In a story as poignant as it is telling, an Illinois wealth manager related that he and his two sisters must now provide for their retired parents' financial security.
"My parents' case is what inspired me to get into this business," said 42-year-old Joseph Guin of Guin Financial in Vernon Hills, Illinois, who advises nearly 100 clients, each with a minimum $1 million in investable assets.
His dad owned a small but profitable handyman remodeling and construction company. However, when he was in his early 50s, the real estate firm that had been his main client decided to bring the handyman operation in-house. With few other clients to fall back on and no financial representative to guide them, Guin's parents, who put three children through college and paid for two weddings, eventually lost their home and savings.
Today, the dad, 66, and mom, 60, live with a daughter and son-in-law. With no pension, no retirement savings, and no other assets (liquid or illiquid), their income consists mainly of monthly Social Security checks, which must cover about $600 in monthly prescription costs. The three children pitched in to take out long-term care insurance and life insurance, and are paying the premiums. The mom works part-time for her advisor son and receives medical coverage.
Rues the younger Guin, "They had nothing to show for all their work at the end. They didn't have good counsel." A looming question for the family is how to provide for mom and dad for the next 10, 20, or even 30 years.
According to the 2008 Retirement Confidence Survey by the Employee Benefit Research Institute, one in four Americans 55 adn older report liquid assets of less than $10,000, and 43% have less than $50,000. News flash! A nest egg that size will likely be woefully insufficient.
This year, the first wave of baby boomers reaches 62, the age when they are first eligible for Social Security retirement benefits. This 78 million-strong cohort will define and re-define retirement and what it means to grow old. As they do, they will raise an age-old issue with new-age ramifications: outliving one's wealth. Called longevity risk, this issue adds another facet to the already loaded definition of risk. For boomers, it's encapsulated in the question, "Will we run out of income before we run out of steam?"
According to the latest figures from the National Center for Health Statistics, U.S. life expectancy reached 77.8 years in 2004, nearly 10 years more than it was when the first boomers were born. With ever-improving health and medical care, what might life expectancy be in 18 years, when the trailing edge of the 1946-1964 baby boomer generation reaches Social Security eligibility? It's entirely feasible that people who worked and saved 40 years, from age 25 to 65, will find themselves living 30 years in retirement. A few, whose number increases every year, will live 40 years or more after reaching traditional retirement age, or as many years as they worked.
What theories and strategies should advisors and retirees rely on as you consider the new risk of longevity to a retirement portfolio?
In his 1996 best-selling treatise on risk, Against the Gods, author Peter Bernstein stated that "risk" had become synonymous with "variance." He referenced the work of Harry Markowitz, who used the concept of risk to help construct portfolios for investors who wanted to maximize returns but avoid variance, i.e., risk. A mathematician, Markowitz put a number on investment risk by computing how widely returns on an asset swing around their average: the standard deviation. An efficient portfolio, he said, is the average of the expectations for each of the individual holdings, any one of which may disappoint while others exceed expectations.
Thanks to Markowitz, who won a Nobel Prize in Economics in 1990, modern portfolio theory drives much of today's investment strategy. But Bernstein's book, regarded just 12 years ago as the preeminent account on risk, is conspicuously silent on the topic of longevity risk. If you've been used to managing only volatility, then you will need to expand your notion of risk and refine your role, responsibility, and relationship with your clients.
The Key Role of an Advisor
In Palisades, New York, Northwestern Mutual Financial representatives Chandresh and Uma Shah help their clients wrestle with the complex issues of longevity risk by asking a single question, "What level of income, if it were to drop for any reason, would give you concern about your financial future?"
The husband and wife duo, who jointly have more than 40 years experience in the business, multiplies that number by 1.5 and then helps their clients plan for that amount of income. Most have assets that make such planning relatively easy. The Shahs have discovered that many clients want to use their wealth to leave a legacy for either charity or their heirs. Still other clients need help with retirement planning when the unexpected occurs. Such was the case with a single retired school teacher who married for the first time at age 68.
In this case, Uma Chandresh relates, the man had already retired and taken a single-life annuity pension that could not be passed on to his new 55-year-old wife in the event of his death. She makes $80,000 per year; his income is $60,000 annually. They own $500,000 in real estate but have few other assets.
At issue was determining how best to provide for their retirement as a couple, as well as how leave a legacy for her two children and grandchildren. The Shahs addressed the issue with a $1 million life insurance policy for the husband that will, in turn, provide for the wife after his death.
In another case, the Shahs tell the story of a retired couple, ages 68 and 60, whose children are literally purchasing their own inheritance. Using the Shah's formula, the couple determined they needed $5,000 per month for living and travel expenses. Their house is paid for, but between their 401(k) withdrawals and Social Security, they were short of their goal by more than $1,000 per month. The couple's two successful children, both physicians, decided to gift their parents $1,000 per month. They say it's appreciation for the many opportunities their parents provided them. In return, the parents named the two children beneficiaries on their life insurance policy and their home.
