Quarterly Newsletter of The Fiduciary Group®

THE

INDEPENDENT ADVISOR

By Malcolm Butler, J.D.Presidentmalcolm@tfginvest.com

A common question that I frequently hear is “how can we invest fresh cash

in stocks and bonds when prices seem so high?” Stock indices have repeatedly set new records this year, and bond prices have moved

higher as yields have hovered near historic lows. Inves-tors have continued to put money into these investments despite perceived high prices and geopolitical tensions that appear set to ignite global conflict.

A successful long term investment strategy should be based on building a portfolio with a combination of equities and fixed income securities. With cash earning virtually noth-ing, there really is not much incentive to hold cash in an investment account. However, it is indeed the investor’s

dilemma to com-mit to invest fresh cash when prices appear expensive for both of these asset classes. No one wants to buy something only to see the price de-cline shortly after the purchase.

I believe you can find suitable investments when-ever you

have cash to invest, regardless of what direction you think the markets may next be headed. More often than not, markets act much differently than one expects. Headlines may or may not move markets. It is too difficult to time market direc-tion based on perceived market reaction to specific events.

CONTENTS

Investing Cash in Bull MarketsMalcolm Butler, J.D.

M&A ReturnsJoel Goodman, CFAScott McGhie, CFA, CPA

Medicare 101Andrew Clark, MBA, CFP®

The Gen-X 401(k) MillionaireJulia Butler, J.D., MBA

conserve. plan. grow.®

Investing Cash in Bull Markets

OCTOBER 2014

Top 25 Years by # of Closing All Time Highs(Since 1928)

Rank Year # All Time Highs

1 1995 77 2 1964 62 3 1928 53 4 1961 52 5 1987 47

1998 47

7 1955 46 8 1997 45

2013 45

10 1929 43

1985 43

12 1996 39 13 1965 37 14 1999 35 15 2014 YTD 34 16 1968 33 17 1972 31

1986 31

19 1983 29 20 1959 27 21 1954 26 22 1958 24

1980 24

24 1991 22 25 1992 18

34 All Time Highs in 2014 and Counting

There are many factors which affect a market’s valua-tion. Market direction has a big influence, whether in an uptrend or a downtrend. Positive price momentum has played a critical role in the stock market’s almost nonstop climb upward this year. Investors have bid up prices for stocks despite lower growth profiles for companies oper-ating in an economy that is stuck in a low growth mode. Because of high profit margins, company net income has been growing faster than revenues and the overall econo-my. There is plenty of liquidity around the world, which has also helped to drive valuations higher. Cash has been directly flushed into the financial markets both from central banks and from money market and savings accounts.

Investor demand for US bonds has been nearly insatiable, even though expected returns are modest. Low inflation expectations have positively impacted bond prices as investors recognize that real returns on bonds (returns after inflation) are not totally unattractive. With all of these fac-tors contributing to market advances, there is no easily dis-cernable ceiling on asset prices. Just because indices are at high levels does not prevent them from moving higher.

There are a number of different valuation metrics that pro-fessional investors utilize in determining where a current market might be valued in relation to past market periods. One of the most common is the Price to Earnings ratio (P/E). The current P/E ratio based on trailing earnings for the S&P 500 index is around 18, while the 50 year average is 16.5. The P/E ratio has been as high as 30.7 and as low as 6.8 over the past 50 years, so the current valuation does not appear overly excessive. Bonds are probably much more richly valued. The 5-year US Treasury bond cur-rently yields less than 2% in contrast to an historical high yield of 6.26% and an historical low yield of 0.54% over the past 50 years.

In the current market environment, we have seen pretty much all asset classes rise in value as opposed to valua-tion increases in specific sectors. Back in 2000, technol-ogy stocks were rising euphorically and disproportionally to other economic sectors. In 2007, housing stocks and subprime debt led the way higher. In these prior periods, those specific areas of the markets could be characterized as being in bubble territory. These days, investors appear to be spreading their risks around in a more balanced manner.

