Tag Archives: financial advisor

9 Reasons Consumers Need Advisors More Than Ever

My Comments: This is a self-serving blog post. While I should apologize for this, there are millions of Americans who will find themselves looking for financial freedom in the years to come and unless they have developed the necessary skill sets, they will find themselves behind the curve in a big way. Somebody has to step up and provide good advice. I like to think of myself as one of those with good advice.

The title says there are 9 reasons here but I didn’t count to see if it was true. I simply found some meaningful truths about us and how people in my profession can help others. Oh, and make a meaningful living for ourselves as the years pass. That’s always a good thing.

I don’t share the underlying gloom that motivates Van Mueller, but there are truths in what he says. As consumers, it’s what we do with information that will make the difference.

Aug 13, 2014 | By Paul Wilson

Van Mueller kicked off the 2014 Advisor Network Summit in Las Vegas.

“Right now we are in the middle of the greatest opportunity in the history of the industry. Every single institution we think we can depend on won’t be there in the future. We’re not in a recovery – the government is printing trillions of dollars. Soon, you’re going to see crashes in stocks, bonds and real estate markets.

The world just went $100 trillion in debt. The U.S. is $17 trillion in debt, but the rest of the world is $83 trillion in debt – there’s no one to borrow from. We’re so close to a calamity and the only people who can help are in this room.”

“The attention span of an average American is 12 seconds. No commercial is longer than 30 seconds now because people don’t pay attention that long.

Nobody cares about you; it’s about them. Customers tell me, ‘You’re the smartest advisor I know.’ But I don’t know anything other than how to ask what matters to people.”

“Don’t you think any politician would fix the economy if they could? But no one knows what’s coming next.

Ask your clients, ‘If nobody knows what’s going to happen, should you take a lot of risk and put your money in danger or develop a strategy that will keep your money safe and every time something bad happens, you take advantage of it?’

Politics isn’t going to fix this; it’s a math problem. It’s about taking responsibility for our own lives. Show people they can stay in control. We sell control.”

“45 percent of all working Americans have nothing saved for retirement. When you are talking with affluent prospects, ask them, ‘Do you think our government is going to let those people starve? No. How will they help them? They’re coming after those who have money.’ You’re running out of time to take control of your money and lives.”

“Half of Americans can’t afford their current home. One little downturn, and you’re talking about a house of cards. Tell your customers, ‘It doesn’t have to happen to you.’”

“Some people say, ‘This sounds like a lot of doom and gloom.’ Many people give up and say, ‘There’s nothing I can do.’ Tell them, ‘Have there ever been bad times before? During those bad times, did some people make money? Was it those who were prepared or those who winged it? Which do you want to be?‘”

“There was no such thing as the good old days. This is the greatest transfer of wealth in the history of the U.S. It’s the greatest time ever to be an agent. You are not each other’s enemies. Find fellow advisors and get better.”

Vocational Training Is No Substitute For High School

Internet 1My Comments: Some of you are aware of my continued interest in the welfare of the magnet programs across Alachua County. I’ve been a member of the advisory board to the two programs at Buchholz High School since the mid 90’s. They are, respectively, the Academy of Finance and the Academy of Entrepreneurship.

The original intent in the early 90’s, from the perspective of the business community, was to encourage work related skills in these two generic disciplines, such that upon graduation, students who were unlikely to continue on to college, would graduate from high school with a skill set that would help them be more employable by members of the business community.

It didn’t work out that way. For one thing, the idea of “vocational education” went out of favor as “demeaning” to those less blessed with raw intelligence. Never mind that those students would likely benefit in later life had they had a high school education more suited to their intellectual capacity. Some of us are fast and athletic; some of us are slow and uncoordinated, which describes me. Same with our brains.

The other thing that happened, in large part thanks to the respective program directors, was due to something else that surfaced. Namely, that if a middle school student already had a reasonable idea which academic track they wanted to follow, there was now a high school program somewhere in the district that allowed that person to get a leg up on competition when it came to leaving high school and entering college. As a result, over time, the profile of the students in the respective academies became more and more advanced, to where today, virtually 100% of the participating students are going on to college as they are academically advanced. But they are not necessarily “employable” in the context of our original intent.

The dilemma for the business community, and Buchholz High School, is that we have identified the best and brightest with an interest in economics and marketing and finance, but we still don’t have a pool of students with high school diplomas and job related skills that we can add to our list of employees. They are moving on to college and will be overqualified for what we need today.

