Your Wealth & Life - UBS this edition of Your Wealth & Life, we take an in-depth look at the status...

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Personal strategies for wealth managementCIO Wealth Management Research

2016 Retirement guide

Your Wealth & Life

2 November 2015 Your Wealth & Life

Contents01 Editorial

03 80 is the new 60: Investor perspectives on retirement

04 Review of 2015

05 Was 2015 a sequence risk year?

06 Expectations for 2016 and beyond

08 Interview: David McWilliams interviews Brian Doherty

1 1 Safe withdrawal rates for 2016

12 Checking in with the 2005 and 2010 retirees

13 Is inflation really 0%?

14 Spotlight: Succeeding in retirement with Goals-Based Wealth Management

16 The Fed and your balance sheet

17 The health of your plan depends on your health

18 Redefining risk

19 In summary

21 Disclaimer

22 Publication details

This report has been prepared by UBS Financial Services Inc. (“UBS FS”). Please see important disclaimers and disclosures at the end of this report.This report was published on 16 November 2015.

Michael Crook discusses this edtion of Your Wealth & Life in a short video. Click the photo to watch.

http://www.ubspodcast.ch/us/wmr/podcast/en/topofthemorning/151113-YWL_Michael_Crook_Nov_2015.mp4

Your Wealth & Life November 2015 1

Dear readers,As we head into 2016, many investors who are approaching retirement or recently retired have expressed concern about the market environment and apprehension about what the next year has to offer. In fact, in stark contrast with this time last year, our quarterly investor survey indicates that more investors are now pessimistic rather than opti-mistic about the current economic outlook.

Such concern is justified, as there is perhaps no period that carries as much financial risk and uncer-tainty as the years around retirement. A bad start can impact income and net worth for decades.

In this edition of Your Wealth & Life, we take an in-depth look at the status of retirement in 2016. Successfully navigating retirement requires a total wealth approach that considers the full set of options available to achieve goals and objectives. We hope the analysis and strategies presented here will help you clearly develop your retirement plan and feel more comfortable that you will achieve it.

Michael Crook, CAIA

Mike Ryan, CFA

Mike Ryan, CFAChief Investment Strategist, WMA

Regional CIO, Wealth Management US

Michael Crook, CAIA, CRPCHead of Portfolio & Planning Research

CIO, Wealth Management US



How does the current environment impact your retirement?

The last 12 months produced lackluster portfolio returns, but recent retirees don’t need to

be worried about sequence risk right now. Unfortunately, they do have to confront the likeli-

hood of positive but low returns for the foreseeable future.

4 Review of 2015

5 Was 2015 a sequence risk year?

6 Expectations for 2016 and beyond

Spending and inflation in today’s environment

The Bipartisan Budget Act of 2015 eliminated a valuable claiming strategy from Social Secu-

rity. Broad-market measures of inflation also appear to systematically underestimate cost-of-

living increases for retirees.

8 Special interview with Brian Doherty on the recent legislative

changes to Social Security claiming strategies

11 Safe withdrawal rates for 2016

12 Checking in with the 2005 and 2010 retirees

13 Is inflation really 0%?

Retirement planning strategies for you to consider

Shifting to a goals-based approach and reconsidering the definition of risk in retirement can

improve your retirement experience. Tactically, retirees have an opportunity to revisit their

liabilities before the Fed begins to normalize interest rate policy in earnest. Finally, uninsured

healthcare and long-term care expenses can derail a financial plan if they are not properly

addressed.

14 Spotlight: Succeeding in retirement with Goals-Based Wealth Management

16 The Fed and your balance sheet

17 The health of your plan depends on your health

18 Redefining risk

On the following pages, we will walk you through a range of issues related to retirement strategy. Feel free to select the individual topics of greatest interest to you from the list below, or read the report in its entirety to gain an in-depth look at all relevant retirement topics.


Source: UBS

My time (70s)

Transition (60s) The last waltz (80+)

Downsize home

Cash flow/income stream

Healthcare/Long-term care

Estate planning

Maintain lifestyle

0 25 50 75 100

Fig. 1: Investors report different goals and objectivesdepending on the retirement phase

Retirement phase by age group, in %

Pull quote box

80 is the new 60: Investor perspectives on retirement

What do investors think about retire-ment? UBS Wealth Management Ameri-cas investigated this question in our quarterly investor survey, Investor Watch, and found that the very definition of retirement has changed.1 For instance, the survey indicated that investors now think about retirement in multiple phases – each with unique goals and objectives (see Fig. 1). The first phase, which our Client Strategy Office titled “transition,” reflects a period of work-ing reduced hours, switching careers, or devoting significant time to philan-thropic efforts. The second phase, “my time,” is characterized by a complete exit from the workforce and a desire for increased travel and leisure. Finally, “the last waltz” is a third phase of slowing down and reflecting, but is also defined by increased health concerns. This phase is typically associated with one’s 80s and 90s. Financial needs will change over each of these phases, but planning for each has to start before retirement.

The survey also identified a possible blind spot around perceived income needs in retirement. Through each of the three retirement phases, respondents reported that they expect to need a percentage of pre-retirement income that is lower than the industry rules of thumb. High-net-worth and ultra-high-net-worth investors tend to save a larger portion of their income pre-retirement than the general population so it is conceivable that industry guidelines might overstate their income replacement needs, but the reported figures (roughly 55-65% of

pre-retirement income) appear quite low. An in-depth goals-discovery process can add a lot of clarity around determining actual needs.

Finally, the survey reveals that many pre-retirees find themselves preparing for their own retirement while still providing financial support and guidance to their own parents and adult children. This “sandwich” nature of the pre-retirement period increases complexity even further, as these issues impact everything from housing choices to spending needs.

