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Retirement Income Reporter: Coping with Limits

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The recent past was grand. Boomers don’t care for limits. Boomers create excess with everything they touch. Not only do their large numbers create this excess quite naturally, they had to leverage it with the largest amount of absolute and relative debt in recorded history. Total credit market debt may stand at 350 percent-plus of our GDP. Federal entitlement promises and obligations may be even larger that the GDP of the entire world!

The near future will be less grand. Will boomers be the only ones feeling the negative consequences resulting from their narcissistic insanity, their lack of self-restraint, their profound love of self at the expense of all others and all other responsibilities?

The debt balloon has been pricked in many places. The air is coming out. This ebbing tide will strand many. Both the good and the bad will suffer from it, including those who thought they were making good decisions and taking reasonable risks.

Here are some key questions about what we may anticipate:

- Where is the “economic frostbite” likely to be felt first?

- What products, services and businesses are not likely to come back?

- Where is the “economic gangrene” likely to develop?

- Where will the new positive cash flows come from?

- Where will innovation and productivity growth come from?

This article looks at the sources of uncertainty that limit our ability to answer these questions with precision. Remember, in order to survive uncertainty, it is better to be approximately correct than precisely wrong. A lack of precision is not necessarily a bad thing.

So, what are the sources of uncertainty that are factored in our decisions whether we make explicit (and perhaps precise) forecasts of them or not?

Using RIIA’s risk matrix shown (above) in Table 1, let’s examine the three broad categories of risk factors as well as their main features. What risks have moved to the forefront and therefore replaced traditional investment accumulation risk concerns? What risk factors have changed and will materially affect our clients?

- Have new hazards developed?

- Are we exposed to these hazards where we were not before?

- Have the consequences of exposure changed?

- Have our probabilities of experiencing positive consequences dimmed?

- Have our probabilities of meeting negative consequences increased?

Here is a sample of the questions that arise during RIIA’s teleconference calls where the membership convenes to discuss the reality that we see, the trends that we fear and the outcomes that we want to create. Remember that these questions are asked with two time frames in mind: First, what will the answer be for this year? Second, what will the answer be five or 10 years from now?

Political Risks

Do you expect:

- More or less inflation than the long-term average?

- Higher or lower tax rates on those who pay taxes?

- More or fewer taxpayers as a share of the total population?

- A cyclical business recession or a government-engineered depression?

Business Risks

Do you expect:

- More or less global trade?

- More or less economic productivity? more or less technological innovation?

- Higher or lower oil prices?

Personal Risks

Do you expect:

- More or less physical violence in the world?

- More or less physical violence in your neighborhood?

- Higher or lower mortality rates?

- Improving or worsening health levels?

Using RIIA’s risk matrix in the context of these questions and choosing a single, most important risk factor for each of the top-level political, business and personal risk categories shown on the x-axis, let’s look at an example of change that may materially affect our clients. Focusing on the three factors of inflation risk, market risk and longevity risk was a commonly held and reasonable view of the risk profile of accumulation-driven investors. Given the recent changes in American governance, public policy risk (tax risk in particular), issuer risk and personal health risk may become the new consensus risk profile for the average retirement income investors.

You may also take the analysis one level deeper by looking at risk dimensions shown on the y-axis to ask and to answer the following questions:

- Do I see new hazards for retirement income that were not present in accumulation?

- Am I, or are my clients, exposed to new hazards?

- Have the negative consequences of this exposure to old and new hazards increased or decreased?

- Have the probabilities of suffering these negative consequences increased or decreased?

We answer these questions consciously by what we say and what we write. We also answer these questions implicitly by what we do. It is important to pay attention to these questions because making good decisions means taking reasonable risk.

Some people lied, cheated and defrauded others and some are now meeting the consequences of their actions. It is hard to feel very sorry for them.

Some people took crazy risks and some of them met with the expected consequences. We can feel sorry for them but should they not be held accountable for their decisions and their actions?

Some people made good decisions — optimizing decisions — and took reasonable risks. Things changed on them. Rather than keeping the playing field level, authorities seems to be playing “Calvin ball” where the rules change as the preferred player wins or loses. Reasonable risks became un-reasonable risks. Not only should we feel sorry for them but we should also find out how not to experience the same fate.

When Things Crash

Many, if not most, crashes involving complex machinery (airplanes, automobiles, computer software, etc. — should we add investment portfolios to the list?) are eventually attributed to “operator error.” How can we keep problems limited to the level of un-avoidable operator error?

The good news is that there is an answer. We saw this in action with the airplane that ditched successfully in the Hudson on a freezing day in January 2009. The pilot was trained. The crew was trained. They did what they were trained to do. They did it successfully. The odds were overwhelmingly against them. They still did it successfully.

This is a lesson for us in the financial advice business. What should we train for? Are we sufficiently trained? Will we be able to do the right thing when what we trained for is called into unexpected action?

RIIA believes that the traditional curriculum of investment accumulation is an insufficient body of knowledge for retirement income. We need to train for something bigger. RIIA believes that financial advisors need more training than they currently have. Financial advisors will need to be vigilant as one-size will not fit all and set-and-forget will be stressed to the breaking point by wild randomness. A narrow focus on financial assets will not be sufficient to answer the needs of retirees. We need to train not only for optimizing decisions, but also for decisions that bring resilience and reliability.

Francois Gadenne is chairman and executive director of the Retirement Income Industry Association in Boston; see