Bull markets are defined as extended periods of stock market gains. The current bull market is over 5.5 years. The average of all bull market advances is just under 5 years. However, during 1990-2000, the bull market lasted for about 9 years! The percentage gain of the current bull market is about 200% from the market lows. The aver-age of all bull market gains is about 165%. Four other bull markets, however, have had gains ranging from 225% to over 400%. So even while the current bull market has had

an impressive run, it has been outmatched in several prior periods of stock market growth.

While asset prices can continue to increase, we should probably not expect the strong double digit annual returns to continue indefinitely. From these current record levels, both stocks and bonds are likely to generate lower returns during the remaining length of this bull market. Return expectations need to be tempered accordingly.

If you accept the premise that market timing is not an ef-fective strategy, investing cash should be done on a regular basis, regardless of what might be happening on any day in the markets. In addition, as we don’t have any simple method of determining at what price level a market will top out, disciplined and continual cash investing is warranted. Investing cash (and periodic rebalancing of portfolios) should be done based on a long term strategy and pursuant to an appropriate asset allocation, regardless of market direction.

Source: Strategas

Putting the Current Bull Market in Context S&P 500 Historical Bull Markets 1928-Present

S&P 500 Valuation at Bull Market Peaks

1932-37

1949-56

1990-00450%

400%

350%

300%

250%

200%

150%

100%

50%

120100806040200

1982-87

3/9/09 to Current66 Mos, 197%

Average57 Mos, 165%

1942-46

1974-80

Bull Market Duration (Months)

Bu

ll M

arke

t A

dva

nce

(%

)

2002-071957-611970-73

1987-901962-66

1966-68

Date Level TTM P/E NTM P/E8/2/56 50 14.1 NA

12/12/61 73 24.2 NA2/9/66 94 18.5 NA

11/29/68 108 19.5 NA1/11/73 120 19.1 NA

11/28/80 141 9.8 NA8/25/87 337 20.7 15.27/16/90 369 16.0 12.63/24/00 1,528 29.6 24.710/9/07 1,565 17.5 15.29/30/14 1,972 17.9 15.4

Average* 18.9 16.9* average excludes current bull market

Mergers and acquisitions (M&A) are on the rise as both the number and value of announced transactions is nearing levels last reached in

2007. We believe that there are a number of reasons for the surge in activity and expect the pace and level of deal making will have implications for investors. At its essence, the goal of M&A is to combine two firms that will be worth more together than apart. Economies of scale, expected synergies, competitive positioning, and growth are often cited as potential benefits, but engaging in a merger or acquisition requires a willingness to place capital at risk

and a motivation to act. Global consulting firm, McKinsey & Company, in a June 2010 report, noted that roughly 70 percent of mergers fail. However, this daunting statistic has not restrained recent deal flow, which has been supported by the following catalysts: 1. An improving business outlook2. Excess cash on corporate balance sheets3. Low interest rates4. Higher stock prices5. The need to generate revenue growth6. Pressure from activist investors

M&A Returns

Monthly Number of U.S. M&A Deals

Monthly Value of U.S. M&A Deals($, Billions)

Source: Strategas

Source: Strategas

Joel Goodman, CFAChief Investment Officerjoel@tfginvest.com

Scott McGhie, CFA, CPASenior Investment Manager

scott@tfginvest.com

3

100

88

70

0

500

1000

1500

2000

2500

0

25

50

75

100

125

'99 '01 '03 '05 '07 '09 '11 '13

S&P

500

Pric

e

Mon

thly

Num

ber

of U

.S. M

&A

Dea

ls

(12M

o M

A)

2000 Market Peak 2007

Market Peak

107

85 81

0

500

1000

1500

2000

2500

0

25

50

75

100

125

'99 '01 '03 '05 '07 '09 '11 '13

S&P

500

Pric

e

Mon

thly

Val

ue o

f U

.S. M

&A

Dea

ls

(12M

o M

A)