Whether or not these survey findings reflect your specific thoughts around retirement, one conclusion is clear: Retire-ment is a complex stage of life filled with both opportunity and risk. The research, analysis, and conclusions presented in the following pages are designed to help you plan for and navigate retirement with that challenge in mind.




Absent a blockbuster November and December, 2015 will likely be forget-table from a market perspective. Most major asset classes are in slightly positive or slightly negative territory for the year, but some – mainly emerging markets and commodity-focused areas of the market – have significant losses (see Fig. 2).

Market volatility was also periodically higher over the course of 2015 than the relatively low post-crisis levels many investors became accustomed to over the last five years (see Fig. 3). That being said (and despite perceptions to the con-trary), volatility has not been unusually high over the last 12 months. Addition-ally, stock/bond correlations remained negative – indicating that diversification is alive and well. All of these factors have added up to disappointing returns and a choppy ride. Through 31 October, most globally diversified portfolios are roughly flat for the year.

Source: Bloomberg, UBS, as of 30 October 2015

0–5–10–15–20 5

Fig. 2: Emerging market and commodity-focused areas of the market have significant lossesTotal return by asset class, in %

Emerging market USD fixed incomeUS large cap equity

US municipalsInternational developed equity

US governmentUS high yield corporate bonds

CashUS investment grade credit

US small cap equityUS mid cap equity

International developed fixed incomeEmerging market local fixed income

Emerging market equitiesCommodities

Source: BAML, Bloomberg, UBS, as of 30 October 2015

VIX Index

40

30

0

10

20

50

2010 2011 2012

Year

2013 2014 2015

Fig. 3: With the exception of a temporary spike in 2015, market volatility was not unusually high over the last 12 months

VIX Index since 2010

Review of 2015Lackluster returns and increased downside capture

More troubling, investment portfolios continue to exhibit reduced upside cap-ture and significantly increased down-side capture when compared to the US equity market. In other words, when investors compare their portfolios to the S&P 500 Index, they see a bit less of the upside on positive days and a lot more of the downside on negative days. This is a trend that started following the financial crisis but shows no signs of abating.

One stark example: pre-crisis, the down-side capture of a conservative portfo-lio averaged 4% between 2002 and September 2008. Since then, it’s been 26%. In other words, prior to 2009, an investor holding a conservative portfo-lio could confidently ignore the nightly stock market report and know that, in general, declines in the US equity market would not have much of an impact on her portfolio. That’s no longer the case.


Sequence risk occurs when negative returns early in retirement represent a significant risk, since the order in which returns are experienced has a major impact on the value of a portfolio (see Fig. 4).2

Was 2015 one of these years? The answer for most investors is a clear and simple no. The impact of one year of flat returns is not sufficient to derail a retirement plan. However, retirees with portfolios that were concentrated in assets that did particularly poorly in 2015 should be diligent in revisit-ing their financial plans. Declines in a port-folio (including spending plus investment losses) of more than 10% early in retire-ment can have a long-term impact on the sustainability of the portfolio, unless a recovery is quickly forthcoming.

In order to quantify this impact, we ran a series of simulations to compare the impact of a flat or down year in the first year of retirement. Assuming a balanced portfolio and roughly a 4% withdrawal in the first year, we found that a 0% return year resulted in approximately a 2% decline in the probability of success, whereas a 10% decline in assets (includ-ing both spending and investment losses) resulted in an 8% decline in the long-term probability of success. Importantly, house-hold-specific considerations will drive these results, so it’s important to update personal financial plans on a routine basis.

Fig. 4: The impact of early negative returns compared to later negative returns on a portfolio can be substantial

Per 100, in USD

Scenario 1 Scenario 2

Year PerformanceWithdrawal

(USD)Value (USD) Performance

Withdrawal(USD)

Value (USD)

0 100 100

1 -10% 4 86 8% 4 104

2 -10% 4 74 8% 4 108

3 0% 4 70 8% 4 112

4 0% 4 66 8% 4 117

5 3% 4 64 8% 4 122

6 3% 4 62 6% 4 125

7 3% 4 60 6% 4 128

8 3% 4 57 6% 4 131

9 3% 4 55 6% 4 135

10 3% 4 52 6% 4 139

11 6% 4 51 3% 4 139

12 6% 4 50 3% 4 139

13 6% 4 49 3% 4 139

14 6% 4 48 3% 4 139

15 6% 4 46 3% 4 139

16 8% 4 46 3% 4 139

17 8% 4 45 0% 4 135

18 8% 4 44 0% 4 131

19 8% 4 43 -10% 4 114

20 8% 4 42 -10% 4 99

Average 3.40% 3.40%

Source: UBS, as of 30 October 2015

Was 2015 a sequence risk year?



One of the main challenges facing retir-ees today is that higher-than-average equity market valuations and lower-than-average bond yields will likely lead to lower-than-normal returns over the next five to ten years.

A good indicator of long-term equity returns is the “cyclically adjusted price-to-earnings ratio,” otherwise known as the CAPE ratio. If this sounds familiar, you might have heard Nobel Prize win-ner Robert Shiller talking about CAPE ratios in the media recently.

The CAPE is a measure of the price investors are paying for a dollar of earn-ings in the equity market. When the CAPE ratio is high, investors are paying more for each dollar of earnings than they expect to receive in return. The result is lower equity market returns. The opposite is true when the CAPE is low: Investors are paying less to buy each dollar of earnings, and future returns tend to be higher. The reason this is important is that the CAPE has moved steadily up since 2009 (see Fig. 5) and now stands at around 25, which has historically been associated with annual returns of about 6%.

