] And Wingee, you’ve mentioned this a couple of times so I just wanted to have you elaborate. You’ve mentioned that your products are in the lab. What is the lab and what are you doing there?
Wingee Sin: [0:39:32] Yes. We are trying to design more investment solutions for the Defined Contribution plan. So yeah, so that’s what the lab’s up to.
Gillian: [0:39:41] We’ve talked a bit about active management, but I want to drill down, how does this apply to income investing?
Steve Deschenes: [0:39:45] Sure. Well, part of the difference between active and passive in general is that passive is going to represent 100% of the market risk. And you’re going to be invested in all those sectors that have gone up. One of the benefits you have in active management is to actually find managers that are more focused on managing when markets are performing poorly. And that downside protection, that low downside capture of volatility is really important. And you can within the active management universe screen for that, look for managers that have done well in previous market downturns. In fact I did one piece of research that looked at managers that had done well on a trailing three year basis in market downturns and said, “How well are they going to do in the next market downturn?” And <a href="https://www.americanfunds.com/advisor/literature/viewFile.htm?lit=338261&fileType=cpdf" target="_blank" >that group of managers outperformed in 11 out of 12 of those bear markets<a/> that followed. So there is an opportunity to screen for that lower volatility on a higher dividend focused manager and make that a bigger part of your portfolio as you move into retirement because obviously volatility itself is accentuated via withdrawals. If the market’s down 20% and you’re taking 5% out of the portfolio every year, well your portfolio personally is down 25% in that year. And it’s hard to have enough saved to, you know, obviously benefit from the next leg up in the market when you’re down 25%. So it’s important to focus on finding the right kind of active managers.
Gillian: [0:41:07] So not the hotshot manager with the 12 month track record, that’s not what you’re looking for?
Steve Deschenes: [0:41:10] No, much more fundamental factors, exactly. You know, good downside capture, the level of ownership in the fund itself matters and low expenses. And expenses are a direct deduction from their results in finding the managers, just eliminating the three-quarters of the funds that are most expensive is a terrific screen to get you to a cohort of managers that are more likely to do better.
Gillian: [0:41:31] That’s a really interesting point, Hersh, what are your thoughts?
Hersh Cohen: [0:41:33] Yeah. That’s, I agree, it’s, I think good active management will bring to bear a lot of experience and judgment. And it requires judgment to do better than average. And so I would say two examples of the past 5 or 10 years that are meaningful, that would make a meaningful difference would be number one, avoiding companies that would be cutting dividends. And so you had to avoid bank stocks in 2008 or otherwise you got crushed. On the other side, and so managers who did that managed to preserve capital much better. In the last couple of years all I’ve heard is why everybody should sell utilities, why they’re no good – why they’re no good. Our view was on a price earnings ratio, yes, they looked expensive. But on a yield to treasury basis, they were not expensive. And so we kept utilities and telephone stocks. And they’ve actually been pretty good this year. They weren’t so great last year, this year they’ve had a really good year. So you can’t do it right every year. But those are areas, both an avoidance and an ownership of things that I think where makes a difference with active versus passive.
Gillian: [0:42:49] Okay. So we’ve talked a bit about allocation across asset classes. But we haven’t talked about product allocation. How do you look at bringing together various categories of products within a portfolio?
Wingee Sin: [0:43:00] So I think when earlier we mentioned about the importance of longevity risk and how to manage that and annuities is a good way of managing longevity risk. And so we are hoping to sort of come up with products that sort of help look at the annuitization process but being able to offer it to the masses. If you think about buying an annuity at the moment it is sort of a challenging process. You have to go to a financial advisor and then you have to work with the financial advisors to determine which annuities are appropriate for you. And that’s probably the best way to go about it. But how do we make sure that everybody in the US can have access to annuitization? And so we believe that annuities can have a place within a workplace savings plan and being able to offer that and marrying that with investment solutions can be a really effective way in managing both accumulation and decumulation.
Gillian: [0:43:48] Hersh, how do think about the product [inaudible]?
Hersh Cohen: [0:43:49] Yeah. Well, product allocation is what I alluded to before, when you have bonds, when you manage balanced portfolios and you have bonds that have matured, what do you do now? So one possibility is a kind of a straight fixed annuity as low cost as you can get, that’s one possibility. A second would be take higher risk. The government is forcing you to go out higher on the risk scale. So that might mean as I say, master limited partnerships or it might mean higher yield funds or more leveraged funds, things that you might find distasteful but you might want to put a piece of – a piece of with those maturing bonds. There’s no perfect answer with this unfortunately. It’s really a balancing act and requires a lot of thought and a lot of work and a lot of handholding and so it’s tougher. I mean this is where the really low interest rates now have forced people to do things they wouldn’t necessarily want to do.
