Income planning has become a very common practice for many advisors over the past several years, but has really come to the forefront as market volatility has made clients re-think how they will receive income and where the income will come from. The top question on most clients’ minds is, “Will I have enough income to last the rest of my life?”
The traditional income planning strategy that many clients have used over many years, based on the advice of their financial planner, was to take 4 percent to 5 percent of their accounts as income. This philosophy may have worked prior to the year 2000, but since then is just plain bad advice. If a client is withdrawing 4 percent to 5 percent experiencing declines in the principle of their accounts because of poor market performance and being forced to take required distributions, they could significantly reduce the chances of maintaining their income requirements.
Many advisors have adapted the rule of 100 in order to explain to clients the amount of a portfolio that is appropriate for market risk in designing an income plan. The rule states that 100 minus the age of the client equals the maximum amount of the client’s accounts that should be subject to market risk. This can be a good rule of thumb approach when determining product allocation as a part of an income plan. Using this rule typically allows for 60 percent to 70 percent of a client portfolio to be allocated to fixed products with the other 30 percent to 40 percent allocated to growth accounts. This product allocation can help lead to dependable income for a client using guaranteed products to produce income. However, in many instances the client still needs growth in their portfolio in order to keep pace with inflation and overcome longevity concerns.
A solution to the income planning challenge is to add actively managed accounts to the mix. You see, annuity planning can go a long way to solving the income planning challenge, but many clients need more growth than annuities provide and are willing to subject a portion of their portfolio to market risk. However, the same old buy-and-hold strategies that have caused them to lose money over the last decade are largely the reason why they are more concerned about income planning. So, adding actively managed portfolios into a client’s income plan can dramatically increase the likelihood of having increasing income for a lifetime.
Actively managed portfolios offer the opportunity to participate in the upward move of the market and avoid moves lower, so that gains are locked in and losses are largely eliminated. An active account manager can use technical analysis, charting, analytics and momentum recognition to identify trends in the market. This allows for the opportunity to recognize a trend change and exit the market when the trend moves lower or enter the market when the trend moves higher. Some active managers even use inverse positions to take advantage of moves lower so that a profit can potentially be made no matter what direction the market is headed.
Adding active management to an income plan allows clients to have the best of both worlds in income planning. Guaranteed accounts provide short-term income while actively managed accounts give clients the opportunity to allow a portion of their portfolio to continue to grow in the market to replace any principle that may have been used to provide the short-term income and/or just increase the overall value of their retirement accounts.