2000 Market Peak

2007 Market Peak

Corporate America is flush with cash. As the chart below shows, cash and short-term investments as a percentage of assets is at record levels. Risk aversion coming out of the Great Recession led companies to hoard cash in order to refortify their balance sheets. In many cases, corporations are now overcapitalized, and the excess cash is restraining

Benchmark nominal yields are low and credit spreads are narrow creating an attractive financing environment for companies making acquisitions. While the Federal Reserve’s asset purchase program is nearing completion, recent easing by the European Central Bank (ECB) provides an offset and is supportive of lower bond yields. Our best guess is that low global sovereign bond yields may help keep U.S. rates low in the near-term as capital flows continue to gravitate toward relatively higher yielding U.S.

earnings growth and returns on capital. Companies are feeling pressure to be more strategic with their cash or risk having activist investors exert more influence on capital allocation decisions. We expect that high cash balances will continue to support increased M&A activity as firms deploy cash or become an acquisition target themselves.

Treasury securities. For example, the current yields on the 10-Year U.S. Treasury Bond and the 10-Year German Bond are 2.5% and 0.95%, respectively. While these yields are nominal and do not differentiate between inflation differ-ences between the two countries, the higher U.S. nominal yields are attracting foreign buyers. We believe low inter-est rates will continue to be a tailwind for M&A activity as debt markets remain accommodating.

Cash on Corporate Balance Sheets

Low Interest Rates

S&P 500 Cash & Short-Term Investments as a Percentage of Assets

Source: Standard & Poor’s, Compustat

Geopolitical conflicts in the Ukraine and Middle East, a slug-gish European economy, and concerns over a hard landing in China comprise a short list of macroeconomic risks. Yet, in the U.S., there has been enough positive news for corporate chieftains to rule out a double-dip recession and look for ways to create shareholder value. Duke University’s quar-terly survey of chief financial officers reports that companies

expect to increase capital spending and hiring over the next twelve months while the survey’s Optimism Index has been steadily increasing toward its prior peak attained in late 2007. Confidence in the business outlook is an essen-tial ingredient for combinations to occur, and we believe it is an important factor in the resurgence of mergers and acquisitions.

Improving Business Outlook

2%

4%

6%

8%

10%

12%

14%

2%

4%

6%

8%

10%

12%

14%

'94 '96 '98 '00 '02 '04 '06 '08 '10 '12 '14

The availability of attractively priced debt capital has resulted in cash comprising a significant portion of consid-eration paid in M&A transactions since 2008. We would expect this trend to continue as long as accessible debt markets persist. However, recent transactions have been funded with a larger equity component as firms have been more willing to use an appreciating stock as currency for acquisitions. According to data from JPMorgan and Dea-

logic, the percentage of “all-stock” deals announced during the first quarter of 2014 is approaching levels seen during the bull market of 1995-1999. Higher stock prices should continue to enhance M&A volumes, but we are mindful that the market may become more discerning if deal fund-ing becomes too reliant on stock as the primary financing vehicle.

Higher Stock Prices

Global 10 Year Government Bond Yields

M&A Volume by Type of Financing

Source: Bloomberg

Source: J.P. Morgan, Dealogic 5

U.S.

France

Germany

Japan

Switzerland

2.49

1.29

0.95

0.49

-

0.5

1.0

1.5

2.0

2.5

3.0

3.5

Jan-14 Feb-14 Mar-14 Apr-14 May-14 Jun-14 Jul-14 Aug-14 Sep-14

0.53

52% 37%

22% 20% 19%

44%

21%

28%

22% 37%

27%

25%

26% 35%

57% 43%

54%

31%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

'95-'00 '01-'03 '04-'07 '08-'09 '10-'13 Q1 '14 All Stock Mix All Cash

Cost cutting and financial engineering have produced good earnings growth for companies over the past few years. Revenue growth has been harder to achieve as growth in gross domestic product (GDP) has been sluggish, largely because of weak consumer spending which contributes

