At the age of 55 I am getting to that point (regrettably) that it is becoming more and more difficult to do the things that I did as a younger man. However, this article’s title isn’t referring to my inability to touch my toes without straining most muscles in my body. No, I am referring to the stretch for yield by institutional investors that just my strain, tear, rip, and snap their portfolio’s fixed income exposure.

The holy grail for most public fund and Taft Hartley plan sponsors remains the ROA (return on assets assumption). As such, as interest rates continued to fall in the US, plan sponsors either exited fixed income or they sought higher yielding, less liquid fixed income alternatives in an attempt to generate a return that approximated their ROA. We’ve already discussed on many occasions the negative impact on the asset / liability relationship from reducing fixed income within a plan’s portfolio. There are short duration liabilities that can be immunized with lower yielding fixed income instruments that don’t need to have a return anywhere near the ROA.

In the second instance, the reach for yield has created crowded trades that may be difficult to unwind, potentially exacerbating any loss. We are beginning to see the higher yielding segments of the US credit markets twitch. In the week ended Wednesday, August 6th, EPFR reported that mutual fund flows from high yield funds was -$7 billion, which is the largest withdrawal since 2010, and the largest as a % of AUM ever. Furthermore, the flight to quality that has pushed the yield on 10-year Treasuries to a 52 week low of 2.39% (as of this morning), has also seen it’s yield spread to high quality credits expand beyond 100 bps for the first time since June.

Don’t be shocked if higher yielding credits in ETFs and mutual funds continue to see outflows. The fear of Federal Reserve tapering, geopolitical uncertainty (Ukraine / Russia and Iraq), and Europe’s inability to generate sustained economic growth are creating angst among the investing community. If you want to alleviate this uncertainty, KCS has developed an investment approach to convert your alpha assets (ROA-driven) into beta assets (liability focused) that will help stabilize your funded ratio, potentially reduce contribution costs, and use your fixed income exposure more wisely. Why risk injury trying to exit the credit markets with everyone else.

We are pleased to announce that August 1, 2014 marks the third anniversary for Kamp Consulting Solutions, LLC. KCS has spent the last three years fighting to keep defined benefit plans active. We continue to bring a different message to the marketplace that both assets and liabilities need to be managed together to accomplish the objective of maintaining a healthy retirement program for the plan’s beneficiaries.

Furthermore, we are excited to be part of a coalition that is bringing Double DB to the marketplace. DDB is a “fixed cost” defined benefit plan that is superior to the myriad hybrid plans that have been introduced into the market. This plan design just may provide the impetus for plan sponsors to maintain their current DB plan.

We are excited about what we’ve accomplished in our first three years, and very much look forward to helping plan sponsors and plan beneficiaries during our fourth year.

We are pleased to provide you with the KCS Second Quarter 2014 Update. We have a lot to be excited about at KCS, as we continue on our mission to help Pension America achieve their goals and objectives.

Please don’t hesitate to reach out to us if we can be of any assistance.

We have been coerced into thinking that wealth creation will provide for us in retirement, when in fact we should be focused on how we can create an income stream that will provide us with a meaningful income in retirement.  How many of you (us) focus too much attention on the month-to-month or quarter-to-quarter swings in the account values of our 401(k)s, 403(b)s, etc?

I believe that traditional DC statements need to be enhanced to reflect a projected income stream at various interest rates.  What does a $75,000 balance really mean to a 45-year-old?

Let’s create a profile of an average worker.  The employee is 65 years old, their final salary is $45,000, and they’d like to replace 75% of their final salary on an annual basis in retirement until demise (80 years old).  Social security (average payout) provides $1,294 / month, so we’ll say $15,500 per year.  How much would that individual had to have saved by the time they were a 45-year-old to replace $18,200 / year (($45,000 X .75) – $15,500)?  Well, that really depends on the interest rate (return) that was available to an investor at that time, and whether an annuity has been established that will carry her through to age 80.

For instance, at 45 years old, an account balance of $82,000 invested at 5% will provide upon retirement (age 65) an $18,200 annual income until age 80.  Since the “average” 401(k) balance is somewhere between $80,000 to $90,000, that person is on target.  Right? Perhaps, but maybe not.  Where can that investor get a 5% annuity at this time?  If for instance, they can only get an annuity that has a 3% interest rate, that same investor would need a $134,300 balance at age 45 to collect that same $18,200 / year until age 80.  God forbid rates continue to fall and the annuity is at 1% interest, that 45-year-old needs to have $224,000 accumulated.

So, focusing on the total value of the account and not translating that into an income stream can provide employees with a false sense of security.  We’ve all discussed the negative impact of falling rates.  Retirees and those nearing retirement are forced to save considerably more now than they would have 10-15 years ago, if they expect to replace a decent percentage of their final average salary. 

Finally, if one wants to maintain the purchasing power of their income stream throughout retirement (assuming inflation is at 3%), the account balances at age 45 have to be significantly larger.  In fact, that 45-year-old would have to have $166,100 in their account (and not $134,300) invested at 3% to accomplish their goals.  This balance is significantly greater than the average account today, and dramatically larger than the median account of only $13,000. We have a problem, and the lack of transparency into what our account balances can buy in the form of income isn’t helping.