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 two-part 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.
Part One of this column introduced the idea of distributing our earnings into “envelopes,” or establishing 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. A near-term goal envelope may be targeted to a goal that is still a few months or years in the future, and a really long-term goal envelope, like retirement savings.
This column continues showcasing the envelopes strategy of investing.
Maintaining the Envelopes
The envelopes approach is a model of simplicity. You determine your time frames for each envelope and segment your investments accordingly, with the very safe investments in Envelope 1, progressing along the risk continuum, sequestering the most volatile and risky investments to Envelope 3, which you don’t need to touch for 10-plus years.
The foundation of the approach is to maintain a safe, principal-protected pool of assets at all time. Things get a little more complicated when you have to consider how to move assets between the envelopes as the first envelope’s assets are spent down.
Clients should focus first on refilling Envelope 1 with all income distributions from the other two envelopes except when you are opportunistically taking advantage of depressed prices to reinvest. When the final year of Envelope 1 approaches, Envelope 2 assets are liquidated to be shifted into Envelope 1. Every so often you will liquidate highly appreciated assets to move to Envelope 1 and/or 2.