About “Sequence of Returns Risk” in the HECM discussion

March 6th, 2016  | by Jason Oliva Published i HECM, News, Retirement, Reverse Mortgage

Just like any relationship, whether emotional or professional, communication is integral to developing a meaningful connection that allows each of the parties involved to effectively understand the needs and wants of their partners.

While the importance of meaningful communication may sound like a cover story worthy for the front pages of glam-mags like Cosmo and Vogue, this concept is critical for reverse mortgage professionals in their ongoing efforts to forge relationships with financial advisers as well as other retirement professionals.

The financial services industry is complex and within the retirement planning microcosm, it can seem as though advisers speak a different language. For reverse mortgage lenders, that can seem to only widen the divide between them and planners.

The truth of the matter is that reverse mortgage lenders and financial planners meet with a similar clientele. Typically, these clients are older adults who, in most cases, have built a substantial amount of home equity during their lifetimes and they’re entering retirement with the same goal: not outliving their money.

U.S. seniors had about $5.76 trillion in aggregate home equity last year and that number continues to rise each quarter, according to the most recent readings from the National Reverse Mortgage Lenders Association/RiskSpan Reverse Mortgage Index for the third quarter of 2015.

However, among Americans ages 55 and older—those nearest to retirement who should already have built significant savings—29% report having no savings or pension, according to a survey conducted last year by the Government Accountability Office. GAO’s research also consistently showed that people ages 55-64 are less confident about their retirement, with many planning to work longer to afford it.

The enormous stockpile of housing wealth among this older demographic, coupled with their unpreparedness and lacking confidence, offers an opportunity for reverse mortgage professionals to engage financial planners in a meaningful dialogue about how a Home Equity Conversion Mortgage (HECM) can best serve their clients’ needs.

But reverse pros need to be able to talk-the-talk, and that requires knowing the proper financial planning lingo to show that a reverse mortgage, when used strategically, could be the solution to any number of retirement road bumps.

“Reverse mortgage loan originators need to have a fundamental understanding of what financial advisers are trying to accomplish with their clients, which is basically to have their money last as long as they will be alive—but also taking into consideration that there will be market volatility,” said reverse mortgage industry veteran Shelley Giordano, who chairs the Funding Longevity Task Force, a group of financial planners and professionals focused on the strategic use of housing wealth in retirement.

Market volatility presents a real opportunity for the use of reverse mortgages in retirement planning, especially when considering the downward pressure faced by the Dow Jones and S&P 500 indices since the beginning of this year.

For many retirees who have a sizeable portion of their savings invested in stocks and other market instruments, having a resource that isn’t directly impacted by the ups and downs of the market could provide some extra protection for their retirement. Given the recent market volatility, reverse mortgage professionals must convey this message as they approach financial advisers.

Sequence of returns risk

Depending on a retiree’s allocation of market-related investments, dips in the financial markets could have an adverse effect on a person’s ability to retire comfortably.

As financial planning research has demonstrated—and widely publicized in the mainstream media lately—the strategic use of home equity can greatly increase the spending horizon of a person’s portfolio to last them for a 30-year retirement, particularly when using the line of credit option.

In this case, the reverse mortgage is used largely as a reserve, where a borrower draws from the loan only when his portfolio experiences a lower return. As retirees make withdrawals from their investments, negative returns that stack up early on during this period when a person is accessing their funds subjects them to what is known as sequence of returns risk.

For retirees who are living on the income they earn from retirement investments, this sequence risk is a primary concern which can cause some people to begin selling off assets for much lower than their worth.

“Understanding sequence of returns risk is important because if you have to sell-off too many assets in retirement because they are undervalued, and if there’s an extended period where there is a bad sequence of returns, that can be very dangerous,” Giordano said.

It is important for originators to have at least a basic understanding of sequence of returns risk so they can mention it in their conversations with financial advisors.

“Reverse mortgage experts need to know about Sequence of Returns Risk because this is one of the best ways a reverse mortgage can be incorporated into an overall financial or retirement income plan,” said Jamie Hopkins, professor of taxation at The American College in Bryn Mawr, Pa. “It [reverse mortgage] is one of the few assets someone might have where they can really get income that’s not correlated to the market.”

Hopkins, who is a frequent commentator on reverse mortgages for Forbes, has presented at several reverse mortgage industry conferences to discuss how reverse pros and financial planners can learn to speak the same language when it comes to serving their borrowers and clientele.

According to Hopkins, sequence of returns risk is going to be an even bigger concern as less people in the future retire with traditional pensions.

“All of a sudden, you’re going to have more people worried about sequence risk,” he said. “High net worth clients are equally concerned about this risk—it’s not a risk that only applies to a small subset of retirees.”

For reverse mortgage originators, the point is to at least have a basic understanding of sequence of returns risk, even if that means just being able to mention this concept to a financial advisor.

“If an originator can mention sequence risk and say reverse mortgages can stand in for having to make withdrawals early in retirement when the portfolio is undervalued, then they have a basis to start learning what researchers like Dr. Barry Sacks, Wade Pfau, Tom Davison and John Salter are writing about,” Giordano said.

Using a reverse mortgage to buffer against market swings and sequence risk falls within the greater context of portfolio sustainability, which is another important financial planning talking point originators should bear in mind.

Portfolio survival

Many financial advisers base their plans on the idea of portfolio survival. This is the essence of retirement planning. As advisers run Monte Carlo simulations to determine the likelihood that their clients’ assets will be able to survive a certain number of years, and under what circumstances and scenarios this will be possible, two major objectives are minimizing sequence of returns risk and improving cash flow.

A reverse mortgage helps accomplish both of these goals by reducing what advisers call the “withdrawal rate” from the portfolio. For example, if a retiree finds himself subject to sequence risk and he needs to sell 7-8% of his portfolio’s assets every year, under this strategy the portfolio might not survive a lengthy retirement.

“If we get too high of a withdrawal rate, we know that can actually deplete your portfolio fairly quickly,” Hopkins said. “A lot of financial advisers are looking for ways to lower that withdrawal rate, especially early in retirement so it increases the survivability or success of the portfolio.”

For further strategic discussion about how the HECM works to use home equity wisely in retirement mode, contact Warren Strycker who represents The Federal Savings Bank nationally, 928 345-1200.

It can be your “fish in the water” security when you turn 62.