The New World Of Portfolio Management For Retirees

By Kendall J. Anderson, CFA :

One of the greatest strengths of American capitalism is how it addresses the problems faced by its citizens. The greater the problem, and the more lives impacted by the problem, the more entrepreneurs, academics and government officials there are seeking solutions. As it is, government tends to attack problems with laws and regulations that they hope will then steer profit seeking entrepreneurs to find a solution benefiting all of society. In the world of investment management, these profit seeking entrepreneurs rely heavily on the work of academic researchers to isolate a process that can then be manufactured into a product and monetized.

Of the many problems facing our citizens today, the needs of aging baby boomers should be considered a priority. I do not say this because I happen to be one of those boomers, but because of the economic burden placed on their children and grandchildren in covering health care, Social Security, and the day to day living needs of this massive group of individuals. This burden will continue to grow year by year at the rate of 10,000 per day for at least the next ten years.

Of course a simple solution would be to let the boomers fend for themselves, and be responsible for all the costs of their own lives, as is done in the majority of the world. Obviously that solution would not sit very well with the boomers themselves, nor would it sit well with the majority of the population. However, the more that boomers fend for themselves, the better off all of society will be. This has been the driving force of academic research and product manufacturing for today's retirees, most of which has revolved around sustainable lifetime income or products offering to pay a higher yield than easily available to the public. These products have led to government regulations placing limits on the aggressive salesforce of broker dealers and insurance companies who are, at least in the current DOL's opinion, skimming too much off the top for themselves. Their solution, which takes effect on April 10th, is to minimize conflicts of interest through disclosure and assumption of liability for the distributors of retirement products.

My concern goes well beyond that of regulation. My concern has to do with the lack of portfolio management skills of those financial advisors who the current and future retirees rely upon. The majority of these advisors have lived in an isolated world of product distribution whose portfolio management skills revolved around a suitability standard. My concern has to do with the current academic research that is attempting to find certainty where no certainty exists. My concern has to do with a government that believes all that is needed to improve portfolio management skills can be accomplished by filling out a bunch of paperwork that protects the distributors more than current and future retirees.

I am afraid that these new rules will have little impact in the short run on solving the long-term problems facing retirees and their children. Over time, as the courts interpret and apply the rules of fiduciary standards under the DOL regulations, the financial industry will evolve and produce a better outcome. Until that time, I thought I might help by sharing an article with you written in 1979, towards the end of the last bear market in bonds. There are very few of us in finance today, including academics, government employees and financial advisors, who were actively working with individual investors to build and manage portfolios 38 years ago. Given that we are near, if not already at the end of, the great bull market in fixed income investments, revisiting 1979 may help each of us as we make decisions about our own portfolios.

The article was penned by John Train, one of my favorite authors. His book, The Money Masters, published in 1980, is still on my shelf and is still used for support when I am faced with a difficult decision. The article below, titled "The Trustees' Dilemma," appeared in the July 9th, 1979 edition of Forbes Magazine. With a lot of charm, Mr. Train shares a story of one woman, her family, and the difficulty of applying proper fiduciary management to her trust account. He ends the piece with a call for help from other professionals, as "it's a problem that requires airing."

