Where to begin? There’s so much going on in the world of retirement planning it seems almost impossible to find solid answers for the questions challenging advisers and consumers as the business of spending an accumulated nest egg becomes a reality for more people every day.
To help you make sense of it all, this issue of the Retirement Management Journal® (RMJ®) showcases tools developed by the Retirement Income Industry Association® (RIIA®). In particular, you’ll see signposts that highlight the RMA® curriculum as well as discussion of the Household Balance Sheet View℠.
The selected papers focus on two of the four signposts introduced in the Winter 2014 RMJ: the RMA Toolbox and the Client Diagnostic Kit. Further definition and understanding of RIIA’s Advanced Adviser Education can be garnered from RIIA’s website.
Now, to the papers… I am proud to announce that Dirk Cotton, author of The Retirement Café blog and owner of JDC Planning, LLC, in Chapel Hill, N.C., is the winner of this year’s Practitioner Thought Leadership Award. In his paper, “Sequence-of-returns Risk: A New Way of Looking at Spending or Saving Scenarios with Path Dependence,” Mr. Cotton notes that financial advisers would be well served to better understand sequence-of-returns (SOR) risk. But not in the usual way.
To some, Mr. Cotton writes, SOR risk means the probability that a retiree will outlive her retirement savings portfolio as a result of a series of poor portfolio returns soon after retiring. To others, it refers to the variance of portfolio terminal portfolio values resulting from path dependence, whether or not that variance results in portfolio failure.
What is path dependence? According to Mr. Cotton, path dependence refers to spending or saving scenarios in which portfolio value is a function of the order of portfolio returns. “Path dependence can lead to portfolio ruin, but it doesn’t always,” Mr. Cotton wrote. “Path dependence can even increase a portfolio’s balance beyond its expected value. Path dependence can help or harm, but in either case it is uncertain, and that is the financial definition of risk.”
Two papers about systematic withdrawal plans and how to improve them also deserve your attention. One is written by a team of authors from PricewaterhouseCoopers (PwC) and the other written by a team of authors from Milliman.
Leveraging agent-based simulation and their unique Retirement Income Model, the PwC team presents an alternative to the time honored and often-misunderstood 4% safe withdrawal rate. They highlight the importance of managing a client household’s “fundedness”, rather than focusing on a withdrawal rate. The PwC paper highlights the importance of differentiating recommendations by market segment and taking into account a client’s entire household balance sheet, household behaviors, sequence-of-returns and sequence-of-consumption risks, the impact of capital markets, the economy and shocks rather than focusing on a market-driven withdrawal rate.
The team of authors at Milliman explores how to improve upon the sustainable withdrawal rate. In their paper, they present a stochastic modeling approach to calculate a sustainable withdrawal rate derived from two risk management strategies: 1) the traditional 4% rule approach, which uses fixed allocation to stocks, and a large allocation to bonds, to generate income and manage risk, and 2) the managed risk 6% rule approach, which relies on managed risk equities to generate income and manage risk.
In their paper, Milliman further illustrates that the key to creating a sustainable retirement income, and overcoming the fear of running out of money in retirement is rooted in the effective management of three fundamental risks facing retirees: market risk, inflation risk and longevity risk.
Continuing the theme of bringing solutions to making the nest egg last, we have a paper from TIAA-CREF, “Thinking Past Savings: Research from TIAA-CREF Reinforces the Need to Focus Clients on Reliable Retirement Income,” which shares highlights from their proprietary “2015 Lifetime Income Survey.” Findings from the Survey confirm Americans continue to be challenged to save and to plan, even though security in retirement is a top priority. In addition the paper provides guidance to advisers on where they can uniquely help their clients build a secure “floor” through understanding the value of certain products. By recognizing the uniqueness of each client’s household balance sheet, the effects of market changes coupled with unique shocks to the client’s plan, the paper offers advisers insights to helping their client adjust as needed and build a secure retirement.
To close this issue, we look beyond today’s retirees and consider the future in “Generation X and Y as the New Wealth Holders: The Implications of a Generational Shift in Financial Advising Clientele.” With the current client base spending down assets, how does an adviser grow a practice? Relationships have always been important to retaining clients, and building cross generational relationships with the children of current clients bring new challenges to the adviser. This paper demonstrates the value of figuring out the next generation in order to capture a growing wealth that’s just beginning to show its potential.
There’s much to read in this issue, an issue that not only advances and adds to the body of retirement-planning knowledge but also offers information that financial advisers and others can put into practice in the real world.
As always, Kim McSheridan, our assistant editor, and the RMJ staff and volunteers thank you for supporting the RMJ. Authors please consider submitting papers for consideration in future issues. Members don’t forget to distribute the PDF version of the RMJ to your constituents.
Robert J. Powell, III
Editor & Publisher, [email protected]