The outlook for fixed income is also not very promising. The current low yields imply annual returns (see Fig. 6) of 2-3% in high-quality bond portfolios. Higher yields would be a welcome respite for most retirees, as the longer-term benefit of higher yields far outweighs the cost of short-term losses. We expect long-term bond yields to modestly increase in 2016, but our forecasts in this regard have persistently been too high.

Finally, against this backdrop of lower return expectations, retirees have a related problem to wrestle with: The cost

Expectations for 2016 and beyond

Source: Robert Shiller Online Data, as of 30 October 2015

25

10

15

20

30

Jan 09 Jan 10 Jan 11 Jan 12 Jan 13 Jan 14 Jan 15

Fig. 5: CAPE has steadily increased since 2009

Cyclically adjusted price earnings ratio (CAPE), in USD



of “purchasing” safe income in retire-ment, whether through a bond portfolio or in the form of an annuity, has risen significantly over the last decade (see Fig. 7). Higher bond yields would help miti-gate this hurdle, since $1mn in a bond yielding 5% produces a lot more income than $1mn in a bond yielding 2%, although investors must be prepared for the possibility that the Federal Reserve could normalize short-term interest rates without longer-term rates budging at all. As a rule, retirees should not count on significantly higher fixed income returns in designing financial plans at this time.

Source: Barclays, Bloomberg, UBS, as of 30 October 2015

3-year forward return (annualized)

Barclays aggregate yield-to-worst

17

11

14

–1

2

5

8

20

1976 1982 1988 1994 2000 2006 2012

Fig. 6: Current yields imply annual returns of 2-3%

In %

Source: UBS, as of 30 October 2015

18

12

14

16

20

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Fig. 7: The cost of safe income in retirement increased roughly 27% over the last decade

Cost of retirement spending by year, in USD


David McWilliams: Okay, let’s jump in. Social Security recently announced no increase in the cost of living adjustment. Due to the recent low inflation environment, it seems this feature may be overlooked by retirees. Is COLA an important benefit?

Brian Doherty: COLA is incredibly important and most people do overlook it or don’t give it any consideration when they make their claiming choice. This has been the case, David, for many years, even when COLA increased every year.

The last time they announced that there was no increase, I believe in 2009 and 2010, a lot of recipients of Social Security benefits were very angry. I can almost guarantee you that when they made their claiming decision, they didn’t give COLA one second of thought. Maybe a lot of them didn’t even know it existed or how it worked. But they became big fans of it after they started to receive their benefits for a couple years and saw increases in their monthly Social Security checks. They then came to expect their check to go up every year. In the years when it didn’t, and now there have been three of them in the last 10

David McWilliams, Head of

Wealth Management Trans-

formation at UBS, recently

interviewed Brian Doherty,

President of Social Security

consulting company Filtech LLC

and in partnership with New

York Life MainStay Investments.

Mr. Doherty is a nationally rec-

ognized expert and speaker on

Social Security and the author

of Getting Paid to Wait: Bigger

Social Security Benefits – the

Simple and Easy Way.

Interview

Brian Doherty


Getting paid to wait


years, it angered Social Security benefi-ciaries because for most of them, it’s the only pay raise they’ll receive in their retirement.

I think if they had known how impor-tant COLA was going to be when they claimed their benefits, they may have made a different decision and may have delayed claiming their Social Security benefits, so they could apply that COLA percentage to a much bigger number and receive much bigger dollar increases every year for the rest of their lives.

David: So, Brian, how does a high-net-worth or ultra-high-net-worth fam-ily maximize its Social Security benefit and turn it into something that could be impactful in their balance sheet?

Brian: Great question. I think the high-net-worth and the ultra-high-net-worth individuals are in the best position to maximize their Social Security benefits. You can claim them as early as age 62 or wait until age 70, but if you claim at 62, which is currently the most popular age to claim, you lock into the small-est benefit you can receive every year for the rest of your life. If you wait until age 70 to claim, you lock into the high-est benefit you can receive every year for the rest of your life. In fact, the benefit at age 70 is 76% bigger than the benefit you’d receive if you claimed at age 62 (see Fig. 8). Most of the experts that look at this will tell you that people should delay as long as they can, ideally until age 70. But unfortunately, David, very few people

actually do that. Basically, they just don’t want to wait that long. They don’t think it pays to wait.

I think the high-net-worth individual is in the best position to delay claim-ing their benefits because if they need income while delaying, they can access their accumulated assets to generate the income they need to do what I call “bridging the gap” between age 62 and 70. When they do that, they position themselves to have a much more finan-cially comfortable retirement.

David: “File and suspend” has histori-cally been a great strategy for maxi-mizing benefits, but it was recently eliminated by Congress. What are your thoughts on that development, and are there other strategies still available?

“ The longer you live, the harder it is to maintain your standard of living.”


Brian: Congress recently eliminated both the “file and suspend” and the “restricted application” claiming strate-gies. You can still use the file-and-sus-pend strategy for the next six months [through April 2016] and the restricted application strategy if you turn age 62 by the end of 2015.

Both of these strategies made it easier to delay claiming Social Security ben-efits. Although these strategies will no longer be available for people claiming their benefits in the future, it still makes a great deal of sense to delay claiming Social Security benefits as long as pos-sible, ideally until age 70.