The Trustees' Dilemma

John Train

A widow was left a substantial amount of money by her husband when he died. The income went to her for life, with the capital to be divided among their three children after her death.Her late husband had been a successful New York businessman, and the family had two large houses: one in Greenwich, Conn. and one on Cape Cod, where they went in summer. The children liked coming to the Greenwich place on the weekends and spending long periods on Cape Cod in summer, so she kept both. As a result, the widow found herself living at the limit of her resources.At her annual meetings with her trustees, the problem was aired frankly. How could she maintain the houses and keep up roughly the same standard of living as before, with her husband's considerable salary no longer available? Each year it was decided to sell some growth stocks with low yields and move into bonds or high-yielding equities to maintain the needed income, and hope that all would end well.So the trust portfolio eventually became roughly half fixed-income securities and half high- dividend stocks , notably utilities and the like.Unfortunately, however, the investment objective was impossible on its face. At a time when costs are rising 10% a year, income has to rise 12% to 15%, as the tax bracket rises, in order to stay even in real terms.Now, very few income stocks increase their dividends at anything like 15% a year; and, of course, bond payments don't increase at all.After some ten years of princely existence, the widow's buying power in real terms was about 40% of what it had been just after her husband died. The old trustees, friends of her husband, stepped down, and new ones with a more austere and realistic attitude came in. They were dismayed at what they saw. She had to sell both her houses and move into a smaller one, where it was a strain to have any of her children for weekends, since they now had families of their own and come in groups of four or five.She has many years of life ahead of her, which she will spend in straitened circumstances. If she had cut back right away and adopted a realistic investment policy, she could have been comfortable for her lifetime.Furthermore, in the future, when the grandchildren come into the inheritance, they will have a justifiable complaint against the old trustees, if they're still around. They can't make out a case at law, but it seems to me that they can certainly make one in common sense and morality. By investing flat out for income at a time of hyperinflation, the trustees knowingly dissipated the corpus of the testator's estate, and thus did violence to his stated wishes and gypped the remaindermen. When the grandchildren ask what happened to their inheritance, their elders will have to explain that it was essentially blown on high living. In fact, the widow herself also has a valid complaint. The original trustees, old business friends of her husband, were paid to give her the benefit of their realism and experience. Why didn't they look ahead and set her on a sustainable course?This quandary afflicts most trustees of generation-skipping trusts today. I observe that many trusts are now invested about half in equities and half in fixed-income instruments, with the income beneficiary consuming the distributions from both sections of the trust.However, in real terms, the bond income these days is simply a return of capital: The buying power of the bond is declining at much the same rate the interest is being paid out (faster, for municipals).The

When my children were young students I let them know that it was easy to obtain A's in school. All that was necessary was to find out what their teacher wanted and give it to them. If all you want is an A, don't waste your time studying anything beyond what the teacher wants. Don't think, don't question, and don't learn; just do what your teacher wants. Of course they knew from the tone of my voice that I would be completely disappointed in them if they wasted their education on obtaining A's this way.

The suitability standard practiced by the vast majority of financial advisors is similar. Advisors obtain their A's by giving the client what they want today, without thinking and without questioning. When John Train discusses the original trustees' investment approach he says, "They can't make out a case at law." He means that if an advisor adheres to the law, meaning gives the client what is suitable for her needs, an advisor or agent will not be reprimanded. But the rest of his sentence shows us that a fiduciary should go beyond the legal limits: "…but it seems to me that they can certainly make one in common sense and morality."

None of us know how the future will unfold. It is because of this fact that a primary duty of all fiduciary advisors should be to construct a portfolio that helps with the needs of clients today, but allows for enough change to meet the needs of clients tomorrow, no matter what they are.

For today, that means to remember that inflation over the past twelve months was 2.1%. For a taxpayer in the 28% tax bracket, the minimum earnings needed to maintain buying power in the short run is 2.92% before any spending takes place. It seems to me that investing in bonds, or for that matter buying an income annuity whose payment is fixed and based on today's rates of interest, will have the same effect on the long-term welfare of retirees as John Train's widow experienced fifty years ago.

Mr. Train ended, "I would appreciate comments from professional trustees on this issue. It's a problem that requires airing." So would I.


Anderson Griggs & Company, Inc., doing business as Anderson Griggs Investments, is a registered investment adviser. Anderson Griggs only conducts business in states and locations where it is properly registered or meets state requirement for advisors. This commentary is for informational purposes only and is not an offer of investment advice. We will only render advice after we deliver our Form ADV Part 2 to a client in an authorized jurisdiction and receive a properly executed Investment Supervisory Services Agreement. Any reference to performance is historical in nature and no assumption about future performance should be made based on the past performance of any Anderson Griggs' Investment Objectives, individual account, individual security or index. Upon request, Anderson Griggs Investments will provide to you a list of all trade recommendations made by us for the immediately preceding 12 months. The authors of publications are expressing general opinions and commentary. They are not attempting to provide legal, accounting, or specific advice to any individual concerning their personal situation. Anderson Griggs Investments' office is located at 113 E. Main St., Suite 310, Rock Hill, SC 29730. The local phone number is 803-324-5044 and nationally can be reached via its toll-free number 800-254-0874.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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