Managing Risk to Create Retirement Income

In turning its attention from accumulation to decumulation, the 401(k) industry created new products to solve income needs, but they came with significant disadvantages, according to the presenters from Milliman during a session at Schwab Impact in November.

Ken Mungan, head of Milliman’s financial risk management practice, and Janet McCune, principal and leader of business development and communications for the Milliman Southern Employee Benefits Practice, described the strategy Milliman has developed to help advisors overcome the myriad risks clients face once they begin taking withdrawals from their retirement accounts.

First, of course, is market risk. Volatility, sequence of returns and behavior all affect market risk.

“Sequence of returns comes into play when withdrawals begin,” Mungan said. When the market is down, clients are depleting their portfolios at an accelerated rate.

Volatility forces clients’ hands when they react to market drops by jumping into cash and missing the rebound. Mungan said that in addition to losses incurred in the drop, missing that rebound reduces returns by another 2%.

He offered an example of how difficult it is to change behavior with a story of his home life. In all the years he’s been married, he began, his wife has made several suggestions for ways he could change his behavior that he has never followed. “To be fair,” he joked, “she hasn’t changed either.”

He said to the audience, “If you can’t change your behavior for your spouse, you’re not going to do it for an investment product.”

Inflation risk is another challenge retirees face when they start drawing down their portfolios. Mungan noted that the oft-touted 4% rule works when the client has a large allocation to bonds, but by changing the risk management technique used on the portfolio, an advisor can “dramatically improve” upon the 4% rule.

Milliman uses managed risk equities to address those challenges. The 4% rule isn’t based on sophisticated models; just the simple assumption that inflation will be in place forever, “usually around 2%,” Mungan explained. He called that strategy “inflation pre-funding,” claiming a large portion of clients’ portfolios will go to inflation.

A contingent growth strategy, however, uses managed risk equities to provide an alternative to inflation mitigation. Higher inflation typically comes with an increasing stock market over time; those higher equity returns will offset higher inflation.