Advisors blessed with intelligent clients rarely need to explain the importance of saving: clients know that funding their retirement is fundamentally their responsibility. But an excess of virtue can become a vice.
The purpose of decades of saving is to fund decades of spending. One of an adviser’s core challenges is to educate clients about swerving from aggressive accumulation, to designing their portfolio for measured decumulation. This is captured in the title of my recent book co-authored with Riaan Nel: It’s the Income, Stupid!
This column introduces the profound paradigm shift clients will need to undertake, redesigning their portfolios to produce predictable income in the “new normal” of miniscule interest rates. We hope you share it with your clients, so that they better understand your advice.
In Kathryn Forbes’ much-loved book, Mama’s Bank Account (best remembered through the 1948 film I Remember Mama), each Saturday evening Papa Lars would bring home his carpenter’s pay in coins. Mama Marta would allocate the funds “to the landlord…to the grocer,” etc. It is a charming scene.
Most of us do something similar with our savings. We distribute our earnings into “envelopes,” or establish mental accounts, that devote pieces of our overall assets to different purposes. We may have, for instance, mental accounts for housing (rent or mortgage), transportation, food, gifts, and luxuries like a vacation. Many households aspire to have a “rainy day” fund for emergencies, although for many it is only a hope.
Each account may be invested differently. An emergency fund envelope should be in a highly liquid form because an illness or layoff may strike at any time. The goal of an emergency fund isn’t growth, but capital preservation and immediate access. The same is true for any envelope related to day-to-day spending. A near-term goal envelope may be targeted to a goal that is still a few months or years in the future. For example, a “goal fund” may be used for a house down payment, college tuition, a wedding, or an expensive vacation. A specific mid-term goal envelope, such as for a vacation or a house down payment, can be invested with some growth in mind. However, capital preservation is still important.
Finally, a really long-term goal envelope, like retirement savings, can be invested for growth, as long as the long-term goal is still far away. However, as the day approaches when the long-term goal envelope is needed—when that long-term goal becomes a mid-range goal, and then a short-range goal—the investment strategy should change accordingly.
A common but outdated rule for really long-term goal funds is that a growing percentage of the portfolio should be in bonds (which are less volatile than stocks, but also return less). That percentage should be roughly equal to the investor’s age. Under this guideline, a 58-year old investor saving for retirement should have roughly 58% of his or her retirement savings in bonds.
As we’ve alluded to in previous chapters this is an outdated approach, as much of the research on reverse glide paths illustrates: It’s better to glide toward a conservative allocation the closer to retirement you get, and then reversing the process to glide to increasing stock allocation the older you get.