Lessons from the Institutional Side
To sharpen its own perspective on longevity risk, Russell Investments turned to its nearly 40 years' experience of advising and managing large, institutional assets. Two recent events have shaped institutions' view of risk. The first was the combination of disastrous financial markets and decreasing interest rates that prevailed between 2000 and 2002. The second was passage of the Pension Protection Act of 2006, which among its many effects set a higher bar for institutional reporting of pension fund liabilities and assets. As a result of these two events, institutions are now refocusing investment attention less on maximizing returns and more on matching investment strategies to liabilities. That is, they are concentrating on how much annual income they need to meet present pension plan obligations.
Retired individuals face a similar liability. A retiree's number one concern at retirement is that she does not want to outlive her money. Like a pension fund, retirees want to make certain their assets in retirement will provide enough annual income to last them the rest of their life, a paradigm that dramatically changes their attitudes toward investing.
In response to this shift, financial institutions such as Russell Investments and others are rolling out new mutual fund products that will help retirees draw a steady stream of income from their investments. Generically known as "distribution funds," they carry product names such as retirement distribution, income replacement, and managed payout. The funds have slightly different objectives. Some provide a stable income while preserving principal; others dip into the principal in order to deliver larger payouts over a targeted number of years. Unlike annuities, the payouts are not guaranteed. On the flip side, the investor retains ownership and control of his assets, which allows him to sell it any time if plans change. That's a plus if the fund exceeds projections or if the investor intends to transfer ownership to heirs or a charity.
One advantage of distribution funds for an individual investor is that once the inputs are set, there's little an advisor or client need do but monitor the portfolio to ensure it performs as advertised. But what about the non-average investor? What about managing other forms of risk or the unexpected? For that, clients must turn to the expertise and creativity of their financial advisor.
Working in Retirement
Kirk Greene runs Greene Wealth Management, LLC, an independent registered investment advisory firm in Seattle. He began his career 30 years ago selling life insurance, then moved into wealth management in the 1980s when barriers between insurance and consulting began to fall.
At age 54, Greene is a boomer himself, and he knows the statistics by heart. "Beginning in 2011, a boomer will turn 65 every eight seconds," he recites.
"Eighty percent of our clients are boomers," he says. Even though Greene's clients represent the top decile of assets saved, he says longevity risk still is one of the most important topics of all. "We're talking with our clients about this every single day."
To focus on what his clients really want and need in retirement, Greene takes a prescriptive approach. He asks his clients two questions: "What do you envision retirement being?" and "How much spendable income will you require?"
To the first question, many clients answer that they may want to work, but perhaps not as many hours. Some want to work three days a week; others are looking for three months on and three months off or some other combination. Others may wish to pursue a totally different career or even serve as a volunteer. (For more on this issue, see Olivia Mellan's column on page 89.) To the second question, Greene says initial reactions rarely hit the mark. "This is not an easy number for people to compute," he notes. He helps clients hone in on an after-tax spending target: what they need to meet their living, luxury, and charitable giving requirements in today's dollars. Coming up with a realistic spending target is paramount, Greene emphasizes. It takes time and a careful review of current spending habits.
Once the income target is set and resources known, Greene runs a post-retirement analysis. Employing Monte Carlo simulations, Greene forecasts rates of success if the client were to live to age 95. While that may sound conservative, Greene says it's a good starting point for discussion. He suggests periodic reviews to make sure the client stays on track.
"The problem is, if you are wrong, and the client runs out of money while he is living, it is not just a bad outcome, it is a catastrophic failure," Greene said.
Greene's opinion is that eight out of 10 boomers are ill-prepared for retirement. "There are going to be a lot of people who simply don't have enough money," he said. "They may say they like working, but the fact is they may not have a choice. They may work on a reduced schedule, but they need the money." (For more on Greene's approach to working in retirement, and on Ken Dychwald's research on this topic, see the sidebar "Retirement and Working.")
The Three Rs of Advising
As the definition of risk evolves to include longevity, it is changing the role, responsibility, and relationship between advisors and clients. Your role is to engage with clients on development of a long-term plan and then allow product choices to fall out of that, not to make a firm's products roll up to a client's long-term plan. Your single most important responsibility toward your retired or soon-to-be-retired clients is to help them visualize a future income requirement and figure out where it's going to come from. Finally, your relationship with a client should be such that if future expectations are unrealistic, then you are positioned to coach a client on how much and how soon they need to modify their lifestyle. This may include considering post-retirement employment.
Investors need someone who can provide a high level of planning, discipline, and reassurance. More and more understand that they need just one person they can trust who's going to help them have confidence in their plan, and who can help them stick to it in times of high anxiety.
While all of this could be your biggest challenge, it coincides with an even bigger opportunity, that of serving the next generation of retirees and helping them improve their financial security.
Tim Noonan is managing director, individual investors product and advice group, for Russell Investments, headquartered in Tacoma, Washington. He can be reached at email@example.com.