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MFS’ Doug Orton on Retirement Planning: The Weekend Interview

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On a snowy day in January, Doug Orton, vice president of business development with MFS Investment Management in Boston, made the trek to AdvisorOne’s offices in Hoboken, N.J., to talk about retirement savings and how advisors can talk about the subject with clients still leery of re-entering the equity markets after the financial crisis.

MFS recently launched a new section on its website for advisors to help clients take control of their retirement and gauge whether their plans are on track, and Orton is charged with developing ideas for financial advisors specifically around their retirement practices.

“We see retirement planning as a great way to help advisors build their business,” he said during an interview that focused on how MFS was helping advisors respond to investor fears of market volatility.

During the Q&A below, Orton (left) pinpointed three areas of retirement income planning that advisors should help risk-averse clients address. All involve some form of asset diversification:

1.      Time Diversification. Investors are sitting on a lot of cash because they’re still hesitant about re-entering the equities markets since the financial crisis. Many still believe they can reach their long-term financial goals, but how can they if they remain overweight cash?  Orton believes advisors must help clients determine the right amount to set aside for expenses and safety in tough times. Once that issue is resolved, then the discussion can shift to actual investments for long-term goals.

2.      Tax Diversification. Retirees often believe they will pay fewer taxes in retirement, but the reality is that how much they pay for taxes depends on their accounts’ registration type. Traditional IRAs and 401(k)s are treated as ordinary income while munis, Treasurys and Roth IRAs are tax-protected.

3.      Allocation, Diversification and Rebalancing. Rebalancing helps a portfolio last long enough to generate income in retirement—and portfolio longevity depends on diversification and withdrawal rates.

AdvisorOne: Thanks for coming out in all this snow, Doug. Let’s get started with you telling me more about your three diversification topics.

Orton: What led us to come up with these three topics was an investor survey that we did last year. MFS found that after the downturn, investors were a lot less confident about what they owned, and when we asked them how they felt about their investments, they were more protective of what they owned. We also asked them, “How would you like to feel about your investments?,” and they said, “Confident,” but only 9% of them had a match between how they wanted to feel about their investments and how they actually felt.

They’re not really sure that they have the right strategy to meet their long-term goals. Clients have moved into cash and fixed income, and what we’re hearing from advisors is that clients are still reluctant to move back into equities. As we wrote about asset diversification, we thought we would touch on it briefly and move on, because everybody is already pretty familiar with it, but from what clients were saying in the survey, it turns out that they’re not.

AdvisorOne: What should the conversation with clients look like? What’s your advice to advisors?

Orton: If clients are telling us that growth isn’t as important—and the measure of growth as their primary goal got cut in about half over the financial downturn—how we talk about equities really should be in the context of how we

protect a portfolio in retirement from the biggest threats, which are longevity and inflation. If you don’t have at least some equity, the chances of your portfolio sustaining income over a 30-year period are extremely low. Advisors need to focus on long-term sustainability.

AdvisorOne: How do you convince an uncertain client to take such a big step?

Orton: That’s where time diversification comes in. As people enter retirement, they have this perception that their time horizon goes to zero. Part of that is perfectly rational, because if I retired right before the downturn and had to sell some equities at the trough, I’ve really done long-term damage to my portfolio. So advisors need to talk to clients about the purpose of cash in a portfolio. If you think of cash as a volatility damper, you need very large amounts of it to have any effect. But if you view it as a way to buy time, it’s more effective.

AdvisorOne: Tell me more about buying time.

Orton: What we found from interviewing clients is that depending on age, they had between 26% and 30% of their portfolio in cash, which is a high number. But if I’m going to pull 4% a year from my portfolio after retirement, which is what most of us agree is about the number that people should do, if I have only 12% to 16% of my portfolio in cash or short-term bonds, now I don’t have to worry about selling for three to four years. Three years without having to sell equities leaves a portfolio in good shape because you’ve had time to recover from a downturn. That leaves 10% that we can use to meet long-term income and sustainability goals.

AdvisorOne: What are advisors telling clients to do with that 10%? What do clients want to do with it?

Orton: Clients are still pretty risk averse. What we’re hearing from advisors is that they’re having more success inching back in, and not saying, “Hey, we’re going to add a large-cap growth component.” Instead, they may be positioning multi-asset class portfolios with balanced funds and asset-allocation funds as a way to get the client back into equity without the volatility that clients are still leery of.

AdvisorOne: Let’s get into tax diversification. That immediately brings to mind the current turmoil in the muni market, where everyone is running for the exits.

Orton: Uncertainty around tax policy, from the retiree’s perspective, is an incredibly dangerous thing. For a retiree who has all their assets in IRAs, 401(k)s, Social Security income and pension income, all of that income is not only taxable, but taxed under ordinary income rates. If tax rates go up, there’s nothing they can really do other than take more out of the portfolio, which has an impact on sustainability. Or they can spend less, which isn’t a very popular option with clients. For an advisor who isn’t also a tax advisor, how do you help the client solve that? Building a tax-diversified portfolio is a way to get there. It’s not just a question of whether you should have munis, but for some of your retirement assets a Roth conversion may make sense.

AdvisorOne: As for asset rebalancing, it’s always a moving target, isn’t it—especially when inflation enters the picture?

Orton: Yes. If you’re not increasing withdrawals for inflation, and if you’re taking 4%, really no matter what mix you use everything is fine. Once you add in an inflation adjustment—an all-bond portfolio is an example—it goes from a 100% success rate to a 19% success rate. Inflation is a huge danger in retirement if you don’t have an equity allocation. But if you add in an even moderate amount of 25% equity, your success rate will go way up.

Read about MFS Investment’s 2011 outlook on high-dividend stocks at