You may be familiar with traditional financial planning, which looks at your net worth, your cash flow, and then zeros in on your investment portfolio, or, if you don’t have one, draws up a plan to create an investment portfolio as the central focus of the plan. It looks like a pie chart, is called your asset allocation, and is comprised of stock and bond funds, typically in a +/- 60/40 split. Even employer 401(k) plans have been adding allocation and balancing tools to help you construct a better portfolio if you don’t have professional help.
As sensible as this sounds, focusing on an investment portfolio is not retirement income planning.
In this post we’ll discuss some key differences between saving for retirement, something we’ve been encouraged to do our entire lives, and retirement income planning, something that specifically addresses income during your non-working years.
Accumulation vs. Retirement Income
An investment portfolio is not a retirement income plan. It’s an accumulation vehicle. Retirement income is not about getting a maximum return on risky investments. It’s about creating a secure, risk-free stream of income for the rest of your life after you stop working and earning. The two are related, but they are not the same thing.
Retirement income planning sounds like something you might do decades after you start your savings, as you enter your golden years. In fact, it’s the essential underlying basis of a lifetime financial plan, setting the stage for all of your financial planning, including how to set up and how much to fund an investment portfolio. So it should start early, when you first begin saving and setting up investment accounts, and it will evolve as your life changes.
Every financial planner and advisor today understands how important retirement income is to their clients. Most will tell you that focusing on your investment portfolio will provide a more comfortable retirement, and can cite volumes of stats and studies about the relationship of long-term investing and retirement income. For these advisors, investments equal retirement income.
Over the past 30 years, the financial services industry has been busy developing methods for turning your savings into a managed investment portfolio. After all, selling securities and building client portfolios is what financial advisors do.
Retirement income has largely been an afterthought. There are countless studies about the appropriate balance between risky stocks and less risky bonds. There are dozens of short questionnaires to determine your ‘risk tolerance’ so the balance can be tilted towards your level of concern about market losses. There are software tools for optimizing portfolio risk and return. And there are other tools aptly named ‘Monte Carlo’ for projecting future probabilities and the potential for your portfolio to grow or fail based on a number of adjustable factors (‘educated guesses’).
There are practically no tools that allow you to understand and easily convert your earnings and savings into a secure risk-free or low-risk retirement income floor.
Instead of having a pie chart of risky assets at the center or your financial life, your family lifestyle should be at the center, with a focus on your earnings and savings as the keys to creating and maintaining your family’s current and future standard of living.
As skilled as they are at the art of accumulation, few planners and fewer financial advisors (brokers) understand the very different issues involved in creating secure retirement income. The standard solution from the industry for retirement income is to spend-down (sell off year-by-year) your portfolio, at +/- 4% a year, and hope it lasts. Market drawdowns can reduce your annual withdrawal amount and shorten the amount of time the portfolio lasts, increasing the risk that you may outlive your savings.
This systematic withdrawal approach works best (ie, with lower risk) for larger portfolios (generally, north of $1-2 million, which equals about $40-80k/yr in income), and simpler (cheaper) lifestyles. In other words, systematic withdrawal may not provide enough safe income for a long enough period for the typical affluent but not high-net worth family (less than $2 million is assets), who spends too much and has saved too little. This is a big risk to take when you are no longer working.
Creating Secure Retirement Income
There is a safer way. In creating a lifetime financial plan, we can calculate the ratio of your savings to your expenses, along with your estimated Social Security and all other household resources, to determine how well you will be able to fund your retirement income needs. Based on whether you are underfunded, constrained, or well-funded, regardless of your level of affluence, we can lay out the savings and investing approaches that will result in the highest amount of annual risk-free or low-risk income you can expect to achieve. Uncertain market results are not part of these calculations.
These income approaches include and can combine guaranteed simple immediate annuities, Treasury STRIPS or TIPS that mature in an annual ladder, laddered corporate bonds, perpetual preferred stock, and other low-risk income investments. If you have sufficient savings beyond what is needed to fund your income floor, then we can set up an upside investment portfolio with that amount above your income floor for discretionary and legacy purposes.
Lifetime financial planning with its underlying focus on retirement income creates a secure outcome—not just a hopeful bet on market returns.
We have left the era of the corporate pension behind, and are now firmly planted with both feet in the manage-it-yourself 401(k) era. In those days gone by, pension fund managers handled retirement income planning while you worked in the corporate garden. Now you’re on your own, and need more than the financial industry’s accumulation mindset to create your personal retirement income floor—your personal pension plan.
In this series of posts on Lifetime Financial Planning and retirement income management (see next post, “Charting the Differences Between Accumulation and Retirement Income”), I will discuss the broad approaches people take to retirement today, the risks we face during retirement, why retirement planning is important regardless of the kind of retirement you plan, how it can make a difference to you, and the Lifetime Financial Planning process step-by-step, so that you can become better informed about savings, investments, and creating a more secure retirement now, even while you are still working.
If at anytime during this series you have questions or comments, please feel free to comment below or to contact me directly via email, the contact form, or phone (201-741-9528—please leave a message and I’ll get back to you shortly). I’m happy to discuss retirement planning, goals, concerns, and lifetime financial planning any time.