People are living longer today than ever before, which is music to some people’s ears, as it provides more time with loved ones and the ability to have more and varied experiences. However, living longer poses an unanticipated risk — the possibility of outliving your money.
According to the World Bank, the average life expectancy for a person born in the U.S. in 2015 is nearly 79 years, compared with 75 years in 1995. In 2015 there were 72,000 centenarians living in the U.S., and this figure is expected to surpass 370,000 by 2050.
In addition to more Americans living longer, the population growth is slowing, resulting in an older America. This shift in demographics will have ripple effects for financial advisors and the U.S. economy.
Confronting potential tepid economic growth and preserving retirement savings will provide future obstacles for financial advisors. According to The Economic Policy Institute, retirement savings is alarmingly low, with the average retirement savings for all U.S. families just north of $95,000, and half of working-age families having nothing saved for retirement.
It is imperative that clients have clear goals and priorities in place so financial advisors have solid targets to aim for. Once the goals are in place, investment portfolios can be constructed to achieve the income requirements, which is easier said than done, as key decisions lie ahead.
For example, a retired couple in their early 70s have saved $1 million. They strive to enjoy their lives to the fullest, but wish to pass at least $500,000 in today’s terms (inflated at 2.25%) to their heirs. With these requirements in hand, we now can formulate a portfolio to achieve these goals.
In figure 1, we show a moderately conservative portfolio (40/60) that includes real estate investment trusts. Based on the index returns and standard deviations from the past 15 years, this portfolio has an expected annualized return of 6.2% and standard deviation of 7.4%.
Using this return distribution, we can determine if the goals are attainable.
In order to maintain their desired living standard, an annual withdrawal rate of 5% inflated at 2.25% is required. Due to increased longevity, goal number one is in jeopardy, as some of the Monte Carlo simulations start going broke in year 24 (figure 2).