Traditional Asset Management Does Not Work For Retirement Income Planning

10 Year Average Returns Are Not A Safe Guide F...
10 Year Average Returns Are Not A Safe Guide For Retirement Income Planning

Now that we know the major threats a portfolio will face through retirement, it’s time to look at the traditional approach to conquering those challenges.

As you work and save for retirement you are taught to be flexible and 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.

These asset accumulation strategies fail to offer the kind of assurances investors need when it’s time for those assets to support you entirely. These traditional management strategies will have a place in a well-balanced portfolio, but not the leading role that the major management firms would like you to believe.

Regardless of how traditional asset management advice has worked for you to date, there is good reason 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 of the 4% Withdrawal Rule was published in the Wall Street Journal recently. And This Recent Post explores the topic further.

In summary, recommendations based on complex computer models have traditionally 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. 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. Recent market performance models now put safe withdrawal rates at just 1.5% to 2% of a portfolio, or recommend drastically reducing consumption in bad years.

The first red flag is the ‘probability of success’ attached to a strategy when the computer spits out your numbers.  And most distressing is the sheer random, insecure nature of a total reliance on the markets….

The Problems With Probabilities:

When you put your faith in a system with a low probability of success, market fluctuations will require income adjustments and constant changes to spending patterns to stay on track.

As we understand from the previous page, there are numerous financial threats in retirement.   And with a statistical model, there is 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.

The Vanguard study noted in the article further asserts the point this way: If investors are relying on either gains in the stock market or bond-market yields to make their money last, “then investors must either accept continuous, relatively smaller changes in spending or else run the risk of having to make abrupt and significantly larger adjustments later.” Feel free to download read the Vanguard study here.

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

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.

So what is “probability of success”? In realistic terms, it is the chance of failure.  When it comes to retirement income and taking care of your basic expenses, failure is unacceptable.  Why expose yourself to probability risk at all?

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.

Your income therefore 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 asset management approach to retirement income planning does not work, because it has absolutely no guarantee of success.

It is true that if assets are sufficient, continued market participation will lend many benefits in retirement.  But this participation 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 separately 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 I will come full-circle and talk again about how the pension-approach will alleviate this unacceptable ‘probability of success’ that is inherent when too much weight is given to an algorithm. Computers don’t care about your finances but I do.

Carry On To See The Solution…..