Activist investors have long played a role in mergers in acquisitions. During the 1980’s, activists were referred to as corporate raiders because they would purchase large stakes in companies and then use hardball tactics in order to effect change. While the activist investor base has grown considerably, their game plan is simple and has not changed significantly over time. Activists seek out under-valued companies and then pressure management teams to unlock shareholder value, either through financial engi-neering (use leverage to increase dividends or repurchase shares) or through implementing a change in business strategy (replace existing management team, sell unprofit-able business lines, or merge with another firm, among others). The challenge for companies is that activists are often focused on short-term results rather than long-term

70% of GDP. While consumer spending is beginning to re-cover as employment statistics and wage growth improve, the positive impact on revenue growth has not been real-ized. M&A offers the potential to offset the lack of organic growth and a means to produce top-line results.

value creation. Nonetheless, the influence of the activist community is growing.

Assets managed by activist hedge funds are up 245% since 2008 and now exceed $110 billion. While this number represents less than 1% of the total stock market value of the companies in the S&P 500 Index, their collective impact is much greater than their assets would indicate. According to Factset Research, activist investors have initiated nearly 150 campaigns aimed at company manage-ment teams during 2014. In our view, the increased role of activist investors is here to stay, and continued success will likely attract more assets to the strategy, placing further external pressure on companies.

Need to Generate Revenue Growth

Pressure from Activist Investors

Global Activist Hedge Funds(Assets Under Management, $BN)

Source: Strategas

-

15

30

45

60

75

90

105

120

'03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14

The return of M&A activity has implications for investors as it provides a perspective on market sentiment and a window into the risk tolerance of corporate executives. The equity market has been applauding deals as shown in the below chart. According to year-to-date data compiled by Strategas Research, for the sixty-day period following an an-nouncement, the performance of acquirers has been better than the S&P 500 Index by 11.4 percentage points. In our view, the market’s receptiveness may be indicative of some complacency, especially given the long-term data regard-ing the lack of success of mergers. We would not expect this performance trend to persist as merger announcements historically have been met with skepticism by speculators whose tactic has been to “short” or sell the stock of the acquirer and purchase the stock of the target in order to benefit from the arbitrage between the two stock prices.It is difficult to conclude whether corporate executives are increasing deal activity because they are reaching the limit

of the benefits gained from financial engineering or because their risk appetite has returned. Nonetheless, the pickup in activity is meaningful and suggests a more optimistic outlook. We believe the conditions discussed above should remain supportive of additional deal flow over the near to medium term. Returns from activist hedge funds have been good, but we would caution against equating their success with a strategy that attempts to project and invest based on M&A activity. Further, a good M&A environment is very sensitive to the health and sentiment of the debt and equity capital markets, which may turn on and off rapidly and without notice.

Implications for Investors

7

Performance of Acquirers Relative to S&P 5000-60 Days After Announcement Date (Equal Weighted)

Source: Strategas

98

100

102

104

106

108

110

112

0 10 20 30 40 50 60 Trading Days After Announcement Date

“It is difficult to conclude whether corpo-rate executives are increasing deal activity because they are reaching the limit of the benefits gained from financial engineering or because their risk appetite has returned.”

Medicare 101 Andrew Clark, MBA, CFP®

Chief Planning Officer & Senior Investment Managerandrew@tfginvest.com

Alongside planning for income needs in retirement is the issue of health care. After meeting basic income needs, health care is the number one

concern retirees face. The average 65-year-old couple will need over $240,000 to cover future medical costs, not including long-term nursing care (Source: Fidelity). This estimate includes co-payments, deductibles, prescription drugs, and other expenses but not long-term care. Retirees and near-retirees are often confused about the options, plans, and enrollment periods for Medicare. This article addresses the basics.

Who is eligible for Medicare?• People 65 and older.• People under 65 with certain disabilities.• People of any age with end-stage renal disease requir-

ing dialysis.

What are the types of Medicare?Part A – provides for hospital stays, home health services, and hospice care.Part B – provides for physician care, outpatient care and medical equipment.Part C (Medicare Advantage) – includes Part A, Part B and often Part D services. This is private insurance and oper-ates more like an HMO or PPO.

