Our comprehensive and custom retirement income plans address the three major risks that affect those who have stopped working and rely on their assets to provide income.
Sequence of return risk is the most crucial risk facing people that no longer have a paycheck and are relying on their assets to provide an income through retirement. Market returns within the first five years of retirement have a major effect on the amount of income that can be generated by a portfolio of assets.
For example, if you have $1,000,000 in assets when you retire, you may estimate that you can safely withdraw roughly 4% annually, or $40,000 per year. If retirement begins during a bull market, where your investments can grow more than 4% annually, your assets will continue to increase even while taking a $40,000 distribution each year. In this scenario, you may even increase your distribution in future years. If your portfolio grows to $1,200,000, then a 4% distribution would be $48,000 per year.
However, if you retired in the summer of 2008 with $1,000,000 in assets, by March of 2009 your portfolio may have been worth as little as $600,000. A 4% distribution in that instance would be $24,000, which could severely limit your ability to meet your cost of living and pay your bills. If you took a flat $40,000 per year distribution in this instance, your withdrawal rate would equate to 6.7%, greatly increasing the possibility of running out of money.
We believe the best and most effective way to mitigate this risk is to set up a separate portfolio of very safe and reliable fixed income investments that will help ensure your income needs are met. This portfolio can be designed to last up to five years, providing an added layer of safety in the event of another significant market downturn. With the remaining assets likely invested in stocks, the fixed income investment and five-year horizon should be enough time to ride out a negative market cycle.
Longevity risk is the risk of outliving your assets. People who retire today can expect to be in retirement for up 35 years, which is a long time to live without a paycheck. Traditional retirement planning was based on putting a greater percentage of assets into safer fixed income strategies, with the belief that with no paycheck, retirees could not afford to lose any of their principle. Unfortunately, this strategy often does not provide the required return to sustain an income stream to last 25 to 35 years.
We understand that to address this risk, retirees will need to generate a higher return on their investments, which requires rebalancing a portfolio to include a greater percentage of quality stocks in a well-diversified asset base. This combination of stocks and fixed income can help create the enhanced return that is necessary for your savings to last through retirement.
Inflation risk is the last major risk that retirees must address when building a sustainable plan. Inflation averages around 3% per year, which means that the cost of goods and services that you consume could double in as little as 18 years. At that rate, your daily $4 cup of coffee will rise to $8, and filling up your gas tank could regularly top $100. A fixed income retirement strategy, which usually comes from a pension or fixed income investments, may not be able to address these rising costs.
We combat this risk by building well-balanced and diversified portfolios that can provide both the safety of fixed income and the growth rate of stocks. The key is providing a rate of return that grows faster than the rate of inflation. Since Social Security is indexed for inflation, choosing the most advantageous Social Security strategy can help mitigate inflation risk.