This article is part of a series; click here to read part One.
Let’s continue to review the last 3 guidelines
in the manifesto for my approach to retirement income planning.
Approach retirement income tools with an
The financial services profession is generally
divided between two camps: those focusing on investment solutions and those
focusing on insurance solutions. Both sides have their adherents who see little
use for the other side. But the most efficient retirement strategies require an
integration of both investments and insurance. It is potentially harmful to
dismiss subsets of retirement income tools without a thorough investigation of
their purported role. In this regard, it is wrong to describe the stock market
as a casino or to dismiss annuities or permanent life insurance as expensive
For the two camps in the financial services
profession, it is natural to accuse the opposite camp of having conflicts of
interest that bias their advice, but each side must reflect on whether their
own conflicts color their advice. On the insurance side, the natural conflict
is that insurance agents receive commissions for selling insurance products and
may only need to meet a requirement that their suggestions be suitable for
their clients. On the investments side, those charging for a percentage of
assets they manage naturally wish to make the investment portfolio as large as
possible, which is not necessarily in the best interests of their clients who
are seeking sustainable lifetime income and proper retirement risk management.
Meanwhile, those charging hourly fees for planning advice naturally do not wish
to make their recommendations so simple that they forego the need for an
ongoing planning relationship. It is important to overcome these hurdles and to
rely carefully on what the math and research show. This requires starting from
a fundamentally agnostic position.
Start by assessing all retirement assets and
A retirement plan involves more than just
financial assets. The retirement balance sheet is the starting point for building
a retirement income strategy. At the core is a desire to treat the household
retirement problem in the same way that pension funds treat their obligations.
Assets should be matched to liabilities with comparable levels of risk. This
matching can either be done on a balance sheet level, using the present values
of asset and liability streams, or it can be accomplished on a period-by-period
basis to match assets to ongoing spending needs. Structuring the retirement
income problem in this way makes it easier to keep track of the different
aspects of the plan and to make sure that each liability has a funding source.
This also allows retirees to more easily determine whether they have sufficient
assets to meet their retirement needs or if they may be underfunded with
respect to their goals. This organizational framework also serves as a
foundation for choosing an appropriate asset allocation and for seeing clearly
how different retirement income tools fit into an overall plan.
Exhibit 1.1 provides a basic overview of
potential assets and liabilities to consider.
Exhibit 1.1: Basic
Retirement Assets and Liabilities
Distinguish between technical liquidity and
An important implication from the retirement
balance sheet view is that the nature of liquidity in a retirement income plan
must be carefully considered. In a sense, an investment portfolio is a liquid
asset, but some of its liquidity may be only an illusion. Assets must be
matched to liabilities. Some, or even all, of the investment portfolio may be
earmarked to meet future lifestyle spending goals. Curtis Cloke describes this
in his Thrive University program for financial advisors as allocation liquidity.
Retirees are free to reallocate their assets in any way they wish, but the
assets are not truly liquid because they must be preserved to meet the spending
goal. Assets cannot be double counted, and while a retiree could decide to use
these assets for another purpose, doing so would jeopardize the ability to meet
future spending. In this sense, assets are not as liquid as they appear.
This is different from free-spending liquidity,
in which assets could be spent in any desired way because they are not earmarked
to meet existing liabilities. True liquidity emerges when there are excess
assets remaining after specifically setting aside what is needed to meet the
household liabilities. This distinction is important because there are cases
when tying up a portion of assets in something illiquid, such as an income
annuity, may allow for the household liabilities to be covered more cheaply
than could be done when all assets are positioned to provide technical
In very simple terms, an income annuity that
pools longevity risk may allow lifetime spending to be met at a cost of twenty
years of the spending objective, while self-funding for longevity may require
setting aside enough from an investment portfolio to cover thirty to forty
years of expenses. Because risk pooling and mortality credits allow for less to
be set aside to cover the spending goal, there is now greater true liquidity
and therefore more to cover other unexpected contingencies without jeopardizing
core spending needs. Liquidity, as it is traditionally defined in securities
markets, is of little value as a distinct goal in a long-term retirement income
plan. It must be true liquidity to count.
This is an excerpt from Wade Pfau’s book, Safety-First Retirement Planning: An Integrated Approach for a Worry-Free Retirement. (The Retirement Researcher’s Guide Series), available now on Amazon.
Originally posted at https://retirementresearcher.com/the-retirement-researcher-manifesto-part-two/