Part D – prescription drug plan offered through a private stand-alone plan, or as part of Medicare Advantage.Traditional Medicare – this term refers to Part A and Part B coverage.

How much does it cost?Part A – most people do not pay a monthly premium for Part A as you or your spouse have paid Medicare taxes for Part A while you were working.Part B – premiums vary based on your income:

source: Medicare.gov

Part C – Premium varies by plan and features chosen.Part D – varies by plan with higher income consumers paying more.Beyond your premiums you will also have other costs:• Deductibles.• Co-Pays.• There are no caps for traditional Medicare out-of-

pocket expenses, while there are caps on what you can pay for Medicare Advantage plans.

How do I enroll for Medicare?Some folks are auto-enrolled:• If you are 65 and you are receiving Social Security,

you are auto-enrolled in Traditional Medicare and your Medicare card is mailed to you around 3 months prior to your 65th birthday.

• If you are under 65 and receiving disability Social Security benefits, you are automatically enrolled in Traditional Medicare, with your card mailed before the

Individual Tax Return Less than $85k

$85,000 - $107,000 $107,000 - $160,000 $160,000 - $214,000 > $214,000

Less than $170k

File Joint Return

$170,000 - $214,000 $214,000 - $320,000 $320,000 - $428,000 > $428,000

File Married & Separate Tax Return Less than $85k

Not Applicable

Not applicable

$85,000 - $129,000 > $129,000

You Pay (2014)

$104.90

$146.90

$209.80

$272.70

$335.70

Preventative care:• Medicare provides for an initial wellness visit as well

as an annual wellness checkup.• Screenings for most common cancers (colorectal,

breast, prostate, etc.).• Cardiovascular screenings.• Diabetes screening (for those at high risk).• Glaucoma screening (for those at high risk).

Hospital services:• General nursing.• Semi-private room.• Diagnostic and therapeutic services.• Meals and supplies.• NOT INCLUDED: private duty nursing, private room,

telephone, internet services.

Home Health care:• Patient must need intermittent skilled nursing care,

physical therapy, speech-language therapy, or occupa-tional therapy.

• The home health agency must be approved by Medi-care.

• The patient must be homebound, and a doctor must certify this condition.

Long-term skilled nursing facility care: Medicare is a short-term solution, only providing skilled nursing facility care for up to 100 days, after a 3 day quali-fying hospital stay.

Medicare is an important tool in helping to defray the cost of health care in retirement. While you may also purchase Medicare supplemental insurance (private insurance that pays what Medicare doesn’t, also known as Medigap coverage) or long-term care insurance which steps in for skilled nursing care after Medicare’s 100 day limitation, it is important to understand your Medicare coverage.

Two helpful links to help you do this:www.mymedicare.gov – your personal Medicare informa-tion.

www.medicare.gov/find-a-doctor – find out if your doctor or specialist accepts Medicare.

25th month of your disability.Who is not auto-enrolled?• Someone who is not receiving Social Security benefits

but is turning 65 and wants Medicare must enroll.• Someone who has end-stage renal disease.

Enrollment periods – Traditional Medicare:Initial Enrollment Period: A person can sign up when they are first eligible for Part B - at age 65. There is a 7 month period starting 3 months prior to your birthday, includes your birth month and ends 3 months after your month.

General Enrollment Period: If you didn’t sign up during your initial enrollment period, you can sign up between January 1 and March 31st with coverage beginning on July 1. Please note that you may have to pay higher premiums for waiting until the general enrollment period - as much as a 10% premium penalty may apply.Special Enrollment Periods: If your spouse works and you are on his or her group plan, you can wait to sign up for Medicare until as late as 8 months after the employment of your spouse ends. If you have been volunteering in a foreign country, you can sign up at will after your eligibility date.