By Matthew Yglesias

A growing chorus of progressives, ranging from Rick Pearlstein to Dana Goldstein to Kevin Drum are suggesting that maybe Rick Santorum was right and instead of trying to give everyone a college prep education, we need a return to vocational schooling. After all, as Drum says “American high schools ought to be as good at turning out plumbers as they are at turning out future English majors.”

It’s true that we need plumbers, but I don’t think this has the implication that Drum thinks it has. For starters, as Kevin Carey notes it turns out that “most plumbers, pipefitters, and steamfitters get their training in jointly administered apprenticeships or in technical schools and community colleges.” This is similar to his point from a little while back that a large and growing fraction of auto mechanics have post-secondary training. In other words, while it’s true that we don’t necessarily need a large increase in people with traditional liberal arts degrees a large share of the career-focused education we need still has to occur at the post-secondary level. That’s for two reasons, the most fundamental of which is simply that as we grow more technologically sophisticated as a society all kinds of work becomes more complicated, technical, and specialized. The kinds of colleges that offer good training to be policy-focused journalists probably don’t offer great training to fix the automobiles of tomorrow, but that doesn’t mean car mechanics don’t need additional training.

The other issue is that if you look at countries that have successful high school level vocational training (Germany always seems to come up) you’ll note that kids go into the training with a solid grounding in the basics. Dana and I both visited a vocational training high school together in Finland, focused on teaching people hairstyle and makeup skills. What struck me is that the girls (and they were basically all girls) to the best I could tell were competent in algebra, literate in Finnish, and had an okay grasp of a foreign language.

The kind of low-achieving American 15 year-olds who’d be put on a “vocational track” generally don’t have those kind of skills. What they’re getting out of high school (ideally) isn’t so much college preparatory work as it is remedial work designed to put them on track to receive career training. That’s not an ideal function for high schools to be serving, and oftentimes they don’t do a good job of it, and arguably remediation could be better-integrated with vocational training but as is often the case in education it’s a problem with earlier roots. If the outputs of America’s K-8 education keep improving (which they do in fact seem to be doing) and we invest more in quality preschool, then we’ll have more latitude to talk about moving kids into job training sooner.

3 Essentials Missing From Many Retirement Plans

retirement-exit-2My Comments: One thing I’ve learned over the years is that people in my profession have a profound bias when it comes to trying to explain the dynamics of money. We include a lot of self promotion.

I’ve also learned that I’m not immune to this bias. Some of this is justified since probably 95% of the target population is misinformed about those same dynamics. While they should be willing to learn all they need to know so they can do it themselves, those same 95% will not or cannot apply the necessary time and energy. So the issue becomes, “To Whom Do We Turn for Help?”. If I’m going to survive, I have to focus on those who need help.

I’m doing the best I can to bring you stuff like this to help you better understand the background noise.

Erika Rawes / July 07, 2014

Work is a major part of our lives. From the moment we reach adulthood (and sometimes even before adulthood), most of us find a job and we work for the next 40 or 50 years until it’s time to retire. Retirement is thought to be a sort reward for working hard during all of those years. We accumulate savings so we can enjoy those final chapters in our lives without having to worry about money, as for the average person, money is a daily concern.

Perhaps, retirement savings should be as easy as putting away a percentage of our income into a savings fund and then collecting small increments of this savings once we retire — up the mountain and then back down. It’s not exactly that simple, however. Tax legislation, the various types of retirement accounts, contribution limits, Social Security laws, and pricey medical care make this simple concept — save now so we can enjoy retirement later — much more complicated.

Since we have so many factors to consider — all of which have a role in determining how well we save, the return we earn, and how well we maximize and preserve our money — we try to make the best decisions possible. Lincoln Financial Group conducted a study on the underrated impact of taxes on retirement. In the 2013 study, Lincoln examined the habits, knowledge, and behaviors of individuals between the ages of 62 and 75 with incomes in excess of $100,000.

Using data from the Lincoln Group study, we found a few common must-haves that appear to be missing from a high percentage of retirement plans.

1. Proper Tax Planning

Many future retirees think costs like discretionary expenses and home repairs are the highest costs during retirement. When Lincoln asked pre-retirees about what they thought their highest expenses would be during retirement, the top answers among survey respondents were home mortgages, healthcare, and travel and leisure.

