Active investment management’s weekly magazine for fee-based advisors

Clients still need—and want—to build wealth after retirement

by Feb 16, 2022Advisor Interviews

Clients still need—and want—to build wealth after retirement

by Feb 16, 2022Advisor Interviews

More retirees are increasingly seeking a higher standard of living in retirement, while also living longer. Advisors need to meet those twin challenges with highly adaptive income- and growth-oriented investment strategies.

Many retirees these days are spending so much while ticking off their growing “bucket list” that they need separate “buckets” of money to also keep their portfolio growing.

According to a J.P. Morgan Asset Management report, a greater number of retirees not only want to periodically withdraw money to live out their dreams, but they also want to keep a substantial balance in their retirement plans to continue building wealth. Key findings from the report covering defined contribution plans include the following:

Average contribution rates remain too low: Participants start saving at 5% and never reach 10%. Inflation-adjusted salary has remained flat during this time, which impacts how much people save.

Retirees are spending at higher-than-expected levels: Income replacement at retirement is more than 90%, contradicting the rule of thumb of 70%-80%.

More people are staying in their plans after they retire: 42% of participants remained in the plan three years after retiring—more than double from ten years ago. More participants will need help decumulating their assets.”

“Participants are trying to continue to generate income from the wealth they’ve accumulated, so they can maintain the same lifestyle they had while they were working,” Kelly Hahn, one of the report’s authors and a defined contribution strategist and executive director at JPMorgan Chase, told BenefitsPRO.

To accommodate these growing trends for retirees, JPMorgan has introduced a more “dynamic” strategy to maintain retirement income within the plans it offers, resetting optimized annual spend-down amounts each year as retirees age and begin to spend less.

Other financial advisors have also noticed this growing trend among their client base, and many have adjusted their investment strategies accordingly. A common theme across advisors is employing the “bucket” approach—segregating assets within portfolios—so that overall portfolios continue to grow even as clients spend on travel and other long-awaited items on their retirement wish lists.

Advisors also have adopted additional strategies to help ensure these clients don’t outlive their savings. These include greater adoption of risk-oriented, actively managed strategies from third-party investment firms—with the goal of seeking asset growth with an enhanced focus on downside mitigation.

For this issue, Proactive Advisor Magazine asked several experienced financial advisors:

How do you address the challenges of client longevity and longer-term wealth accumulation?

Catherine Seeber, CFP, CeFT
Financial advisor and vice president at CAPTRUST in Lewes, DE

“The traditional three-stage life—educate, accumulate, retire—no longer exists. Retirement years have now expanded into three stages of their own: ‘all go’ to ‘slow go’ to a potential ‘no go.’ Hence, the way we look at retirement portfolios has to change as well. Relying on the traditional model of reducing equity exposure beginning at age 65 or at retirement, and increasing bonds, no longer works. In considering a potential 100-year life span, that type of model fails. If you are going to keep money growing for the cost of living for decades to come, there is no substitute for equities.

“When clients believe in the concept of lowering risk immediately upon retirement, I point out, ‘You have worked long and hard and have spent years accumulating your assets. Now it is time for the savings to work for you.’ Should the market correct, we potentially have a longer trajectory in which to see it recover.

“An additional point to make is that in the earlier years of the ‘all go’ stage, clients tend to spend at a greater clip—traveling, buying that boat they have always wanted, upgrading their homes, and so on. This type of spending forces a conservative portfolio to implode over time. The traditional models are far too shortsighted to adequately serve clients beyond the next decade. We like to look at a retirement account utilizing the bucket approach: capital preservation, income, and growth.

“The capital preservation bucket sets aside the funds for immediate spending needs, six to 18 months out. Capital preservation would be diversified across income-producing assets designed to preserve capital while minimizing risk. The income portfolio concentrates on the amount of money the portfolio needs to generate to maintain a certain standard of living. The income-orientation strategy is designed with downside protection and diversification of bonds and alternatives, while allowing for capital appreciation potential via some stocks.

“The growth bucket is separated and can now ‘grow’ with clients for the long haul and can appreciate in order to achieve their financial objectives. The growth-oriented strategy consists of an all-equity approach, allowing for capital appreciation.

