FOR MOST CLIENTS, CRUCIAL financial decisions come toward the end of their lives. Not only do they have to determine when to retire, but they have to find a means to pay for it without depleting their savings too soon.
Instead of simply allocating assets in stocks and bonds and using occasional withdrawals to create retirement income, researchers such as Moshe Milevsky, professor of finance at York University in Toronto, have suggested that financial advisors encourage their clients to allocate those assets among a variety of retirement-income options.
MAIN ISSUES
Milevsky’s book, Pensionize Your Nest Egg, recommends placing retirement assets into distinct product categories, or silos, each with unique features and guarantees designed to take the edge off the main issues facing retirees: watching inflation nibble at their money, losing too much too early in a “down” market without the time to make it up, leaving a legacy or simply living longer than the retirees had bargained for.
In a recent research paper, entitled An Efficient Frontier for Retirement Income, Wade Pfau, professor of economics at the National Graduate Institute for Policy Studies in Japan, takes this product-allocation concept one step further. He provides a framework to help your clients grappling with these decisions choose from among stocks, bonds, inflation-adjusted/fixed single-premium immediate annuities (SPIAs), and variable annuities having guaranteed living benefit riders (GLWBs).
Although Pfau had looked at different retirement scenarios, his preferred case study focuses on a 65-year-old heterosexual couple with a social security benefit equal to 2% of their assets as of their retirement date. To meet their lifestyle goal, the couple needs to generate additional income equal to 4% of these assets.
In Pfau’s research, he illustrates how 1,001 product allocations perform in meeting the couple’s objectives, then identifies the “efficient frontier” of product allocations.
This efficient frontier indicates the blends that support the highest reserves of financial assets for a given percentage of spending needs or, alternatively, the highest percentage of spending needs that can be satisfied for a given reserve of remaining financial assets.
NO NEED FOR BONDS?
In Pfau’s preferred case study, the couple would be best served by combinations of stocks and fixed SPIAs. In fact, at current product pricing levels, he suggests, there seems to be little need for bonds, inflation-adjusted SPIAs or products with GLWB riders – a conclusion that is somewhat at odds with current retirement planning practice.
These results are specific to the case study in question, of course. Varying lifestyle goals, minimum spending needs, age, gender and the marital status of the retirees all could change which product allocations are on the efficient frontier.
Pfau’s recommendation is not that older clients should dump all their bonds in favour of stocks and/or fixed SPIAs. Rather, he recommends that a retirement portfolio completely ignoring bonds in favour of SPIAs should not be rejected out of hand simply because current interest rates are so low.
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