Sometimes a sub-optimal solution is almost as damaging as the problem itself. Financial advisors appropriately want to help assure that their retired clients do not have to sell equities at depressed prices. Retirees who need income every month to meet regular expenses cannot wait for a market recovery: They need money now, as well as in 30, 60 or 90 days. So advisors need a strategy that produces regular income, but avoids having to sell equities in down markets. There are two strategies advisors are using that are sub-optimal solutions.
Some advisors put a significant amount of money in cash and use it as a “stash” for the client’s monthly living expenses. This approach requires that an amount of money not be invested, meaning it is not producing income for the client. The overall return on the client’s portfolio is therefore driven down.
A more common approach is to put a significant amount of money in bonds. Most advisors I speak with say that they plan on increasing the allocation to bonds as their retired clients age. But high allocations to bonds reduce the potential return on the portfolio. And as the bond portion increases, the expected return decreases. Furthermore, inflation increases the cost of living in retirement and many older people face significantly higher costs in older age for pharmaceuticals and long-term care. Higher costs later in retirement, combined with reduced returns, obviously cause problems.