In reality, around $1 out of every $3 spent by high-income retirees goes to taxes. Taxes are the largest source of spending for retirees in the above $100,000 earnings group, accounting for 31.38% of overall spending.

Retirement SurprisesWhen Lincoln asked retirees about their biggest surprise expenses, taxes were the again most common answer. The average marginal federal tax rate among the survey respondents was 26 percent, and the state rate was 7 percent. Forty percent of survey respondents stated taxes were higher than they expected and even with rates at these levels, 23 percent of respondents stated they were doing nothing to reduce their taxes.

2. A Financial Advisor
With the recent recession resulting in losses for millions and changing legislation impacting several facets of retirement planning, discussing a retirement plan with a financial advisor is a must. A good advisor compares every plausible scenario, and finds the most profitable plan for each individual. This, of course, is different for everyone.

For instance, people often hear about how converting to a Roth IRA is an effective tactic for minimizing tax liability. The Lincoln study found that only 30 percent of retirees were familiar with Roth IRA conversion rules. An advisor can help sort through the information as converting isn’t always best for everyone and even when it is an ideal choice, gradual conversion may be a more effective option.

Those who use a financial advisor have a higher level of confidence in their retirement plan than those who do not use an advisor. The study found that 75 percent of higher income pre-retirees who use an advisor had confidence in their retirement savings, compared to only 59 percent who do not use a financial advisor.

Most pre-retirees simply do not have the time to devote to learning every rule and regulation. Those with a good financial advisor have a resource available to answer their inquiries and educate them on general topics, like tax policy and withdrawal strategy, and also on investor-unique topics, like conversion and account choice.

3. Knowledge and Mindset
The income and spending habits of a retiree are different than those of a working individual. Bureau of Labor Statistics‘ spending data indicates housing is the largest expense for consumer units during their working years. During these years, transportation, personal insurance, and pension costs are also high. The primary source of income are wages and salaries, and investment and dividend incomes account for only a small percentage of annual income for the average worker.

During retirement, Social Security disbursements are the most common source of income as 81 percent of survey respondents cited SS as a primary income source. Sixty-five percent of those surveyed cited salaries as a main income source, indicating a large percentage of working retirees. Pension and retirement plan distributions and investment income were also among the most common sources of income for retirees.

As for spending during retirement, federal income tax is the highest expense for retirees, with the average person in the survey spending $16,625 annually. A mortgage was second on the list, followed by transportation, food, and then real estate taxes. The retirees surveyed spent more on vacationing than they did on healthcare.

When Lincoln compared the retirees’ anticipated spending to their actual spending, there were several large discrepancies. Actual spending on healthcare ended up being significantly higher than the retirees projected, as did spending on household repairs and expenses.

The transition from a mindset of wealth accumulation to wealth preservation is an adjustment. Since we spend our lives continually earning, living on a set amount is difficult for many and it requires strategic planning. A good plan, in addition to mapping out withdrawals and an exact budget, provides a cushion for the adjustment period, anticipating and allowing for a few mistakes along the way.

30 Common Obstacles to Estate Planning

hourglass• It’s too expensive
• My attorney takes care of that
• Planners just want to sell me something
• Too complicated
• It may jeopardize my own financial security
• My children want me to spend it all
• Leaving too much to my children can make them unmotivated
• My children are financially successful already
• My children are financially irresponsible
• I started with nothing
• I don’t like to think about dying
• I’m uncomfortable talking with my children about it
• I don’t want my heirs to know how much I have
• I’m uncomfortable giving my estate away; I might need it later
• All my assets are in a living trust
• All of my property is joint-and-survivor anyway
• Most of my estate is concentrated in one asset (like an IRA or business)
• I’m in a second marriage
• The new tax law eliminates the estate tax anyway
• I bought life insurance to pay the estate tax
• I have enough liquid assets to pay the estate tax
• I’ll just give my estate away during my lifetime
• I want my children to enjoy my estate while I’m alive
• My spouse and I can’t agree
• I’ve already heard it all
• I’m patriotic and I don’t mind paying taxes
• I’ll just leave my estate to charity and not pay any tax
• I don’t know how to equalize my estate so that it’s fair
• I don’t know who to listen to

My Comments: I can’t tell you how many people I’ve talked with over the years who recently lost a parent and are totally exasperated and angry about the lack of planning by their parents. And many of the parents followed the mindless stupidity evidenced by many of those comments above. It’s one thing to be ignorant and uninformed, but another to be stubborn and stupid. It leaves hard feelings that simply need not be there.

