Traditional Asset Management Doesn’t Work For Retirement Income Planning

After taking a week off to organize my thoughts and clear a pile of paperwork, I decided to take a course from WJB Training Bolton. We left off at the point of covering the major threats a portfolio will face through retirement and now it’s time to look at the traditional approach to conquering those challenges. 

 

It should come as no surprise that asset accumulation strategies fail to offer the kind of assurances everyone needs when it’s time for those assets to support you entirely. Even still, traditional management strategies will have a place in a well-balanced portfolio, just not the leading role that the major management firms would like you to believe.

 

As you work and save for retirement you’ll no doubt alter investment strategies to adjust to the constantly changing economic environment. Over the years the typical advice has led people to save incrementally, use dollar cost averaging, buy low/sell high and shift toward more stable fixed return assets like bonds and treasuries as retirement approaches. Regardless of how that advice has worked for you, there’s good reason to suggest you may want to diverge from that path, at least in part, when it’s time to withdraw assets.

 

As luck would have it, this great article on the subject was published in the Wall Street Journal last week. Recommendations based on complex computer models have always suggested it’s safe to withdraw 4% to 5% of a portfolio for income. The equities markets return 10% in an average year so over time your income should increase to combat inflation and as long as the balance increases you’ll never run out of money no matter how long you live. 

 

Seems easy enough, right? Well, for various reasons that strategy hasn’t performed to plan when put into practice. The first red flag is the ‘probability of success’ attached to a strategy when the computer spits out your numbers.

 

Why the probability of success? In realistic terms, market fluctuations will require income adjustments and constant changes to spending patterns to stay on track. No one knows for sure what will happen so there’s no guarantee for success only a statistical chance. Sure the market may average 10% in the long run but volatility affects you differently when withdrawals are needed for income, regardless of whether the market is up or down today.

 

 

In essence, suffer now or suffer more later. That may not be the kind of worry-free retirement plan you’re looking for. Find the Vanguard study here.

 

Furthermore, new variables that take into account market conditions at the time of retirement are given no consideration in current models. Low interest rates and high stock valuations create a double whammy. Low interest rates mean that the bond yields your portfolio will need to meet projections aren’t available in the current market. And currently high stock valuations increase the probability of a market correction that could spell early disaster for the most carefully designed market based retirement income plan.

 

The biggest problem to this approach, in my opinion, is the fact that a single strategy is applied to planning for the major financial threats we’ve talked about, namely longevity risk, market volatility and inflation. It all depends on the mood of the market, and not just now but every day for the next 20 or 30 years. If you had a choice, when would you like your retirement income to be reduced? I vote never. I’ll repeat myself, the traditional approach to retirement income planning has absolutely no guarantee of success.

 

Yes, if assets are sufficient, continued market participation will lend many benefits in retirement but could come at a steep cost if the majority of your assets are exposed. While you are working, current spending depends on your paycheck and market dips are affordable because you don’t need that money right now. Spending in retirement shouldn’t be any different. Income assets and growth assets should be held separate so you can get the most from both.

 

Separation of powers, so to speak, is an easier approach and will yield more for your future benefit. Next week I’ll come full-circle and talk again about how the pension-approach will alleviate much of the uncertainty when too much weight is given to an algorithm. Computers don’t care about your finances but I do.

 

Stay tuned for next week’s continuation of this series as I get to the point of it all.

 

Take care and have a great week!

 

Bryan J. Anderson