From the May 2008 issue of Boomer Market Advisor • Subscribe!

Maximize return without minimizing lifestyle

An important trend is taking place, and it's not getting sufficient attention: the growing proportion of people entering retirement are lifestyle minimizers, rather than lifestyle maximizers.

What do I mean by a lifestyle minimizer and maximizer? A minimizer is someone who places a strong emphasis on financial security and is willing to cut back on spending to be financially secure. Lifestyle minimizers place a strong emphasis on keeping their assets at the same level with which they started retirement. They'll sacrifice the travel, good restaurants and the updated wardrobes in order to do it. They have high tolerance for frugality. Lifestyle minimizers put an emphasis on saving and an even stronger emphasis on avoiding debt. They abhor credit card debt and try to pay off their mortgages before retirement.

Minimizers are terrific clients. They do not demand the best performance. They tend to be willing to reduce lifestyle in a down market without complaint. They are often too conservative in their investing, but are willing to live with the consequences.

Lifestyle maximizers, on the other hand, place an emphasis on having the highest quality of life that they can manage on their income and assets. Maximizers do not save as much as they should, because they are reluctant to give up current consumption for their future financial security. Many boomers are maximizers. There is a school of thought called "habit theory" that postulates spending and lifestyle patterns are difficult to reverse. It is likely that boomers will bring their maximizing habit to retirement. The fact that boomers have under-funded their retirement will make it harder to maintain their lifestyles once they stop working, but this does not mean they will readily accept a lower lifestyle.

New financial strategies will need to be developed in order to accommodate maximizers. I recently conducted a survey of advisors and found that most believe retirees' portfolios should be comprised of no more than 50 percent equities at the start of retirement. I recognize the need to protect retirees from stock market declines, but high levels of fixed investment will reduce overall return. That's alright for minimzers, but not for maximizers.

Hence, the need for new strategies. The idea that portfolios should become more conservative with age will have to be replaced. After all, if a couple enters retirement in good health at age 65 there is a 25 percent chance that one of them will be alive at age 97. Even if they accept a 25 percent chance of running out of money, a level of risk that most maximizers reject, I think cutting back on return with a 32-year time frame is, at best, premature. The goal should be to prudently maximize the level of equities in the portfolio.

There are a number of ways to do this, including more effective strategies for producing income, more complex methods of developing an asset allocation strategy and more effective use of guarantees. Monte Carlo analysis suggests that a person retiring at age 65 should withdraw no more than about 4 percent of his accumulation to be reasonably assured of not running out of money. This means the person who accumulated $1 million should start by withdrawing $40,000 each year. This Monte Carlo analysis presumes a portfolio that is 50 percent equities. For lifestyle maximizers, financial advisors will then have to come up with strategies that prudently produce more than a 4 percent withdrawal rate. The good news is that there are plenty of ways in which to do this.

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