Essential Legal and Financial Documents to Have

My Comments: This article appeared as An emergency checklist for advisors and clients: essential legal and financial documents. It caught my eye since lists are always useful when it comes to writing a blog post that someone might read. After all, I read this one.

More than that, however, is the fact that getting older is a difficult process. It’s easy to be in denial and pretend our days are not increasingly numbered. And having clients who adamantly refuse to plan properly is a pain in the backside, especially for those family members left behind to figure out the mess.

So I encourage you to read this. If you need help, call me or call your attorney. If you need help finding someone who will focus on you, and you alone, I can give you some names.

by Ike Devji, JD on July 24, 2014

Finding key documents can be trying and laborious under the best circumstances, even with plenty of notice, like at tax time every year. Finding them under stress — or worse, having to have someone else sort through the entirety of the paperwork you have hoarded after an emergency, death or other crisis — is often impossible. This is the list of the most essential legal and financial paperwork that you should be able to lay hands on or instruct others to easily find.

Passports: Make sure they are current and useable. If your kid is off on a summer abroad and gets hurt, it will certainly be the wrong time to discover that your passport is expired (true story) and that you have to wait for the government to reopen and for your passport to be processed.

Copies of other identification:
Driver’s license, Social Security card or other legal forms of ID, including birth certificates, are often required to obtain other documents.

Insurance policies: Life, property, liability and health are four most basic key areas. I’d hate to go on what Allstate (or any carrier) felt like paying me on my homeowner’s policy on good faith alone if my home was damaged or lost in a flood or hurricane. Having a copy of these actual policies is key in demanding service, coverage, and in enforcing the actual contract if required. Similarly, health insurance cards are often kept in places that can be lost or stolen, like wallets and purses — if you’ve ever sat in an emergency room and seen who gets treated first and how well, you’ll get this.

Essential corporate and business documents, including bank statements: If you have corporate documents that control chain of command, ownership, title, account balances and succession, you better know where they are. I am continually amazed at how many doctors don’t have copies of their corporate documents, adding stress, delay and expense when those documents are needed, as in a lawsuit between partners in a medical practice. In that case, you may be stuck with copies that may or may not be accurate.

Mortgages and deeds: These are perhaps the most overlooked, lost and disrespected documents we come across — odd, since it is the single largest asset of many doctors.

Medical records and prescriptions:
This is the most subjective, but if you or a family member have a complex medical history or require prescription drugs to function at a basic level, having copies of the prescriptions at issue is essential, especially during emergencies.

Estate plan: We assume you have one, whether a basic will or a more sophisticated series of trust of various types and that you’ve updated it and you have avoided common mistakes. It does no good if we can’t find it and don’t know who’s in charge.

How and where should they be stored?

The conventional wisdom, and likely the safest bet, is that these documents should be stored at the bank in a safety deposit box. That said, it may be impractical or subject you to delays based on their hours and a variety of other conditions including the substantial limits on access by third-party agents you may want to have possession. Would the person you send be able to get into the box, including your own children?

Home and office storage

Invest in a safe that is both waterproof and fire-rated to withstand most common house fires. “Too big” or “too expensive” is not a valid excuse for almost anyone reading this. Costco, as one example, has large fire-rated safes that will hold guns, laptops, jewelry and documents for as little as $600, and small, entry-level safes are a fraction of that cost.

Consider which documents are sufficient if you have a copy, like an insurance policy, and which require originals, like a passport. Consider keeping the original paperwork for which copies are an acceptable substitute in the bank and the reproduced copies at home. The most prepared also have copies of documents they actually keep on hand at home (like passports) saved somewhere else, as most of us don’t have those details recorded or memorized. Do you know your passport number by heart?

All my personal clients from this month forward will receive electronic copies of their documents, instructions, filings and signature pages on an encrypted “key drive” to help in this process. That drive also allows other documents to be added to it and is encrypted to a high security level. Don’t make electronic copies the primary source; it limits you to times when you have power and computer/internet access, a significant variable for folks in a natural disaster, as one example.