By claiming benefits at age 70, you receive the largest amount of guar-anteed lifetime income from Social Security, the biggest Survivor Benefit possible, and the biggest dollar increases in the size of your Social Security check every year for the rest of your life. Also,


Fig. 8: Retirees can increase their monthly Social Security benefit by delaying their claim

Inflation-adjusted, monthly increase in %

Delay from age

To age

63 64 65 66 67 68 69 70

62 6.7 15.6 24.4 33.3 44.0 54.7 65.3 76.0

63 8.3 16.7 25.0 35.0 45.0 55.0 65.0

64 7.7 15.4 24.6 33.8 43.1 52.3

65 7.1 15.7 24.3 32.9 41.4

66 8.0 16.0 24.0 32.0

67 7.4 14.8 22.2

68 6.9 13.8

69 6.5

Source: Agarwal, Sumit and Driscoll, John C. and Gabaix, Xavier and Laibson, David, The Age of Reason: Financial Decisions over the Life-Cycle with Implications for Regulation (October 19, 2009)

Pull quote

a much larger amount of guaranteed lifetime income, which means a larger amount of longevity insurance and, over-all, reducing your longevity risk.

A lot of people do a “breakeven analy-sis,” and will look at claiming benefits at 62 versus delaying it to 66, which is their full retirement age. This method looks at how long it’s going to take them to make up for all of the income they didn’t receive, by delaying until age 66. Their benefit at age 66 is going to be bigger, but if you do the calculations, it’ll take them 12 years or until age 78. A lot of people do this calculation, see that they won’t break even until age 78, and think they’re not going to live that long, so they claim their benefits early at 62.

In the book, I show that a man has twice the probability of living to or beyond the breakeven age of 78 than dying before it, and a woman has three times the probability. Too many people focus on dying young, but dying too young is not the problem. Speaking in financial terms only – dying too young solves all the problems, because you don’t spend any money when you’re dead. But living long, that’s the problem. Because the longer you live, the harder it is to main-tain your standard of living. So what you want to do is to try to get the largest amount of guaranteed lifetime income or longevity insurance, to reduce that longevity risk. And one of the best ways to do it is to maximize your Social Secu-rity income by waiting until age 70.

“ A man has twice the probability of living to or beyond the breakeven age of 78 than dying before it, and a woman has three times the probability.”

by maximizing your Social Security income, it should reduce the amount of money you will have to withdraw from your accumulated assets in order to meet your retirement income needs. In other words, maximizing your Social Security income by claiming benefits at age 70 should reduce the withdrawal rate on your accumulated assets, which increases the probability that your assets will last as long as you live, if not longer. As my son likes to say: “It’s all good...”

David: You mentioned that the monthly benefit acts as a form of longevity insur-ance. How does that work in practice? And what filing strategies work best to hedge longevity risk?

Brian: As you know, longevity risk is the biggest risk in retirement. The longer you live, the harder it becomes to main-tain your standard of living. So it would be great to be able to get some longev-ity insurance. What exactly is that? Well the best form of longevity insurance is guaranteed lifetime income.

The more guaranteed lifetime income you receive, the more longevity insur-ance you will receive, which reduces your longevity risk in retirement. Social Security is a form of guaranteed life-time income, so it is a form of longevity insurance.

If you delay claiming your Social Secu-rity as long as possible, ideally to age 70, you maximize your benefits. You get




Safe withdrawal rates (SWR) are a popu-lar but incomplete way to think about retirement spending. The most popular form of the SWR is the “4% rule,” which says that a 65-year-old can withdraw 4% of the assets from his portfolio dur-ing the first year of retirement, grow that withdrawal by inflation in subsequent years, and have a minimal probability of running out of money over the next 30 years. The 4% number only has rel-evance during the first year of retirement since spending is then grown by inflation – resulting in a constant standard of liv-ing during the retirement years.

In fact, 4% has been a generally accepted safe withdrawal rate, but more recently, some analysts have suggested that the number should be as low as 2% (e.g., a spending cut of 50%!).

The rationale for the decline is twofold:

1) Portfolio returns are likely to be lower in the future than they have been in the past; and

2) Increased longevity means that 30-year horizons are insufficient.

We agree that both of these factors are important, but we don’t agree with the extreme conclusions. Importantly, a fact that seems to be left out of most of the analysis concluding that SWRs have declined is that inflation is low and is likely to remain low for an extended period. This offsets some of the impact of the low returns, because ultimately inflation-adjusted returns are what mat-ter for retirees.

Previously, we’ve published a “dynamic safe depletion rate” (DSDR)3 for inves-tors who want to use a dynamic form of the safe withdrawal rate (see Fig. 9). This framework incorporates a number of step-ups in spending based on mar-ket performance. Following a flat year in 2015, the DSDR framework suggests that investors should feel comfortable increasing 2015’s spending by inflation (roughly 0.5%) for 2016.

Safe withdrawal rates for 2016

Fig. 9: Dynamic safe depletion rates (DSDR)

Duration of retirement horizon, in years

Retirement duration

DSDR Retirement duration

DSDR

30 4.0% 22 4.5%

29 4.1% 21 4.6%

28 4.1% 20 4.8%

27 4.2% 19 4.9%

26 4.2% 18 5.0%

25 4.3% 17 5.2%

24 4.4% 16 5.5%

23 4.4% 15 5.7%

Source: MSCI, UBS




Source: MSCI, UBS, as of 30 October 2015

2010

2005

100

125

0

25

50

75

150

0 1 2 3 4

Years aer retirement

5 109876 11

Fig. 10: Both cohorts have experienced portfolio appreciation

Portfolio value years aer retirement, in % of original corpus

More concretely, we can look at two recent retirement cohorts (2005, 2010) to see how they have fared using the Dynamic Safe Depletion Rate frame-work. As it turns out, both the 2005 and 2010 cohorts have fared reason-ably well.

For this analysis, we assumed the retiree held a portfolio comprised of 60% in global equities and 40% in investment-grade US fixed income that was rebal-anced on an ongoing basis and made spending decisions on an annual basis.