“The percentages in each bucket are determined by understanding other financial assets that are available, as well as a client’s risk tolerance. Psychologically, knowing each bucket has a specific purpose and time horizon associated with it makes the short-term volatility much more palatable.

“The selection of managers and/or stock selections depends on the market environment. The mixtures are not only contingent upon age but on cash-flow needs, risk tolerance, and other available assets and income sources.”

Luis Padilla, MBA
Founder of Maryland Wealth Management in Sparks, MD

“For many clients, when they save money all of their lives for retirement, and then they’re supposed to start spending it—that’s a difficult thing to do. I’d like for them to have a balance—withdrawing some money, particularly the required minimum distributions from qualified accounts, while continuing to see their assets grow.

“I also practice active cost-of-living (COLA) management when I do my annual reviews with clients. I ask them how much they spent, what they’re budgeting for, and then I do a COLA adjustment. In the early years of retirement, they usually have the same lifestyle as they did while working, and so we adjust accordingly.

“For longer-term buckets, active management of investments works well. We can get a little bit more aggressive in the longer-term buckets because life expectancy is based on at least 20 additional years. Advisors need to segment this bucket correctly so that clients understand that it’s not for an income need, but a longer-term need.

“I am open to considering any tool or strategy that can help manage risk and provide a cost-effective investment solution for clients. My philosophy is that where there is innovation, you should study it. You should consider how it could make you a better wealth manager and help your clients.

“When clients are closer to retirement, we look especially closely at the risk-mitigation capabilities of outside managers, for both income and growth-oriented strategies. They will usually have a manager-based risk-mitigation strategy or an algorithm-based approach. I tell clients that these strategies are like the bumpers placed on a bowling lane for inexperienced bowlers. They don’t guarantee that you are going to get a strike, but they are geared to preventing ‘gutter balls,’ or large portfolio losses in times of market stress.

“We tell clients we are not trying to predict absolute market lows or sell at market tops. We want portfolio management that will help smooth out volatility, have a goal of achieving competitive returns over full market cycles, and strive to avoid steep portfolio drawdowns.”

Andrew Leithe, CFP
CEO of Strategic Financial Services Corporation in Mt. Laurel, NJ

“The psychology of retired clients these days is pretty interesting. Typically, prior to retirement, pre-retirees have the foresight and knowledge their portfolio will most likely decline throughout their retirement years given they are taking distributions that may exceed the growth in their portfolios. However, when they are actually in retirement, they sometimes ignore this logic and want their portfolio to continue to grow or stay level as they distribute income from their portfolios to meet their expense needs. This is most likely due to the large amount of appreciation we have seen over the last few years of 10%-plus returns in the overall market. Unfortunately, these types of returns may not continue going forward.

“Excess annual returns we have seen in recent years will most likely be adjusted down. With inflation increasing due to excessive fiscal stimulus and supply-chain constraints, the Federal Reserve is beginning to tighten the monetary supply and raise interest rates to combat these forces. As a consequence, we are seeing corporate earnings being tested and company valuations being challenged resulting in increased market volatility and a market decline at the onset of 2022.

“To protect our clients’ portfolios, we typically structure them into various ‘buckets.’ Each bucket has its distribution purpose representing sub-portfolios earmarked for short-term funding, medium-term funding, and long-term funding. The short-term and medium-term buckets are used to meet their current income needs while the long-term bucket may be untouched for many years to allow for additional growth in the client’s portfolio and continue to build wealth for the client.

“The short-term bucket typically represents two years of income (years one and two) with a larger allocation to investment-grade bonds and a smaller allocation to equities. During a recession like 2008 or a larger episodic market downturn like the one that occurred in February/March 2020, the target downside risk of this allocation is approximately 5%–10%. To manage this risk, we employ tactical management strategies for both the bond and equity sleeves that are designed to reallocate and preserve the portfolio during heightened market volatility.

“The medium-term bucket typically represents the next three years of income (years three to five) with a moderate growth allocation—typically 40%–60% in equities and 60%–40% in bonds. Dependent upon the market, the equity and bond allocations would be invested across a wider spectrum of assets with a total downside risk target of approximately 10%–20% and an average target annual return of 5%–12%. Similar to the short-term bucket, active managers will be used, though for a smaller portion of this bucket, with a larger allocation to strategic allocations and passive management investments.

