Retirement Risk Redefined

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 protected].