After experiencing significant portfo-lio declines during the financial crisis, the 2005 cohort’s portfolios recently recovered to near their starting values in inflation-adjusted terms (see Fig. 10). Additionally, the DSDR framework enabled spending step-ups in 2007, 2013, 2014, and 2015, leading to a cumulative inflation-adjusted increase in spending of 25% since 2005 (see Fig. 11). This is a fairly positive outcome for

a group that retired right before the larg-est recession and greatest financial crisis in 70 years.

Even so, the 2010 cohort has experienced far superior results. High investment returns have resulted in significant port-folio appreciation even after accounting for withdrawals, while also enabling an increase in inflation-adjusted spending of nearly 50% over the last five years.

To reiterate a point from the last section, results based on a safe spending rate methodology are instructive but incom-plete. Spending is rarely uniform on an annual basis and customized investment portfolios are unlikely to reflect the sim-plified 60/40 portfolio we’re using for this analysis. As an alternative, a com-prehensive financial plan can provide far superior guidance around prudent spending for a specific family.

Checking in with the 2005 and 2010 retirees

Source: MSCI, UBS, as of 30 October 2015

2010

2005

4

5

0

1

2

3

6

1 2 3 4

Years aer retirement

5 109876 11

Fig. 11: Each cohort experienced step-ups in spending using the dynamic safe depletion rate (DSDR) methodBy cohort retirement year, in real USD per 100 of original corpus


The Social Security Administration recently announced that retirees will receive a 0% cost of living adjustment (COLA) in 2016. Despite this decla-ration, you might reject outright the notion that retirees experienced a 0% inflation rate during 2015. You’d be right to do so.

In 1994, the Bureau of Labor Statistics developed an experimental consumer price index for individuals 62 years of age and older, known as known as CPI-Elderly (CPI-E).4 This index uses differ-ent expenditure weightings (see Fig. 12) than the generally cited CPI-U (which measures expenditures for urban wage earners and is used for COLA calcula-tions) to better represent the spending patterns of households that are near or in retirement.

What does the CPI-E tell us? First of all, inflation for retirees as measured by the CPI-E has not been 0%. The CPI-E increased 0.5% since last September and 1.7% year-to-date. Longer term,

CPI-E has outpaced CPI-U nearly 80% of the time since 1994 (see Fig. 13). These numbers may or may not match any one household’s personal experience, but they certainly indicate a mismatch between realized inflation for retiree households and the measure of inflation used for COLAs.

Why are prices for individuals over age 62 currently rising faster than prices for the rest of the population? Retir-ees spend a smaller percentage of their income on food, apparel, transportation, and education – all categories that have had relatively muted price gains as of late. However they spend a significantly larger portion of their income on hous-ing and healthcare. Both of these cat-egories have experienced above-average cost increases in 2015.

Is inflation really 0%?

Source: US Bureau of Labor Statistics, as of 28 October 2015

0 20 30 40 5010

Fig. 12: The CPI-E is more sensitive to changes in housing and medical care, relative to the CPI-U

CPI-E vs. CPI-U expenditure weighting, in %

Apparel

Other goods & services

Recreation

Education & communication

Medical care

Food & beverages

Transportation

Housing

CPI-U

CPI-E

Source: US Bureau of Labor Statistics, UBS, as of 28 October 2015

0.4

0

–0.4

–0.8

0.8

2000 200319971994 2009 2012 20152006

Fig. 13: More oen than not, the CPI-E has experienced a greater year-over-year change, relative to CPI-U

Year-over-year change, in %



In the 2Q 2015 edition of Your Wealth and Life, we presented a wealth man-agement framework that we referred

to as Goals-Based Wealth Management (GBWM). This framework borrows from pension fund management, endow-ment fund management, and behavioral finance to develop a more effective and intuitive system for managing personal wealth.

Based on an individual investor’s goals and retirement objectives, the GBWM framework recommends segmenting assets into three portfolios: Liquidity, Longevity, and Legacy, which are then allocated into appropriate asset classes (see Fig. 14). The Liquidity portfolio is comprised of short-maturity bonds or fixed income and provides cash flow for the next three to five years; the Longev-ity portfolio is a risk-asset portfolio and is sized to contain the spending that the household wants to accomplish for the remainder of its members’ lifetimes; and the Legacy portfolio consists of excess assets that the household intends to use for bequest or charitable purposes. Throughout retirement, assets from the Longevity portfolio are used to replen-ish the Liquidity portfolio as it is spent down.

Not only do retirees find this segmen-tation intuitively useful, there are also investment benefits that make this

SpotlightSucceeding in retirement with Goals-Based Wealth Management

strategy worth pursuing. The Liquidity and Longevity portfolios work together to essentially form a personal pension. In fact, an institutional framework known as liability-driven investing is the basis for that portion of GBWM. Legacy assets, on the other hand, are generally man-aged differently than assets that will be spent during retirement. In addition to households having a different attitude toward risk with legacy assets, there are tax and estate planning issues to con-sider. It’s hard to do this effectively if the assets within all the portfolios are commingled.

There are three significant benefits of adopting the GBWM framework for retirees. First, GBWM provides a funda-mental rationale for accepting a certain amount of risk. While most retirees are unsure whether they are “moderate” or “moderately aggressive,” GBWM asset allocation is based on a household’s spe-cific goals and objectives. Additionally, to ensure optimal asset allocation, we recommend revisiting the household’s objectives regularly, and rebalancing portfolios accordingly.

Second, utilizing a Liquidity portfolio prevents a reach for yield, which leads to better decisions during bear markets. Retirees, endowments, foundations, and pensions all share the challenge of producing income from a portfolio.


