The Prudent Investor’s Approach To Retirement Income

Each day, ten thousand people reach the age where retirement is a possibility.  For some the choice is optional, but for others it is mandatory.  A lively debate is taking place among academics and professionals in the investment industry regarding what the proper approach is for meeting financial needs in retirement.

We know that the majority of the average retiree’s wealth consists of the value of their home and the balance of their 401(k) s and IRAs.  Armed with this knowledge, much of the debate centers on the proper use of these assets to provide income.  Should we suggest the sale of a house and downsizing?  Should we suggest the use of a reverse mortgage?  Should we offer annuities that guarantee lifetime income?  Should we use an accepted model that mathematically determines the amount of distributions a retiree can safely draw on their portfolio? Should we suggest an age based approach, where the amount of money invested in bonds relative to stocks is based on age? Should we spend all our interest and dividends without touching principal? 

Outside of the academic debate, practitioners often recommend the approach that best meets the requirements of their agency.  In simple terms, if they are primarily a mortgage banker, then a reverse mortgage makes the most sense.  A realtor will surely want you to downsize.  According to an insurance agent, annuities are the best.  A financial planner with a bank of computers will verify that a fixed distribution rate based on probabilities is the appropriate approach.  Admirers of Jack Bogel and Vanguard will follow Bogel’s lead and age-weight money between stocks and bonds. Many individuals still hold on to the age old idea of separation of principal and interest.

Not to be left out, investment counselors like ourselves are subject to this same problem.  Each counseling firm believes they have an investment philosophy that is far superior to all others, whether they actually do or do not.

The benefit to those who are near retirement or currently in retirement is that the debate itself will generate new ideas, new products, and new approaches towards solving the needs of retirees, and there will probably be reduced cost due to a highly competitive marketplace.  But until these benefits are fully realized, individuals will have to make decisions today given today’s choices. 

I have worked with retirees for over three decades, and I know that there is no universal solution to this problem. The solution is different for each individual.  The only guarantee I can give our clients is that their financial needs will change with time, and that they will eventually breathe their last breath.  Any investment approach that does not consider both of these facts, death and change, will not suffice.  As the goals of retirees usually consist of both creating income now and of not running out of money before death, we don’t need to look very hard to find guidance for this. These goals are similar to the goals of the vast majority of trust accounts with a life income beneficiary and a remainder beneficiary.  Granted, some retirees are only concerned with their current needs and have no intent or need to pass on assets to another person or party.  However, my experience has been that the vast majority of people do have a desire to spend some of their money and upon death, pass an estate on to a surviving spouse, children, relatives, or a charity.