The fundamental flaw with traditional retirement planning

By Chris Conklin

Insurance Insight Group


Synopsis: The conventional wisdom the financial press espouses about planning for retirement is that your clients should have their money at risk because the risks will hopefully balance out over time. But does this approach really work when you’re retired?

When it comes to planning for retirement, the financial press has had a long-held perception that your clients should have their money at risk — even after they have retired.

For example, Money Magazine Senior Editor Walter Updegrave says, “Smart retirement investing … is about building a portfolio, specifically a portfolio of both stock and bond funds that gives you a reasonable shot at getting you to and through retirement.”1

Based on this conventional wisdom, the financial industry has created target date retirement funds that invest primarily in a mix of risk-based investments — stocks and bonds. While the portion allocated to bonds generally increases as the funds’ customers grow older, still, the underlying assets remain risk-based investments.

Further enabling this belief, regulators at the Department of Labor granted 401(k) and other retirement plan sponsors protection against participants’ claims of improper investment if money is invested in target date retirement funds.

You’re probably aware of the risks associated with stock funds, bond funds and, therefore, even target date retirement funds. Their values can fluctuate every day and can drop substantially from time to time. Members of the financial press, such as Updegrave, would say the risks are likely to balance out over time, a concept that some people refer to as time diversification.

That sounds nice in theory, but there are a few problems with it. For example, suppose your clients need to take withdrawals from their savings every year to supplement their pension and Social Security income. Let’s also suppose there is a very substantial drop in the stock or bond market. Even if the market subsequently recovers, the fact that your clients were taking withdrawals while it was down means their retirement savings may not recover.

Those savings certainly would not recover as easily as if it were the savings of someone who was not taking withdrawals.

Consider also the possibility that your clients will understandably be stressed out about the market drop and may yank most, if not all, of their money out of these risk-based investments after they have lost value. Thus, even if there is a subsequent recovery, they do not participate in it.

I have a very different definition of smart retirement planning than Mr. Updegrave and his brethren in the financial press.
To me, smart retirement planning is not about building a risk-based portfolio and hoping it does well. Instead, it should be about putting together a plan and a collection of assets that can realistically get your clients to their retirement income goal, with plenty of guarantees and downside protection to limit what can go wrong.

If you have clients who have money they cannot afford to lose — or cannot bear to lose — products with principal protection and/or income protection make a lot more sense for your clients’ retirement savings than the potential stress that comes with a reliance on the stability of the stock and bond markets.

The beauty of a fixed indexed annuity is it can steadily grow your clients’ account value over time based somewhat on the appreciation of a bond or stock index, but without directly putting your client’s money in the market. It allows your clients to sleep at night knowing their principal, as well as any previously credited interest, will not be lost due to market volatility and has the ability to grow more predictably over time.

There is also a lot to be said for guaranteed lifetime withdrawal benefits, which are annuity benefits guaranteeing a certain level of withdrawals that can be sustained for the rest of your clients’ lives. Even if the guaranteed withdrawals end up depleting the cash value of the annuity, your clients will continue to receive the payout for the rest of their lives as the issuing insurer guarantees it.

Consider that most retirees have a limited sum of money to work with and lack a second chance if they run out of money. Consider that retirees have little insight into what their investments will ultimately earn and don’t know how long they will live. As a result, they often instinctively crave guarantees, and I believe that’s right and proper.

I would hate to be the advisor who urges them to ignore their instincts and put their money at risk, only to have the markets subsequently go south on them. Wouldn’t you agree?

110 years to retirement - Are you ready?, Money Magazine

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