However, most institutions determined 10 to 20 years ago that focusing on higher-yielding assets in a portfolio resulted in suboptimal performance. Yield might be higher, but total return frequently lagged. The rule-of-thumb around “spend the yield and never touch the principal” simply leads to worse out-comes – particularly in periods of low yields, like we face today. A properly formed Liquidity portfolio resolves this problem.

Third, we commonly see investors lower their portfolio risk following bear mar-kets. We’ve even had a number of investors do this after the temporary downturn in August of this year, which is not surprising given that risk aversion increases following a market decline. Of

course, this is rarely the right move (and leads to lower returns), assuming the portfolio has been properly selected to give the household the highest probabil-ity of meeting its objectives. In order to avoid suboptimal decisions, it is some-times worth “sticking the head in the sand,” and in turn, staying focused on the long-term personal goals and objec-tives rather than the short-term market movement.

“ The rule-of-thumb around ‘spend the yield and

never touch the principal’ simply leads to worse outcomes –

particularly in periods of low yields.”

Source: UBS

Fig. 14: The GBWM framework segments assets into three portfolios, aligning appropriate assets with future anticipated expenses (goals)Goals-based wealth management (GBWM) framework

Liquidity

Legacy

Longevity

LiquidityTime horizon: 0 – 4 years

LongevityTime horizon: 5 years – life

LegacyTime horizon: Life expectancy +





Source: Bloomberg, UBS, as of 20 October 2015

Fig. 15: UBS forecast rates for the Federal Reserve

In %

0.0

0.5

1.0

1.5

- 1 4 20 Oct 15Q4 16Q1 16Q2 16Q3 16Q4

We expect the Federal Reserve to be in rate-tightening mode over the course of 2016. As of October 2015, our cur-rent expectation is that short-term rates will go up 1.25% (see Fig. 15) over the next 12 months – a start toward nor-malization, but not an aggressive rate policy by any means. We also don’t expect large movements in long-term rates as a result of Fed tightening.

However, the recent shift lower in long-term rates (see Fig. 16) makes this a good opportunity for households to once again revisit their current liabili-ties and to determine whether or not it makes sense to refinance any outstand-ing debt to take advantage of lower rates, extend the duration of a mort-gage, or utilize debt for large upcoming purchases.

Those about to retire also have one additional consideration: It can be sig-nificantly harder to manage liabilities proactively post-retirement, as some debt structures may no longer be acces-sible. This is another reason to revisit this topic as part of preparing for retire-ment. Our advice is to always make deci-sions about liabilities in the context of a financial plan. Optimizing balance sheet structure is too complex an exercise to complete successfully with a narrow viewpoint.

The Fed and your balance sheet

Source: Bloomberg, US Treasury, UBS, as of 30 October 2015

1.75

2.00

2.25

2.50

Jul Aug Sep Oct

Fig. 16: Lower rates make for a good opportunity to refinance or utilize debt10 year US Treasury yield, in %


A retirement plan is not complete without addressing healthcare expenses. Traditional Medicare costs generally range from $4,000 to 7,000 per year at the beginning of retire-ment, but can double by the age of 85.5 These expenses can be included in a standard financial plan to test for viability.

Ongoing medical costs aside, one of the large risks overhanging most households is an extended stay in a nursing home. According to the multi-decade University of Michigan Health and Retirement Study, roughly 40% of retirees will require nursing home care at some point. Breaking this down fur-ther, 20% will require more than three years of care, and 10% will require more than five years of care.6 Private rooms in nursing homes can exceed $100,000 per year in many areas.

How should these potential expenses be addressed? One way to under-stand risks is to group them into four broad categories: Frequent/small, fre-quent/large, infrequent/small, and

infrequent/large. Risks that are infre-quent and large are perfect candidates for risk transfer (i.e., insurance). For example, the likelihood of a house fire is extraordinarily small, but most families cannot easily self-insure so they purchase homeowners insurance.

For most households, homecare and nursing home expenses will either fit into the infrequent/small or infrequent/large category. Whether they are large or small depends mainly on the wealth of the family and how it intends to address these needs when they arise. Unfortu-nately, only about 50% of investors have factored healthcare into their financial plan7 – a necessary analysis to know whether or not your current savings are sufficient to handle future costs. In order to address this, our financial planning team recommends investigating the cost of such services in your area and proac-tively deciding whether or not long-term care insurance makes sense as part of pre-retirement planning.

The health of your plan depends on your health




What is risk for a retiree? Absent the “sequence risk” considerations discussed earlier, risk is not day-to-day portfolio volatility. Intuitively, which portfolio is riskier for a typical retiree during retire-ment: (1) a well-balanced, globally diver-sified portfolio, or (2) a portfolio invested entirely in cash? The balanced portfolio is riskier using the traditional definition of volatility as a proxy for risk, but the cash portfolio is riskier in that it virtually guarantees that the household will not achieve all of its objectives in retirement. Risk, properly defined, is the misalign-ment of retirees’ assets and the retirees’ goals.

What, therefore, is the risk-free asset for a retiree? We need to shift away from the traditional framework to answer this question. Assets that perfectly match the spending needs of a retiree are risk-free from that retiree’s perspective. For instance, a high-quality bond ladder (or even better, an inflation-linked bond lad-der) that matches maturities to spending is one of the lowest risk assets a retiree

can hold. This is why pensions and other institutions spend a lot of time and effort matching their bond portfolios to their upcoming liabilities – it is a risk-reducing exercise. Annuities, pensions, and Social Security benefits also fit into the low-risk category for households since they pro-vide predictable cash flows that can be used to match cash flow to goals (see Fig. 17).