Obamacare Helps Add Life to Medicare as Shortfall Delayed

healthcare reformMy Comments: I’ve argued vigorously over these past few years in favor of the PPACA, what all of us know as ObamaCare. Without it we would be at the mercy of the drug industry, hospitals and the insurance industry. Of the five primary stakeholders in the health care debate, any two of those three could have the necessary leverage to reverse the rising tide of cost increases we had been living with for decades or they could sustain it.

That the rising tide is still visible is not a surprise. If our elected leaders in Congress had spent the last few years working to improve the PPACA instead of blindly working to repeal it, the cost savings might already be apparent. Sooner or later is will be obvious. Just look at Kentucky as an example.

As for the drug companies, hospitals and insurance companies, in my mind its doubtful their solution would be in our best interest as citizens and patients. Most likely their solution would be one that serves the best interest of those industries. That’s how free enterprise works. So what happened is we, as one of the five stakeholders, stepped up and said it’s time to stop the rising tide and this is how it will be done.

As all of us know, it hasn’t happened smoothly or without adverse consequences. It’s going to take years for the hiccups to stop. It may never be a smooth running idea, if for no other reason than world economics and demographic forces will intervene along the way. But it’s better than the social chaos that would happen if the health care delivery system in this country collapsed of its’ own weight or became “owned” by the above mentioned industries.

This article suggests at least one measure of good news has surfaced in support of the overall goal. Some of our dilemma is driven by the need to introduce legislation where benefits will be seen long after the current leaders are dead and buried. That goes in the face of decision making that wants immediate results to encourage and justify being re-electied to office.

By Bloomberg News Service / July 28, 2014

The main trust fund behind Medicare, the $583 billion U.S. health program for the elderly and disabled, will be exhausted in 2030, four years later than projected last year, the government reported.

An improving economy and the health-care overhaul known as Obamacare may stave off depletion of the fund as it took in more money and spent less than expected last year. The trust fund pays for hospital visits, nursing care and related services for Medicare’s 52 million beneficiaries. Its assets fell $7.1 billion in 2013 to $281 billion, less than one-third the reduction of a year earlier, according to a report released today by the program’s trustees.

Medicare’s finances are a flash-point in health-policy debates between Republicans, who have proposed converting the program into private insurance subsidized by the U.S., and President Barack Obama. Unusually slow growth in the program’s spending, payment cuts under the Patient Protection and Affordable Care Act, known as Obamacare, and debt-reduction legislation have extended the life of the fund, called Part A.

“Medicare is considerably stronger than it was just four years ago,” Sylvia Mathews Burwell, secretary of the Department of Health and Human Services and a trustee for the program, said today at a news conference. “Cost growth is down. The quality of the care our parents and grandparents are receiving is improving.”

Spending Unchanged
Medicare spending per beneficiary, including outpatient services and prescription drugs that are paid for from separate trust funds that can’t be exhausted, was unchanged from 2012 to 2013. Spending per beneficiary under Part A — for hospital care and related services — fell for the second year in a row.

Growth in Medicare Advantage plans, offered by private insurers including Humana Inc. (HUM) and UnitedHealth Group Inc., accelerated. About 1.3 million people joined the plans in 2013, raising enrollment to 14.8 million, or 28 percent of all Medicare beneficiaries. About a third of Medicare beneficiaries are projected to be in the private plans by 2023.

Medicare’s actuaries, who compile the report, said that fewer people than they expected sought hospital care in 2013 and that those patients used less expensive services when they did. It remains unclear whether that is due to economic pressure on patients or to changing practices by doctors and hospitals, who have been encouraged under the Affordable Care Act to better coordinate their care and avoid unnecessary readmissions to the hospital.

Cost Questions
“The jury’s yet out as to whether we can really count on the pace of cost growth being reduced,” Doug Holtz-Eakin, president of the American Action Forum, an advocacy group that has opposed Obamacare, and a former head of the Congressional Budget Office, said in a phone interview. “My concern is this will take pressure off the Congress and the administration to deal with the real problem and we run the risk of a very bad surprise down the road.”

Social Security’s trust funds, used to make disability and retirement payments, will be exhausted in 2033, the same projection as last year, a second report said.

The program’s trustees, who include the secretaries of the Treasury and Labor departments in addition to Burwell, said payment reductions and productivity improvements under the Affordable Care Act can be sustained.

