In a post-Madoff, post-Lehman, post-AIG world how have the rules of the road changed for financial services companies?

At this juncture in 2009, no one can know the breadth of change that lies ahead. But the change will likely be significant, nothing less than a tectonic shift. The repercussions will surely be felt for decades.

The world of retirement income will not be immune.

Before the recent market crash, retirement income distribution was viewed as the largest business opportunity in the history of financial services. Even after the massive losses in assets under management, it is still the largest business opportunity facing the insurance and financial industry.

But going forward, the manner in which industry professionals approach the retirement income marketplace may be significantly different than what would have believed or expected only a few short months ago.

At a recent industry meeting, for instance, some financial advisors made clear how deeply they have been shaken by the disastrous performance of the equity markets. This emotional impact was especially evident among advisors who have historically relied upon “accumulation logic” in their clients’ retirement income investing strategies.

For context, remember that growth in financial services has been driven by both a ceaseless focus on hopeful accumulation and consistent promotion of asset allocation and modern portfolio theory.

The boomer generation grew up in an investing culture of asset allocation. It was only natural that financial advisors who have been trained to believe that asset allocation is the cure to all investing challenges would tend to persist with accumulation investing strategies in the context of retirement income planning. Investment companies were generally eager to maintain the status quo.

Tools such as Monte Carlo simulation provided a sense of security around withdrawal rates that seemed reasonable if not conservative (for some, too conservative). Advisors repeatedly stated their comfort in recommending withdrawal rates of 6%, or 8% or more. Of course, no one planned for the level of investment losses that have since occurred. Now, Monte Carlo’s presumed sense of security appears false; that is cold comfort.

Systematic withdrawal plans, target date funds and managed payout funds have failed massively, and the collateral damage to many investors’ future retirement security is likely to be severe if not ruinous. In some cases, even bond funds used in asset allocation models as a hedge against equity losses produced significant losses in 2008.

There’s no doubt that many advisors have been deeply affected by the impact of investment losses on their clients’ retirement security.

Consider a retiree taking the recommended 4% withdrawal from a $100,000 portfolio of large cap equities beginning in 2000. By the end of 2008, the value of the retiree’s portfolio declined by approximately 60% to $40,720. Equally disturbing is the fact that, by 2008, the supposedly “safe” 4% annual withdrawal had become an effective 10% withdrawal (assuming annual withdrawals at the beginning of each year).

A significant percentage of advisors who have relied upon accumulation investing logic in their retirement income planning have now likely seen their retirement income worldview change dramatically. There’s a dawning realization that investing for retirement income is both more nuanced and more complex than many had realized.

On a large scale, advisors are beginning to understand the need for outcome-oriented investing strategies that serve to both identify and manage the spectrum of risks retirees face.
The new retirement worldview also recognizes the vital need for an enduring, outcome-oriented retirement income investing framework. The “framework” isn’t a product but rather is a strategy that is compliant, consistent, flexible and communicable.

Products are required to fund the framework, and they are combined strategically to achieve the optimum results. But, over time, products come and go. It’s the framework that endures. To the investor, the framework becomes the consistent, monitor-able roadmap for achieving retirement security.

It will be very interesting to see how product manufacturers respond to a new retirement income worldview. Some are already seizing upon new opportunities to position their companies advantageously in a marketplace undergoing rapid change.

The accumulation-driven approach to retirement investing is both incomplete and insufficient. Advisors are embracing a more thoughtful and strategic approach to retirement income investing and their clients are likely to be well served because of it.

The process of supplanting of the traditional asset allocation culture and its parallel product-centric culture may already be underway in favor of a transparent, technology-driven strategic investing framework that is inherently more relevant to retirees’ long-term needs.

The implications for advisors, broker-dealers and product manufactures are likely to be significant and long lasting.

David A. Macchia is president and chief executive officer of Wealth2k, Inc., Hingham, Mass. His email address is dmacchia@wealth2k.com.

Retirement Income Planning Focus

Before the 2008 crash

After the 2008 crash

  • Reliance upon “accumulation logic”
  • Accumulation investing strategies
  • Traditional asset allocation culture
  • Traditional product-centric culture
  • Target date funds
  • Managed payout funds
  • Bond funds used to hedge against equity losses
  • Monte Carlo simulation
  • Systematic withdrawal plans
  • Adopt outcome-oriented investing strategies
  • Establish an enduring, outcome-oriented retirement income investing framework
  • Use compliant, consistent, flexible and communicable strategy
  • Combine products strategically to achieve the optimum results
  • The framework becomes the consistent, monitor-able roadmap
  • Strategic investing framework is transparent and technology-driven

Source: David A. Macchia, Wealth2k, Inc., Hingham, Mass.