What about dividend-paying equities? The cash flow component is useful for retirees, but it’s also not as predictable as cash flow from an annuity or bond ladder. Volatile price movements also add significant risk for investors who can’t fully cover their expenses with the dividend. The exception to this is a port-folio structure that requires only spend-ing the dividend component of the equity return (possibly combined with a bond portfolio for additional income) with a wide margin of safety – in that situation, the dividends also have been a low-risk income strategy for retirees.

Redefining risk

Fig. 17: Assets that match the spending needs of a retiree are lower risk from an income perspective

Income RiskHigher risk

Lower risk

Volatility

Stocks

High-dividend stocks

Hedge funds

Constant maturity bond portfolio

Cash

Bond ladder / annuity

Inflation-linked bond ladder / annuity

Stocks

High-dividend stocks

High yield bonds

Hedge funds

Constant maturity bond portfolio / ladder

Cash

Source: UBS


Although market returns have been disappointing in 2015, they should not substantially worsen the expectations around meeting objectives in retirement. We don’t expect the probabilities of suc-cess to decline meaningfully when financial plans are updated for 2016. This means that most investors should maintain their course and feel comfortable increasing expenses in 2016 at a level that offsets cost-of-living increases.

As the Federal Reserve starts to normalize interest rate policy, now is a good time to reevaluate any outstanding liabilities and to deter-mine whether or not refinancing those loans makes sense. Revisit-ing financial plans is a great way for making that determination.

Finally, based on research by our Investor Watch team, only 48% of investors are extremely confident or very confident that they are covered against a major health issue or for needing long-term care. We suggest that you proactively determine how to handle these expenses as soon as possible. A liability in this area that is not hedged (either through precautionary savings or insurance) can derail even the strongest financial plans.

In summary


Michael Crook is an Executive Director and Head of Portfolio & Planning Research in CIO Wealth Management Research, where he advises investors on asset allocation, portfolio con-struction, and financial planning. He is an author of numer-ous academic and professional articles.

Brian Doherty is a nationally recognized expert and speaker on Social Security claiming strategies, and the author of a new book, Getting Paid to Wait: Bigger Social Security Ben-efits – the Simple and Easy Way. Brian began his career as a financial advisor with Dean Witter. Throughout his 25 years in the financial services industry, he has held various senior man-agement positions, including President and CEO of Key Bank’s investment subsidiary, Key Investments, and Vice President and National Sales Manager for New York Life’s Retirement Income Security division. Currently, Mr. Doherty is President of Filtech, a consulting company specializing in Social Security claiming strategies that helps retirees maximize their Social Security benefits.

Svetlana Gherzi is a behavioral finance specialist within the Portfolio & Planning Research group in CIO Wealth Manage-ment Research. She is responsible for transforming academic research into actionable ideas and practical tools that financial advisors can use to improve individuals’ financial well-being. She has a BA and MA in economics and a PhD in behavioral science from University of Warwick, UK.

Carey Kaiser is a second-year analyst in the Graduate Train-ing Program at UBS. She is currently working with the Wealth Management Research Portfolio & Planning team, and received her BA in economics from St. Lawrence University.

Jeff LeForge is a Strategist within the CIO Portfolio & Plan-ning Research group in CIO Wealth Management Research. He focuses on advice related to investment strategy, portfolio construction, and financial planning.

About the contributors

David McWilliams is Head of Wealth Management Transfor-mation at UBS. Wealth Management Transformation is a new organization that helps Financial Advisors through its focus on team building, training, planning, increasing productivity, and delivering holistic wealth management.

Mike Ryan is Chief Investment Strategist for Wealth Man-agement Americas and Regional Chief Investment Officer for Wealth Management US. He brings together market and investment insights, and positions them so as to optimize the impact for clients.

Ronald Sutedja is a member of Portfolio & Planning Research in CIO Wealth Management Research. Before UBS, he worked on portfolio analysis at AQR Capital Management. He currently focuses on portfolio construction, simulation, and risk profiling.



DisclaimerChief Investment Office (CIO) Wealth Management (WM) Research is published by UBS Wealth Management and UBS Wealth Manage-ment Americas, Business Divisions of UBS AG (UBS) or an affiliate thereof. CIO WM Research reports published outside the US are branded as Chief Investment Office WM. In certain countries UBS AG is referred to as UBS SA. This publication is for your information only and is not intended as an offer, or a solicitation of an offer, to buy or sell any investment or other specific product. The analysis contained herein does not constitute a personal recommendation or take into account the particular investment objectives, investment strategies, financial situation and needs of any specific recipient. It is based on numerous assumptions. Different assumptions could result in materially different results. We recommend that you obtain financial and/or tax advice as to the implications (including tax) of investing in the manner described or in any of the products mentioned herein. Certain services and products are subject to legal restrictions and cannot be offered worldwide on an unrestricted basis and/or may not be eligible for sale to all investors. All information and opinions expressed in this document were obtained from sources believed to be reliable and in good faith, but no representation or warranty, express or implied, is made as to its accuracy or completeness (other than disclosures relating to UBS and its affiliates). All information and opinions as well as any prices indicated are current only as of the date of this report, and are subject to change without notice. Opinions expressed herein may differ or be contrary to those expressed by other business areas or divisions of UBS as a result of using differ-ent assumptions and/or criteria. At any time, investment decisions (including whether to buy, sell or hold securities) made by UBS AG, its affiliates, subsidiaries and employees may differ from or be con-trary to the opinions expressed in UBS research publications. Some investments may not be readily realizable since the market in the securities is illiquid and therefore valuing the investment and identi-fying the risk to which you are exposed may be difficult to quantify. UBS relies on information barriers to control the flow of information contained in one or more areas within UBS, into other areas, units, divisions or affiliates of UBS. Futures and options trading is consid-ered risky. Past performance of an investment is no guarantee for its future performance. Some investments may be subject to sud-den and large falls in value and on realization you may receive back less than you invested or may be required to pay more. Changes in FX rates may have an adverse effect on the price, value or income of an investment. This report is for distribution only under such cir-cumstances as may be permitted by applicable law.