“The trustees are hopeful that U.S. health-care practices are in the process of becoming more efficient as providers anticipate a future in which the rapid cost growth rates of previous decades, in both the public and private sectors, do not return,” they said in the annual report.

Repeal Scenarios
Medicare spending would grow much faster if provisions of the Affordable Care Act that control cost growth were repealed, the trustees said. Under one “illustrative scenario” that included repeals of several provisions of the law, Medicare spending would consume more than 8 percent of gross domestic product by 2080, compared with just more than 6 percent under current law.

Obama has sought to keep the current structure of Medicare largely intact and allow changes wrought by his health-care law to take effect. In April, the Congressional Budget Office said the program would cost $1,000 less per patient than it had projected in 2010, the year the law was passed. Republicans have also lobbied to raise Medicare’s eligibility age to 67, a proposal Obama hasn’t ruled out as part of a larger budget deal that would include tax increases. Republicans have rejected any budget agreement increasing taxes.

“The president is ready to work with Congress on enacting responsible reforms, and he is prepared to make tough choices,” Treasury Secretary Jacob Lew said at the news conference. “The president will not support any proposal that hurts Americans who depend on these programs today and he will not support any proposal that slashes benefits for future retirees.”

10-Year Investing Forecast: Takeaways for Advisors & Clients

investmentsMy Comments: When you look back ten years from now and wonder if this article came anywhere close to reality, you must remember that people are much happier with you if you estimate low returns and reality turns out to be high, rather than the other way around.

The charts are hard to understand, at least they are for me. The short takeaway for us is that what happened in 2008-09 was not within the 5% chance of happening. A meltdown like we had only happens once every 40 – 60 years. Another takeaway is the expected annual return for stocks from the people referenced. The high number is less than 6% annually. If they are right, then it behooves you to find advisors who give you at least a chance to make money in the inevitable down markets. Because the upmarkets are going to be relatively pathetic.

by Allan S. Roth / AUG 4, 2014

We all want to know how stocks and bonds will perform next year and beyond. Unfortunately, forecasts typically give very tight ranges of returns — and often merely predict the past. That may partly explain why investors continue the pattern of buying high and selling low.

The Vanguard Capital Markets Model, which forecasts both returns and risks over the next 10 years, takes a more useful approach. Your clients might prefer to have more precise forecasts, but uncertainty is a reality.

This forecast may help you both design a better portfolio and explain its rationale to your clients. I spoke with Roger Aliaga-Diaz, a principal and senior economist in Vanguard’s Investment Strategy Group, about the model and its implications for investors.

The Vanguard Capital Markets Model’s estimated returns are based on 10,000 simulations. This Monte Carlo analysis runs not only variations of returns but also ranges of risk (standard deviation) and correlations among asset classes.

The “Range of Returns” and “Asset Class Correlations” tables below shows the forecast returns and ranges and the historical correlations.
2014-08-13 Portfolio_roth_8_14
Portfolio_roth_8_14_2

EQUITY EXPECTATIONS

The first takeaway: Across the board, equities are expected to far outpace inflation, which is estimated at 2% annually. As the midpoint in the range of expectations, U.S. stocks are estimated to return 7.7% annually, while international stocks will yield 8.5%.

International stocks were seen as likely to outperform U.S. stocks for a few reasons, says Aliaga-Diaz: International valuations are more attractive and investors are compensated for taking on more risk. The annual standard deviation for international stocks was 20.9%, he points out, compared with 17.6% for U.S. stocks.

Within the bracket of outcomes that Vanguard believes have a 90% probability of occurring, U.S. stocks are shown as returning between a loss of 2% annually and a gain of a whopping 17.7%.

International stocks, by contrast, are seen as returning anywhere from a loss of 3.3% to a 21.1% annualized gain. To put this in perspective: In 10 years, a $1 million investment in U.S. stocks could be worth anywhere from $820,000 to $5.1 million. And the same investment in international stocks could be worth anywhere from $710,000 to $6.8 million.

Not only is that range of returns incredibly large — and only somewhat helpful from a planning perspective — but Vanguard says there is a 10% probability that the actual return will land outside of these ranges. And the downside risk is even worse after you factor in inflation.

The bottom line, of course, is that equity investing is risky — any forecast asserting otherwise would be claiming to have precise (and, needless to say, impossible) foreknowledge of economies, geopolitical events and investor sentiment. Nonetheless, equities offer the best expectation for high future returns.

