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December 09, 2014 at 07:00 PM
The percentage of Baby Boomers who are confident they will have enough money to live comfortably throughout their retirement years has dropped from 37% in 2011 to 33% in 2014.1 Boomers will clearly have to find ways to make their retirement dollars last for the remainder of their lives. Financial Advisors are now faced with the challenge of guiding millions of these investors into the next stage of life. Your challenges include the behavioral instincts and actions of clients who believe they can do it on their own or with the marginal help of low-cost providers who fail to address the tendency of impulsive investor behavior in a volatile marketplace.
If a lack of retirement savings isn’t enough of a roadblock to your clients’ secure future, then the uncertainties of inflation and market conditions loom along a retirement journey that could stretch for several decades. Your clients’ assets will have to work smarter to produce income and earn the real returns that could produce long-term positive outcomes. Many clients are in a quandary because they fear another market downturn, yet they cling to the standard definition of diversification—which forces them into levels of volatility that their instincts simply cannot withstand. This belief that financial management strategies that work on a spreadsheet but fail on Main Street will somehow succeed next time a crisis arises is not only misguided, but irrational. This is where the value of a knowledgeable Financial Advisor becomes indispensable.
Boomer Retirement Income Risk:
- Inflation
- Negative Real Rates of Return
- Traditional Definition of Diversification
Inflation Risk and the Boomer Cohort
Inflation has shadowed the Baby Boomer cohort that emerged in the 1940’s. The trend of inflation eroding the real rate of return in your clients’ portfolios will likely continue throughout the decades of their retirement. When you consider the rate of return in your clients’ portfolio, does that return take into consideration the erosion of purchasing power due to inflation?
Reaching for Real Rates of Return in a Low Interest Rate Environment
Retirees with money in savings accounts or bonds that pay current low rates of interest are very likely losing in terms of the purchasing power of their savings, due to inflation.
As Financial Advisors, we have to open our clients’ eyes to the real rates of return they are earning. Here’s a simple formula you can use to show your clients how the “real interest rate” of an investment is calculated as the amount by which the nominal interest rate is higher than the inflation rate.
Real Interest Rate = Nominal Interest Rate – Inflation (Expected or Actual)2
An investor cannot control inflation, but a Financial Advisor can suggest investments in a range of asset classes, such as alternatives, that have the potential for long-term protection against inflation.
Traditional Definition of Diversification*
Portfolio construction can make a significant difference in performance, particularly during the retirement drawdown phase. If a retiree expects to have their retirement nest egg last a lifetime, or maybe two lifetimes, it’s critical to look beyond the standard 60-40 Stock/Bond mix and 4% inflation-adjusted withdrawal each year during retirement. As more investors begin to realize that the old ways aren’t working, Financial Advisors have to look to alternative investments to assist in producing potentially positive portfolio outcomes and reduce negative do-it-yourself investor behavior.