Enrollment periods –Medicare Advantage:Medicare Advantage plans have the same initial enrollment period as Traditional Medicare, with the same 7 month window. General Enrollment period: occurs between October 15th and December 7th of each year, with coverage begin-ning on January 1.Special enrollment periods – under special circumstances:• You’ve moved out of your current plan’s service area.• You have both Medicare and Medicaid.• You qualify for the Extra Help program which assists

with prescription drug costs.• You live in a nursing home now or a similar institution.

Now that we’ve looked at the eligibility, costs and enrol-ment periods, let’s look at the coverages that Medicare offers, along with some details about what it doesn’t cover. 9

Medicare Enrollment Period - June Birth Month

Mar Apr May JulJun Aug Sept

Enroll 3 Months Prior Enroll 3 Months After

the median family income for GenXers is about $71,100 (this compares to the U.S. Census Bureau estimate of the median family income for all households of $53,046).

The questions that arise from this data are two-fold: 1) what will it take for Generation X workers to reach the $1 million goal?; and 2) is $1 million enough? I will point out that the relevance of this article is not limited to GenXers, as the observations and recommendations cross over to all generations.

What does it take to be a 401(k) millionaire?The answer depends on how much you’ve already saved, how much time you have, and how much you earn on your savings. For purposes of this discussion, we’ll use the median numbers for GenXers, and assume an annualized return of 7%.

Earning 7% on average, the 50 year old who—like the median GenXer—has saved $70,000 will need to set aside $25,255 a year for the next 17 years in order to have a million dollars. The maximum contribution limit in 2014 is $17,500, and the catch-up contribution for those 50 and over is $5,500 ($23,000 total). Only by maxing out on 401(k) savings (and assuming some employer match) and achieving an annualized return of 7% over the next 17 years will the “average” GenXer reach the estimated savings target of $1 million. Based on the median salary of $71,000, this savings rate is about 36%, well above the average 7% of annual income currently being deferred.

If the “average” GenXer is among the youngest of the generation, the $1 million goal is more attainable with a more modest savings rate. We recommend that work-ers save 15% of their current income to their retirement account, every year of their working life. Assuming the young GenXer has already saved the median $70,000 and saves 15% of current earnings, the 37 year old earning the

Generation X—those born between 1965 and 1978—is known as the “401(k) generation.” They entered the workforce about the time that 401(k)

plans were being introduced, and started their own retire-ment savings earlier than prior generations (the average age to start saving for retirement was 27). They highly value 401(k) plans as an important benefit, evidenced by the 84% participation rate by those who are offered a defined contribution plan by their employer. (Source: Generation X Workers, 15th Annual Transamerica Retirement Survey of Workers, August 2014).

Next year, the first GenXers will turn 50. They will be-come eligible for full Social Security benefits at age 67, so they have a good 17 years left to save for retirement. The youngest of the GenXers will turn 37 next year, giving them a full 30 years to get ready for retirement. Many GenXers are hitting their higher earnings years, which gives them the opportunity to save more.

The Transamerica retirement survey reports that two-thirds of GenXers expect that their primary source of income in retirement will be their retirement account and other savings or investments, not Social Security. (The Social Security Trust Fund is forecasted to reach depletion in 2032, just one year after the first of the GenXers reaches full retirement age.)

GenXers estimate they will need to have saved $1 million by retirement (though 51% of those stated this was only a guess, not based on any analysis of their projected income/ expenses). The average (median) percentage of annual salaries deferred by those participating in a 401(k) or similar plan is 7%. The median total household retirement account savings for GenXers is currently $70,000. As the survey concludes, “they are behind on their savings, but they still have time to catch up.”

According to a May study from the Pew Charitable Trusts,

The Gen-X 401(k) MillionaireJulia Butler, J.D., MBAChief Operating & Compliance OfficerDirector of 401(k) Advisory Servicesjulia@tfginvest.com

median GenX income of $71,000 would be saving $10,650 a year. For the sake of simplicity, let’s ignore--for purposes of this illustration--inflation (price or wage) and assume the worker earns $71,000 a year for the next 30 years. With 7% returns, he/ she will have $1,538,865 in 30 years.