“The long-term bucket typically represents year six and over with a larger allocation to equities and a smaller sleeve allocated to fixed income. This bucket is typically invested more aggressively compared to the two previous buckets. The allocation will mostly consist of strategic allocations and passive management investments with a long-term outlook on growth and value.

“As the client uses the short-term and medium-term buckets, a waterfall approach is designed to refill their income surplus targets from the long-term bucket. When the short-term and medium-term buckets deplete below their target income amounts, the long-term bucket is typically used to replenish them. Furthermore, when there are periods of heightened volatility, market corrections, or recessions, the long-term bucket would be maintained and not liquidated, allowing for this bucket to potentially recover.

“Overall, the mindset of investors has changed quite a bit over recent years. Previously, clients would be more concerned with preservation of capital during retirement with a target return of 2% to 4% annually. However, given the market has been on fire over recent years driven by historically low interest rates and expansive fiscal policies, clients have FOMO (‘fear of missing out’). As we have seen at the start of this year, the period of excess returns will most likely normalize to a moderate growth rate coupled with heightened volatility. Therefore, we are setting clients’ expectations for increased market volatility and single-digit returns. By coupling the bucket theory with active and passive management, we are most likely able to reduce portfolio volatility while still pursuing further wealth accumulation for our clients.”

Timothy Lay, CFEI, AIF
Principal advisor at TPA Financial in Sisters, OR

“Retirees today are faced with challenges in their retirement plans that the previous generation didn’t experience. Not only are they living longer and have more active lives, but they are also sometimes taking care of their parents and their children in some way, with either finances or support at some level.

“Mix that with highly volatile markets, low interest rates on income-based investments, and a media filled with smoke and mirrors—today’s retirees have a lot on their plates.

“My clients are looking for more than just preservation of wealth. In some instances, they don’t need the money from their retirement accounts and want the money to grow for the next generation. Those who do need it for income want to make sure that they can keep up with inflation and still hope to leave something for their heirs. The ‘one size fits all retirees’ approach no longer applies.

“To customize a plan for each individual or family, you must balance everyone’s personalized risk level. There are several ways to accomplish this, but you can no longer have a separate approach to their individual accounts—blending the risk levels and managing expectations is the key to making sure that everyone reaches the level of lifestyle they are accustomed to. Then you must employ what-if scenarios to make sure there is both enough income during the distribution phase—as well as having the opportunity to leave a legacy.

“One of the biggest challenges is that clients tend to have many accounts in different places. Consolidation is one of the best ways to eliminate the complexity for accounts that are producing the necessary income or cash flow. That doesn’t mean consolidate everything. Other accounts can be utilized for special occasions, or unusual events, or even that unexpected medical expense.

“The reality is that there need to be multiple strategies for different clients. You must help the client visualize the clearest picture of what their future could optimally look like.

“In our practice, we utilize active money managers to help create a unique income stream that is based on either a 4%, 5%, or 6% income distribution. These customized portfolios provide a more stable distribution of income while taking advantage of more market or equity exposure and balancing that with the ability to provide a hedge in catastrophic market conditions.

“We meet our clients where they are today and show them that there is a solution that can guide them to the future they imagine for tomorrow. We hope to give them greater peace of mind and hope that their hard work will provide both retirement income and a lasting legacy.”

***

Retirees have always wanted their golden years to be some of the best times of their lives. But there is a greater desire and willingness now to spend liberally to fulfill their dreams. At the same time, many people are living much longer lives than those in previous generations and they want—and need—their assets to continue to grow to accommodate that longevity. Financial advisors are tweaking investment strategies—or adopting new ones—to meet these changing retiree needs and aspirations.

 

The opinions expressed in this article are those of the author and do not necessarily represent the views of Proactive Advisor Magazine. These opinions are presented for educational purposes only.

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Katie Kuehner-Hebert is an award-winning journalist with more than three decades of experience writing about the financial-services industry. She has expertise in banking, insurance, financial planning, economic development, and employee benefits, and her work has appeared in many leading publications.

 
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