With inflation at levels not seen in decades, clients may be fretting more than usual about spending plans, withdrawal rates and asset allocations. But advisors needn’t draw up entirely new plans with each new reading of the consumer price index, a panel of experts said Wednesday at the Morningstar Investment Conference in Chicago.
“I think we should resist this temptation that, just because we have an economic shock, we don’t have to throw out everything we know about retirement planning,” said Karsten Jeske, founder of Early Retirement Now.
Modelling is based on worst-case scenarios, he said, and U.S. inflation at 8% is clearly within those historical bounds.
Christine Benz, director of personal finance and retirement planning with Morningstar, said advisors shouldn’t assume clients are spending 8% more (or 6.8%, per the April inflation data for Canada) today.
Rather, advisors should undergo personalized spending calculations with retirees to have a better picture of how they’re affected. Some will be less vulnerable to high fuel costs, for example, if they aren’t travelling or driving on a daily basis.
Last month, in its latest projections for financial planners, FP Canada advised against adjusting the projected inflation rate to reflect the high current reading. The association said planners should assume an inflation rate of 2.1% for long-term planning.
The client’s age is also an important factor for adjusting spending, Benz said. Retirees tend to spend more in the active, early years of retirement and in the later years when more support is often required.
“Someone in the early phase of their retirement life cycle could potentially take more from their portfolio with the knowledge that their spending will naturally come down,” Benz said.
She also suggested a “variable withdrawal strategy” that adjusts amounts based on the market environment. This means withdrawing less when markets are down, as they are now.
For such a strategy to work, portfolios must be constructed in a way that ensures enough safe assets to draw upon so clients aren’t taking from depressed equity or fixed-income holdings.
Benz recommended having a “cash bucket” for this purpose. While inflation will eat away at cash holdings, the psychological value of showing clients that market volatility won’t disrupt their day-to-day or near-term plans is worth it, she said.
“Advisors don’t have to use buckets at all, but I do think it’s a helpful construct,” Benz said.
When asked about the standard 4% withdrawal rate, the panellists suggested most clients could start higher. Speaking about American clients, the panellists said too many don’t take their guaranteed income from government pensions into account in their plans.
“If you have very little guaranteed income and no flexibility, 3% is the new 4%,” said David Blanchett, managing director and head of retirement research with PGIM DC Solutions.
However, for those with guaranteed income to cover non-discretionary spending, 5% is a reasonable starting point, he said.
Jeske said many retirees can start with 5% or 6% withdrawal rates before scaling down, though this should be adjusted for age and the macroeconomic environment. Most clients wouldn’t want to be withdrawing 5% in the current market, he said.
While markets may be worrying retirees, Benz said clients in the accumulation phase may see a buying opportunity. Higher bond yields will add another dimension to portfolios.
“Potentially, savers could take the pressure off themselves a little bit,” Benz said. “But I think inflation is still a headwind which argues for maintaining ample equity exposure for people who are still in the accumulation/savings phase.”
The panellists also agreed that, despite the selloff in bonds this year, the standard 60-40 portfolio (or some modest adaptation thereof) still has legs.
Bond yields actually have some room to go down now, Jeske said, so clients should stick with bonds now that they may offer their diversification benefit again.