Again ignoring the impact of price or wage inflation, the “average” 47 year old with current savings of $70,000 who earns $71,000 and saves 15% per year, will have $707,479 in 20 years. In order for the 47 year old to have $1 million in 20 years, he/she would need to save $17,785 every year and earn 7% annualized returns. That is a deferral rate of 25% of the median 47-year old GenXer’s salary.

What a difference each 10 years makes—the 10 addi-tional years of compounding enjoyed by the “median” 37 year olds allows them to have twice as much money by retirement as the 47 year olds starting at the same place. Here’s an even more striking comparison. If a 27 year old earning $71,000 has already saved $70,000 and saves 15% ($10,650) for 40 years with a 7% return, he will have $3,174,326 at retirement. Even if that 27 year old starts with $0 and saves the same amount starting at age 27, he/she will have $2,126,114.

The power of compounding can’t be overstated. Those early years of saving are the most important.

Here are the key points that all generations can take from the illustrations thus far:

1. At a minimum, you need to be saving 15% of your cur-rent income to your retirement account;

2. The earlier you start saving, the better off you will be at retirement.

3. If you haven’t saved enough in the first part of your working life, 15% won’t do it (the recommended 15% minimum assumes an average of 15% over the course of an employee’s working life.) You’ve got to max out what the IRS allows, as well as take advantage of an employer match and other retirement accounts such as an IRA. You’ve got a lot of catching up to do.

Is $1 million enough?Whether $1 million in retirement savings is enough depends on how much you spend, and what the purchas-ing power of that million dollars is at the time you retire. Again, let’s use the median numbers we have for GenXers.

Recall that the median salary of GenXers is $71,000. Con-ventional wisdom says you will need to replace about 70%

of your income in retirement. 70% of $71,000 is $49,700. The average GenXer earning $71,000 will need to replace about $50,000 of income with withdrawals from his/ her retirement savings. Using the 4% rule (explained in the in-set below), you would need $1,250,000 in your retirement account to withdraw $50,000 annually. For the average GenXer who earns $71,000, a million in retirement sav-ings is close, but slightly less, than what he/she will need. Under the 4% rule, a $1 million account would provide $40,000 of annual income in retirement.

4% RuleThe 4 percent rule was developed by financial planner Bill Bengen of La Quinta, Calif., more than two decades ago. It basically says that you can afford to spend 4 percent of your savings in the first year of retirement. In each subsequent year, you should withdraw the same amount that you took in the previous year, plus an increase for inflation. If you stick to that rule and are properly invested, your money should last for at least 30 years and, in most cases, much longer. In other words, you should be financially safe.

The bigger issue is the effect of inflation. Assuming 2.6 % inflation (average since 1990), $1,000,000 of today’s dollars buys only $598,484.33 of goods and services in 20 years. In 30 years, $1 million is worth only $462,998 in today’s dollars. If you really think you need $1 million of today’s dollars to fund your retirement in 20 or 30 years, here is what you will really need (assuming the average 2.6% infla-tion):

• To have the equivalent of $1,000,000 of today’s dollars in 20 years, you will need $1,670,888.

• In 30 years, you will need $2,159,836.• In 40 years, you will need $2,791,865.

Inflation also has a significant impact during retirement which needs to be factored in to your investment strategy. Returning to the $1 million example, let’s take a look at how the 4% rule works if you have $1 million in your re-tirement savings. We have illustrated what your withdraw-als would be each year for 30 years, assuming you increase your withdrawals each year to account for inflation. The illustration shows that in order to retain the purchasing power of your $1 million, you must earn an average an-nualized return (net of fees) of 6.6%.

