The Big Retirement Risk Most Advisors' Models Miss

In a blog post this week, Capizzi summarized several insights from the white paper.

Longevity Plus Inflation

Dunham’s research identifies a possible mathematical blind spot. At the Federal Reserve's targeted 2% inflation rate, a traditionally conservative portfolio that generates 4% to 5% net returns could run out one to two decades before the end of a 50-year retirement, potentially leaving clients without resources for the remainder of their lives.

Scientists and industry are pretty certain that someone alive today will live to 150, which could make retirements of 50 or more years inevitable, Capizzi notes.

“The critical question the industry must ask itself,” he said, “is whether traditional retirement planning models will hold up.”

Longer lifespans and rising inflation could force the industry to rethink key financial assumptions. For instance, a client withdrawing 4% annually may need returns nearly double those provided by traditional conservative allocations.

Current planning models often underestimate how small return shortfalls can result in exponential portfolio depletion, Capizzi says. Each rise in inflation of 1% to 2% could require a corresponding increase in portfolio returns.

Dunham’s research indicates that a portfolio with 5% net returns, offset by just 2% inflation, could deplete 10 to 20 years too soon in a 50-year retirement.

Growth vs. Risk

Financial advisors face the challenge of balancing growth and risk in retirement portfolios. Equities are necessary to combat inflation and longevity risk, yet they introduce sequence of return risk, which can upset retirement plans if market downturns occur early.

Conservative strategies, such as overweighting fixed income or holding excess cash, may protect against short-term volatility but often do not generate the necessary long-term returns. Advisors must rethink traditional portfolio construction to ensure sustainable income for longer retirements, Capizzi says.

Multi-Generation Retirement

Traditional retirement planning was not built for a world where people live past 120, Capizzi writes. Because of increases in life expectancy, a phenomenon is emerging whereby retirees may need to support not only themselves, but also their parents and grandparents.

Capizzi posits, for example, a 70-year-old retiree with parents 100 years old and grandparents 130 years old.

“For financial advisors, this changes everything,” he said.

Retirement Real Return Rule

For a retirement portfolio to sustain a half-century lifespan, returns must exceed inflation by about 4% to 5%, Dunham's research shows. Absent that buffer, portfolios could deplete long before a retiree’s expected lifespan.

Advisors must reassess their assumptions about traditional withdrawal rates, portfolio construction and long-term asset growth strategies, Capizzi says.

What Advisors Can Do

The paper offers potential solutions for how the wealth and investment management sector can reimagine approaches to retirement planning.

Financial advisors can adopt an adaptive financial oversight framework that treats retirement like running a personal finance company, in which the retiree is CEO and the advisor is chief financial officer.

In order to maintain a spread of 4% to 5% above inflation to remain sustainable across extended retirements, advisors and their retired clients could address short-term volatility through tactical overlay strategies, while simultaneously focusing on long-term growth.

In addition, retirees and their advisors could maintain sustainable portfolios by adopting a purpose-oriented portfolio strategy, whereby traditional bucket approaches are replaced with four distinct portfolios — distribution, flex, health care and legacy.