Gillian: [0:44:50] Steve, have you seen the same?
Steve Deschenes: [0:44:50] Yeah. No, I would certainly agree, it’s a tough environment. I mean with interest rates where they are. But there are some opportunities. And we think of it is a very personal decision. One of the first questions is how much pension income do you already have, because obviously that is one form of an annuity. Social Security is another form of annuity, and just deferring Social Security by a year is an 8% increase in inflation adjusted income for the remainder of your retirement. So a good advisor should sit down and work with the customer to evaluate all of their guaranteed forms of income, look at deferring Social Security, look at possibly purchasing some additional guaranteed income, at least to meet that threshold, that living expense threshold, there housing expenses, car, healthcare, the basics, you want to cover that so that you can sleep at night. And then obviously the rest of your portfolio that’s dedicated to lifestyle and legacy should be much more market based and focused on growth and focus on the kinds of things you’re trying to achieve. But looking at how much pension income you have, then add Social Security and then look at your basic expenses. Look at that as one barometer of how much you may need. And we all know that Defined Benefit plans have gone away in the last 30 years. But there’s an opportunity to purchase back at least a portion of it as part of your total plan. And that’s something that you should rely on to work with an advisor, to think about that as part of a total holistic solution.
Hersh Cohen: [0:46:15] You know, yeah, it’s interesting. The first question I ask when people sit down with me, the questions I ask is, “What are your liquid assets?” In other words, what are the things that can create income? “What other forms of income do you have? And give me a ballpark estimate of what you spend every year, what you think you need to spend.” In New York, I know, in the New York area it’s always a certain number that I can always almost predict. The sad thing is when you have to tell people, you know, “You’re going to have to keep working for another 10 years. You just don’t have enough.” That’s the worst part and the best part is when you say, you know, “Don’t worry, you have plenty of money, you know, dividend payers. You don’t even have to stretch for income.” That’s the best scenario, so. And then there’s everything in between. But it’s their personal decisions and not easy.
Gillian: [0:47:01] Well, our goal is to get everyone in the other bucket.
Steve Deschenes: [0:47:04] Absolutely.
Gillian: [0:47:05] So I’m going to give you each an opportunity to give us some last thoughts, whether it’s on your particular product or what you want retirees to think about in general. So, Hersh, I’ll start with you.
Hersh Cohen: [0:47:14] What I want is for people to think about retiring long before it’s time to retire, not 5 years or 10 years before it’s time to retire. I want people to think about retiring when they’re in their 20s, as hard as that sounds. For retirees themselves I want them to think about how to produce a regular stream of income, hopefully a rising stream of income. And those to me are the most important factors.
Gillian: [0:47:37] And that certainly plays into the point of getting the workplace onboard early, so any final thoughts?
Wingee Sin: [0:47:42] Yeah. So yeah, I think for employers should think more about workplace savings and the importance of that for one’s savings overall. I think we talk a lot about the retirement savings gap of $4 trillion, having a more robust workplace savings program and that includes both accumulation and decumulation, will be really critical to achieving that.
Gillian: [0:48:03] Great, and Steve?
Steve Deschenes: [0:48:04] Yeah. We’ve talked about a lot of issues and risks and complexity. And I think people have worked to accumulate the assets they have and need to then spend some time in thinking about how they create a sustainable paycheck, you know, from those body of assets, and because they only get to do it once and they probably don’t want to do it again and go back into the workforce. I think it’s important to work with someone to help them, someone who’s seen, you know, lots of different market situations, worked with lots of different clients to help them through that process to build a sustainable, you know, adaptable plan that’ll work well if it’s high inflation or low inflation, whether there is good markets or poor markets, whatever their healthcare situation might look like. You need a plan that can adapt to all those different environments and working with an advisor to help them do that.
Gillian: [0:48:49] So start early, get the workplace involved and you’ll have adaptability and get some help, which all of you are very...
Hersh Cohen: [0:48:55] That’s a good summation.
Steve Deschenes: [0:48:55] Absolutely.
Gillian: [0:48:56] Yes. All of you are very well equipped to provide. So thank you all so much for joining us and for sharing your thoughts on retirement income. Thank you so much for joining us. From our studios in New York, I’m Gillian Kemmerer.
State Street Global Advisors