The Gen-X 401(k) Millionaire

11

fees, which implies gross returns in the 7.5%-8% range. This makes sense, if you’re taking out 4% of account value adjusted by inflation, you need to earn 2.6% more than your 4% just to offset inflation. This really puts a whole new spin on allocation strategies in retirement. With stocks averaging 9% returns histori-cally and bonds 5%, this implies an allocation strategy more heavily weighted to stocks. Especially if we face a long-duration bear market in bonds (returns below the historical average), in retirement you are going to have to have a significant portion invested in stocks.

Inflation is, in the words of Ronald Reagan, “as violent as a mugger, as frightening as an armed robber and as deadly as a hit man.” Think a million dollars is enough? Time to think again.

Note From The Editor:

We hope you have found this edition of The Fiduciary Group newsletter to be both interesting and relevant. We would like to hear your thoughts and suggestions. Please e-mail your feedback to julia@tfginvest.com. If you have family or friends who you think might benefit from receiving our newsletter, please e-mail us their name, address, and e-mail address. Thanks, and we look forward to enhancing our service to you with each edition.-Julia L. Butler, Editor Chief Operating & Compliance Officer and Director, 401(k) Advisory Services

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The big takeaways from the foregoing examples and illustrations are as follows:1. If you think you need $1 million in retirement (which

under the 4% rule would imply an annual income of $40,000 adjusted annually for inflation), you need to understand what the inflation-adjusted equivalent of that is in the year you plan to retire.

2. To have the equivalent (in terms of spending power) of $40,000 annual income in 20 years, you’ll actually need $1.67 million; in 30 years, $2.16 million; and in 40 years, $2.8 million. As you map out your income and savings strategy for the next number of years, fac-tor in both price and wage inflation.

3. To maintain your purchasing power in retirement, you’ll need to earn an average of 6.6% returns after

YearBeginningBalance

PortfolioReturn

Yearly End of Period Withdrawal

End of Year Balance

Value in Today's Dollars

1 1,000,000 66,000 40,000 1,026,000 1,000,000 2 1,026,000 67,716 41,040 1,052,676 1,000,000 3 1,052,676 69,477 42,107 1,080,046 1,000,000 4 1,080,046 71,283 43,202 1,108,127 1,000,000 5 1,108,127 73,136 44,325 1,136,938 1,000,000 6 1,136,938 75,038 45,478 1,166,498 1,000,000 7 1,166,498 76,989 46,660 1,196,827 1,000,000 8 1,196,827 78,991 47,873 1,227,945 1,000,000 9 1,227,945 81,044 49,118 1,259,871 1,000,000

10 1,259,871 83,152 50,395 1,292,628 1,000,000 11 1,292,628 85,313 51,705 1,326,236 1,000,000 12 1,326,236 87,532 53,049 1,360,719 1,000,000 13 1,360,719 89,807 54,429 1,396,097 1,000,000 14 1,396,097 92,142 55,844 1,432,396 1,000,000 15 1,432,396 94,538 57,296 1,469,638 1,000,000 16 1,469,638 96,996 58,786 1,507,849 1,000,000 17 1,507,849 99,518 60,314 1,547,053 1,000,000 18 1,547,053 102,105 61,882 1,587,276 1,000,000 19 1,587,276 104,760 63,491 1,628,545 1,000,000 20 1,628,545 107,484 65,142 1,670,888 1,000,000 21 1,670,888 110,279 66,836 1,714,331 1,000,000 22 1,714,331 113,146 68,573 1,758,903 1,000,000 23 1,758,903 116,088 70,356 1,804,635 1,000,000 24 1,804,635 119,106 72,185 1,851,555 1,000,000 25 1,851,555 122,203 74,062 1,899,696 1,000,000 26 1,899,696 125,380 75,988 1,949,088 1,000,000 27 1,949,088 128,640 77,964 1,999,764 1,000,000 28 1,999,764 131,984 79,991 2,051,758 1,000,000 29 2,051,758 135,416 82,070 2,105,104 1,000,000 30 2,105,104 138,937 84,204 2,159,836 1,000,000

Assumptions: Inflation of 2.6%; annualized (net of fee) returns of 6.6%; annual withdrawals of 4% adjusted by inflation.