Have you ever heard the idea, “the percentage of stocks you should own = 110 – your age? This would mean that if you are 60 and entering retirement, you should have 60% in stocks. Ideas like this make financial planning much easier but does this make sense for you? The general idea seems to make sense, arguing that you should take less risk the older you get.
Formulas like this are a result the financial industry needing to onboard new advisors and the need for them to produce quickly, rather than mature with time. The odds of a new advisor surviving for 5 years at most firms is low, about 5%. The minimums to become a financial advisor are also shockingly low. For securities licensed advisors, there is no educational requirement and they must pass an exam with a minimum score of a C-. In the case of insurance advisors, there is a 32 hours educational requirement, but only a D- minimum exam score. There are some great advisors out there, but just because someone is licensed, doesn’t bestow wisdom. Because most newly minted advisors have limited expertise, the financial industry creates simple formulas for them to follow. Unfortunately, this leads to basic cookie-cutter solutions.
An example of a cookie-cutter solution is the percentage of stock determined by your age. It makes about as much sense as buying shoes based on your height. However, these cookie-cutter solutions are far more pervasive. Most risk scoring uses a simple set of questions to direct the advisor into basic formula-driven asset allocations. If you score a 5, then you get 80% stocks and 20% bonds. The problem with these formulas is that they can expose clients to high levels of risk at exactly the wrong time. According to a Prudential study, they determined that statistically, the most dangerous period to a portfolio intended to provide income is 5 years before retirement and 5 years after retirement. They coined the term “Retirement Red Zone”. This means that according to some cookie-cutter solutions, some are taking a massive risk with their retirement longevity at exactly the wrong time. Being lucky is not the same thing as good retirement planning.
Why don’t most advisors talk about this “sequence of return” risk? The simple answer is that they don’t have an answer to the problem, other than just reducing stocks, which reduces returns, and that creates other problems to the plan. At Eagle West Group, we see the problem as most advisors only having a single layer to their portfolios to offer. A layer of traditionally static allocation is fine, but we believe clients are better served with additional layers of strategies that can get reasonable returns while at the same time dampening volatility (risk). Specifically, we like additional layers of structured income and momentum models that can adjust risk depending on the market environment. Our risk testing allows us to compare alternative solutions to see if we are improving the client’s long term chances of success. Just because a person is comfortable with a level of risk doesn’t mean the risk is appropriate. You also need to do a financial plan to determine how much risk a person’s plan goals can tolerate.
If you would like to know more about our approach or our 3-dimensional asset care solution, register for our next webinar at www.eaglewestgroup.com/events or call our office at 877-834-1850.
Advisory services offered through EWG Elevate, Inc. dba Eagle West Group.
This represents a partial list of clients. They have not been compensated and were not selected based on duration, performance, account size.