The education that financial advisors receive today, while providing the tools and skills needed to help workers build a nest egg, is inadequate to a critical task of planning: ensuring a sufficient income throughout retirement.
This shortcoming, say Dirk Cotton and François Gadenne, can be attributed to the fact that traditional financial planning concepts fail to incorporate, among other things, retirement risk allocations — and thus income protection products like life insurance and annuities — into their models.
To learn more, LifeHealthPro Senior Editor Warren S. Hersch interviewed Cotton and Gadenne, two thought leaders who are endeavoring to plug the protection gap in advisors’ education. Cotton, a retired executive of a Fortune 500 technology company, researches and publishes papers on retirement finance and regularly posts on retirement finance issues at his blog, The Retirement Cafe.
Gadenne is co-founder, chairman and executive director of the Retirement Income Industry Association (RIIA). The Boston-based non-profit provides discussions, communications, research, education and standards to help investors, distributors and manufacturers transition from investment accumulation to retirement management and income protection. The following are excerpts from the interview.
Hersch: Dirk, my congratulations to you on winning the 2015 RIIA Practitioner Thought Leadership Award for your new paper, “Sequence of Return Risks: A New Way of Looking at Spending or Saving Scenarios with Path Dependence.” What do you discuss in the paper?
Cotton (pictured at right): My paper is about the difference between probability of ruin and path dependence, a distinction often overlooked in financial literature focusing on sequence of return risk.
To some people, sequence of return risk refers to the probability that retirees will outlive their retirement savings — the probability of ruin — due to poor portfolio returns soon after retiring. To others, the risk describes the variance of terminal portfolio values or TPVs resulting from “path dependence” — an outcome determined by the order of events — irrespective of whether the variance leads to portfolio failure.
Thus, you can have path dependence without portfolio failure and portfolio failure without path dependence. You could, for example, run a 30-year period of returns through an SWR [sustainable withdrawal rate] model and come out with a successful portfolio result. You can reverse the same returns and have a poor result. The order of investment returns determines, to a large extent, whether or not you will run out of money. Hersch: This paper, I understand, is appearing in the spring 2015 issue of RIIA’s industry publication, Retirement Management Journal. Francois, what’s RIIA’s overarching mission?
Gadenne (pictured at right): RIIA is charged with discovering, validating and teaching the new realities of retirement. The founders, of which I’m one, draw an important distinction between retirement and investment management, a difference that other associations serving advisors often fail to make because of their biases and imprecise use of language.
A prime example of the last is the term “decumulation.” The opposite of accumulation, the word clearly betrays a bias of the investment management world.
Yet, an analysis shows that many retirees are net savers and do not “decumulate” in retirement. What we’ve observed of this demographic is, rather, a series of disconnects — disruptions like unexpectedly high healthcare costs in retirement— that can negatively impact what we call the household balance sheet.
Hersch: Is the investment management bias you describe reflected in the training financial planners receive?
Gadenne: The short answer is yes. At RIIA, we’ve endeavored to counter this educational bias with the development of the curriculum for our Retirement Management Analyst or RMA designation. Underpinning the curriculum are three big ideas: (1) measures of fundedness, (2) the household balance sheet and (3) retirement allocations.
The first, fundedness, characterizes assets under management as overfunded, constrained or underfunded, the category determined by the ratio of household assets to household liabilities.
The household balance sheet is an extension of the familiar net worth statement, but with important differences. For example, it focuses on assets to be used for providing retirement income. And it records values for all financial products held by households. These include retail and tax-advantaged securities, mutual funds, annuities and cash value life insurance; households outstanding debts; plus protection products, including life, health and property/casualty insurance.
Retirement allocations encompass four concepts:
Risk retention, addressed by diversification among risky assets;
Risk management, which entails forgoing future potential returns to limit downside losses;
Risk pooling, which involves the purchase of insurance policies and product guarantees; and
Risk avoidance, which is achieved using risk-free assets like cash and cash-equivalents.
Hersch: The development of the RMA program strikes me as an implicit criticism of existing educational programs for advisors, including those leading to the CFP and ChFC designations. Are you and Dirk suggesting there are big holes in these programs?
Cotton: Yes. I have on my shelf textbooks from Boston University’s CFP program. Though they have chapters on risk and insurance, none of them address spending in retirement.