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y mary minor davis Offsetting the Traditional “Four Percent Rule” Mike Philbrick, CIM®, AIFP®, Senior Vice President and Portfolio Manager To ensure that financial planning truly addresses today’s retirement needs, some wealth managers are rethinking the traditional “4 percent rule” in favor of greater portfolio diversification to address how they can prepare for their clients’ longterm needs, given today’s challenging market conditions. Mike Philbrick, CIM®, AIFP®, is a Senior Vice President and Portfolio Manager at Butler, Philbrick, Gordillo & Associates Group, an affiliate within Dundee Goodman’s Private Wealth division. He shared some thoughts with The Suit Magazine on his team’s approach to managing the contemporary retirement conundrum. The 4 percent rule was devised in the 1990s by California financial planner William Bengen and later refined by other retirement-planning academics. Bengen analyzed historical returns of stocks and bonds, and found that portfolios with 60 percent of their holdings in large-company stocks and 40 percent in intermediate-term U.S. bonds could sustain withdrawal rates starting at 4.15 percent, adjusted each year for inflation, for every 30-year span going back to 1926. However, Philbrick, in quoting from a recent article published by Wayde Pfau, a professor of retirement income at the American College for Financial Services, said there is strong evidence that the rule no longer applies in today’s market conditions. For example, people with portfolios expecting to draw 4 percent in retirement forever with a high level of confidence – without regard for market regime – haven’t factored in that long-term rates are yielding historical low returns of between 2 1/2 to 3 percent. At the same time, the US stock market is near alltime high levels of valuation. . “When these two factors co-exist, a financial plan that’s based on the well-accepted 4 percent rule has about a 57 percent failure rate,” Philbrick quoted from Pfau’s analysis. “What this means is, that if people are planning retirement using traditional portfolio management techniques, they may be go THE SUIT MAGAZINE - NOV 2014
ing into the current situation thinking that they have a high degree of certainty, when the fact is, they don’t,” Philbrick added. “Traditional portfolio management techniques are based on flawed assumptions and behavioral traps that invalidate widely used planning tools, and the lessons from Wade’s article highlight one example of how this can put retirement dreams in jeopardy,” he concluded. It is precisely this type of research and hard evidence tracking that, according to Philbrick, is what sets his team apart for clients, who range from non-pensioned professionals needing an income stream to maintain an accustomed lifestyle, to more sophisticated wealthy families looking for asymmetric returns, as well as small- to mid-sized endowment funds. The firm also works with advisors who rely on their expertise. Basing their assumptions on evidence as opposed to theory, as well as systematic investment programs and proprietary retirement planning techniques adopted from the pension industry, Philbrick said, “We tell clients the truth even if it’s hard to hear. I think this allows clients to build thoughtful plans based on solid foundations. This is one of the key advantages we have as both a group and a firm.” Gestalt Architecture is a process designed by Philbrick’s team to avoid behavioral traps that people fall into when it comes to long-term financial planning. The approach has four legs, including a long-term investment policy informed by true fiduciary standards; a disciplined investment process for delivering strong, stable returns in most markets; use of advanced retirement technology; and providing strong customer service that includes regular contact, transparency and ongoing education. “The key to achieving Gestalt success is diversification,” Philbrick explained. While there was a subtle shift away from the traditional goal of achieving returns higher than the index after the 2008 Global Financial Crisis, as the S&P has soared higher, investors have re-embraced their traditional performance chasing roots. As strong returns have boosted confidence in stocks, these same investors have move to ever more concentrated equity allocations. Apparently investors have short memories about how this story always ends. Quoting Peter Bernstein, Philbrick “Diversification is an explicit recognition of our ignorance.’ We don’t know what’s going to happen. You should own a number of different assets. Having many stocks, even from different countries, doesn’t diversify you,” he added. “Having a portfolio that includes stocks and real estate, US Treasuries, gold, commodities – that will get you a lot closer.” said, Philbrick said that despite the market volatility over the last 15 years, he is surprised to see people are still selecting managers based on recent performance. He noted that selecting managers on the basis of performance over the past 3 to 5 years is “ a near-perfect recipe for substantial longterm under-performance,” He suggested that active management is almost entirely explained by three factors: seeking value, seeking momentum and lowering volatility. “An advisor should be able to explain how he or she is leveraging these factors.” These are the realities that Philbrick and his team seek to bring to their clients when looking at long-term retirement. He said the most important concept in wealth management is that risk is measured as the probability that clients won’t meet their financial goals. Investing should have the exclusive objective of minimizing that risk. “Most prospective clients that we meet with don’t understand the sequence of return risk,” he said. “The five years right before retirement and the five years after retirement – how you do in that 10-year period is a strong indicator of how you will do over your entire retirement. It’s volatility risk that threatens their portfolios, and thus their long-term financial outcomes. For many people, it’s better to get 7% in a lower volatility portfolio than 9% in a higher volatility portfolio when you start to make withdrawals.” Philbrick added that this lack of understanding can undermine clients’ long-term goals. Once you educate investors on the types of issues that they should focus on, it's easier to help them recognize and address those risks along the way. “We take the management of risk very, very seriously.” 1 Adelaide Street East Suite 2100 Toronto, ON M5C 2V9 Telephone: 416.350.3388 www.dundeegoodmanprivatewealth.com BUTLER | PHILBRICK | GORDILLO & ASSOCIATES THE SUIT MAGAZINE p.55
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