The Five Strategies for Retirement Income
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Advisors can choose from five approaches to meet their clients’ income needs in retirement, each with its own merits and drawbacks. Those strategies attempt to solve for a central goal – ensuring that clients don’t run out of money – a risk that is illustrated by my wife’s catering business.
The thing that surprises me most about my wife’s business is how much food is leftover. I often ask, “Is there a better way to manage food costs?” and her answer is always the same: “Better to have food leftover than fall short.” She has the exceptional ability to estimate the amount of food each person will eat, but she can never be sure how many people will come and how much they will eat.
When planning for retirement, we also don’t want to “fall short.” To make sure, we must account for a multitude of factors:
1. How much income do I need?
2. How long will I need the income?
3. What will inflation be?
4. How much do I want to leave for beneficiaries?
Answering those questions is a daunting task that financial applications try to model. However, no matter how good we are at answering them, there is one question that is impossible to answer ahead of time: the sequence of investment returns we receive in retirement. It is one of the most important factors in determining retirement success.
Sequence of returns is the order in which returns are realized. When we accumulate assets, the sequence of returns is of little consequence. To illustrate the point, let’s say you start out with $100,000 invested in stocks. In scenario 1, you experience negative returns at the beginning of your investment horizon, whereas in scenario 2 we flip the sequence so that the negative returns are at the end of the horizon.
For illustrative purposes only, not indicative of any specific investment product.