Clients should also understand the impact of expenses and emotions on these returns. Aliaga-Diaz notes that the projections are geometric asset class returns and don’t include costs, and that even the lowest-cost index funds have some fees. And clients need to stay the course. Even with the least-costly index funds, investors’ returns underperform fund returns — an indication that investors time the market poorly.

FIXED-INCOME INVESTMENTS
Bonds, of course, have lower expected returns with less risk. Vanguard predicts the aggregate bond index of investment-grade bonds will return 2.5% annually — just half a percentage point more than inflation.

The range is much tighter than for stocks, with the 90% confidence interval showing returns ranging between 1.2% and 3.9% annually. Translated again, this suggests that a $1 million investment would be worth anywhere between $1.13 million and $1.47 million after a decade.

Note that these returns are far below those of the last decade, when declining rates were good for bonds. The narrow range of returns for bonds illustrates the role of high-quality bonds; they are more a store of money than a growth vehicle. Hedged international bonds offer similar expected returns and volatility.

Both of these bond classes have little credit risk; increasing credit risk increases correlation with stocks. For example, according to Morningstar, the average bond mutual fund — which is more likely to include bonds of lower credit quality — lost 8% in 2008 while Vanguard’s Total Bond ETF (BND), which follows the Barclays Capital Aggregate Bond Index, gained about 5.1%.

One more note on the inflation forecast: While 2% doesn’t sound unusual, extrapolating the downside shows about a 15% probability of sustained deflation over the next decade. Should that occur, the resulting scenario would be bad for stocks and great for longer-term U.S. government bonds.

CONSTRUCTING A PORTFOLIO
What matters most for clients, of course, are real (after inflation) returns. But to model the impact of inflation, we can’t just deduct two percentage points — because inflation impacts the returns of the asset classes.

The Vanguard model — run for a combination of U.S. and domestic equities, with various maturities of Treasuries and corporate fixed-income securities — looks at various weightings, from conservative to aggressive. The “Portfolio Implications: Real Returns” chart above shows the results.

Because high-quality bonds and equities have low correlation to each other, you’ll note the combined portfolios have less downside than the simple average of stocks and bonds.

The good news is that even a conservative portfolio of only 20% equities is forecast to outpace inflation by 1.7 percentage points annually. And it can still deliver a handsome return if results are high in the range of possible outcomes.

The takeaway here is that clients who have met their goals and have little need to take risk — even those who say they have a high risk tolerance — should consider a high concentration of high-quality bonds. (Think back to March 2009 and ask yourself if clients’ appetite for risk was in fact constant.)

A moderate portfolio of 60% equities is projected to outpace inflation by 4.2 percentage points annually. An aggressive portfolio of 80% stocks does deliver an expected return of 5.4% annually, while the downside is only an extra annualized 0.7 percentage point loss relative to the moderate portfolio.

While this might argue for taking on more risk, few aggressive investors want to stay the course when markets melt down. By my calculations, that portfolio declined by about 31% in 2008; that’s more than two standard deviations away from the mean and should happen only once every 40 years.

HOW MUCH RISK?

Just looking at the numbers, one could conclude that the 80% equity portfolio isn’t that much riskier than the 20% equity portfolio. In real terms, the outcome at the bottom fifth percentile for the 80% equity portfolio loses about 31% of spending power, while the fifth-percentile result for the 20% equity portfolio loses about 22%.

But don’t forget that a fifth-percentile outcome doesn’t measure the so-called black swan event that many said happened in 2008.

What this means for your clients is certainly open for interpretation. This is perhaps the most comprehensive economic model I have reviewed, but even so, it is important to remember that this is only one model.

Vanguard predicts a most likely case of a 5.7% real annual returns for stocks, but other experts are more cautious. In his new book, Rational Expectations, William J. Bernstein predicts a 2% real return for large-cap stocks and 3% for small-cap stocks over the next decade. Rob Arnott, chairman of Research Affiliates, forecasts a 3% real return over the next decade.

My opinion is that the future is even more uncertain than the ranges shown in the Vanguard model — especially on the downside. And as I see it, the world is a less predictable place than ever before.

Allan S. Roth, a Financial Planning contributing writer, is founder of the planning firm Wealth Logic in Colorado Springs, Colo. He also writes for CBS MoneyWatch.com and has taught investing at three universities. Follow him on Twitter at @dull_investing.