Distributed to US persons by UBS Financial Services Inc. or UBS Securi-ties LLC, subsidiaries of UBS AG. UBS Switzerland AG, UBS Deutschland AG, UBS Bank, S.A., UBS Brasil Administradora de Valores Mobiliarios Ltda, UBS Asesores Mexico, S.A. de C.V., UBS Securities Japan Co., Ltd, UBS Wealth Management Israel Ltd and UBS Menkul Degerler AS are affiliates of UBS AG. UBS Financial Services Incorporated of PuertoRico is a subsidiary of UBS Financial Services Inc. UBS Financial Services Inc. accepts responsibility for the content of a report prepared by a non-US affiliate when it distributes reports to US persons. All transactions by a US person in the securities mentioned in this report should be effected through a US-registered broker dealer affiliated with UBS, and not through a non-US affiliate. The contents of this report have not been and will not be approved by any securities or investment authority in the United States or elsewhere. UBS Finan-cial Services Inc. is not acting as a municipal advisor to any municipal entity or obligated person within the meaning of Section 15B of the Securities Exchange Act (the “Municipal Advisor Rule”) and the opin-ions or views contained herein are not intended to be, and do not constitute, advice within the meaning of the Municipal Advisor Rule.

UBS specifically prohibits the redistribution or reproduction of this material in whole or in part without the prior written permission of UBS and UBS accepts no liability whatsoever for the actions of third parties in this respect.

Version as per September 2015.

© UBS 2015. The key symbol and UBS are among the registered and unregistered trademarks of UBS. All rights reserved.

Nontraditional AssetsNontraditional asset classes are alternative investments that include hedge funds, private equity, real estate, and man-aged futures (collectively, alternative investments). Interests of alternative investment funds are sold only to qualified investors, and only by means of offering documents that include information about the risks, performance and expenses of alternative invest-ment funds, and which clients are urged to read carefully before subscribing and retain. An investment in an alternative investment fund is speculative and involves significant risks. Specifically, these investments (1) are not mutual funds and are not subject to the same regulatory requirements as mutual funds; (2) may have performance that is volatile, and investors may lose all or a substantial amount of their investment; (3) may engage in leverage and other speculative investment practices that may increase the risk of investment loss; (4) are long-term, illiquid investments; there is generally no secondary market for the interests of a fund, and none is expected to develop; (5) interests of alternative investment funds typically will be illiquid and subject to restrictions on transfer; (6) may not be required to provide periodic pricing or valuation information to investors; (7) generally involve complex tax strategies and there may be delays in distributing tax information to investors; (8) are subject to high fees, including management fees and other fees and expenses, all of which will reduce profits.

Interests in alternative investment funds are not deposits or obliga-tions of, or guaranteed or endorsed by, any bank or other insured depository institution, and are not federally insured by the Federal Deposit Insurance Corporation, the Federal Reserve Board, or any other governmental agency. Prospective investors should understand these risks and have the financial ability and willingness to accept them for an extended period of time before making an investment in an alternative investment fund, and should consider an alternative investment fund as a supplement to an overall investment program.

In addition to the risks that apply to alternative investments gen-erally, the following are additional risks related to an investment in these strategies:

• Hedge Fund Risk: There are risks specifically associated with investing in hedge funds, which may include risks associated with investing in short sales, options, small-cap stocks, “junk bonds,” derivatives, distressed securities, non-US securities and illiquid investments.

Disclaimer

Your Wealth & Life September 2015 23

Publication details

PublisherUBS Financial Services Inc. Wealth Management Research 1285 Avenue of the Americas, 20th Floor New York, NY 10019

This report was published on 16 November 2015.

Editor in chiefMichael Crook

EditorsAbraham De RamosBarbara Rounds-Smith

Contributors

(in alphabetical order)

Michael CrookBrian DohertySvetlana GherziCarey KaiserJeff LeForgeDavid McWilliamsMike RyanRonald Sutedja

Project Management Paul Leeming

Desktop PublishingGeorge StilabowerCognizant Group – Basavaraj Gudihal, Srinivas Addugula, Pavan Mekala and Virender Negi

1 “UBS Investor Watch: 80 is the new 60,” UBS, 4Q 2013, p. 5.

2 Crook, Michael, “UBS Investment Strategy Insights: Hedging Against Sequence Risk for Retirees,” August 28, 2013, p. 1.

3 “Your Wealth & Life: Navigating Longevity,” UBS, September 4, 2014, p 10.

4 Pavalone, Joseph, & Stewart, Kenneth J., 1996. “Experimental CPI for Americans 62 Years of Age and Older, Briefing on the Consumer Price Index”, December 3, 1996, Attachment F.

5 Kopecky, Karen A., and Tatyana Koreshkova. 2014. “The Impact of Medical and Nursing Home Expenses on Savings.” American Economic Journal: Macroeconomics, 6(3): 29-72.

6 Brown, Jeffrey R., and Amy Finkelstein, “The Interaction of Public and Private Insurance: Medicaid and the Long-Term Care Insurance Market,” American Economic Review, 2008, Volume 98 (3), pp. 1083–1102.

7 “UBS Investor Watch: Unassisted living,” UBS, 4Q 2015, p. 10.

Endnotes

ab

UBS Financial Services Inc. is a subsidiary of UBS AG.www.ubs.com/financialservicesinc

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