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I admire the investment skills RIAs demonstrate. Over a 40-year career, I’ve been impressed with the RIAs I’ve met. The significant majority are quite skilled and take their fiduciary responsibilities seriously. They care about their clients, and they demonstrate it on a day-to-day basis.
Let me share a story of an RIA who will be forced to mount a legal defense because of a lawsuit that is likely to be filed by two of his retired clients.
When I was a young advisor, I learned about the “rule of 100.” This longstanding piece of wisdom provides an age-based, asset allocation guide to the level of risky assets any investor should own. The math is simple: 100 minus the investor’s age equals the percentage of assets allocated to equities. The rule indicates that a 65-year-old investor should allocate up to 35% to equities.
Many investment advisors have moved past the rule of 100 out of the recognition of the differences in priorities among various investors. Some have suggested that an investor who is more risk tolerant might add 10% to the equity allocation, while a more conservative investor might subtract 10%. In any case, the rule of 100 is simply a guide, not a perfect prescription for the best long-term results. But as a guide it offers value. Whether one views it as ideal or flawed, in the context of the rule of 100, it would be hard to justify a 100% equity allocation for a retired investor over the age of 70.
Jim and Joyce
Meet Jim and Joyce, a married couple aged 74 and 73, respectively. Jim and Joyce have worked with an RIA who has designed their asset allocation strategy. According to Jim and Joyce, the RIA described what he’s designed for them as, “Warren Buffett’s portfolio.”
I do not know the composition of Warren Buffett’s personal investments. An article from Forbes stated 99% of his money is invested in a single holding- Berkshire Hathaway. In any case, and apparently unlike Buffett’s investment strategy, the portfolio that the RIA designed for Jim and Joyce contained multiple equity positions.
If we were to rely upon the rule of 100, the equity allocation in Jim and Joyce’s investment portfolio would be about 26%.
Like Warren Buffett?
In the context of money, a comparison which likens Jim and Joyce to Warren Buffett is absurd on its face. Reliant upon their savings to meet day-to-day living expenses, Jim and Joyce gave the RIA all their investment assets to manage – $1.25 million. Recent market performance generated losses in Jim and Joyce’s portfolio exceeding $350,000. Concerned that their standard-of-living has been permanently impaired, Jim and Joyce are suffering palpable anxiety about their financial futures.
Jim and Joyce are good friends with a friend of mine who asked me to chat with them in the context of retirement income planning. My friend had given Jim and Joyce a copy of my book, Constrained Investor. When I spoke with them, I did not provide advice on investments, but rather talked conceptually about risks and risk management.
My first questions addressed their health status. Except for one of them having well-controlled diabetes, they are in excellent health. We spoke about longevity and the importance of durable income. I recommended that they consider longevity insurance (i.e., annuities). I also shared a couple of my favorite statements about retirement income planning:
No retiree stops needing income.
In retirement, it’s your income, not your wealth, that creates your standard-of-living.
I explained to Jim and Joyce that a lack of protection against timing risk has extracted a heavy toll on their ongoing capacity to generate income from their savings. And their decision to purchase quality long-term care coverage was something I praised.
Reminded of Howard Beale
Jim and Joyce are quite angry at the RIA. Over the first couple of minutes of me listening to them complain, I was reminded of the famous line uttered by the Howard Beale character in the great 1976 movie Network:
“I’m mad as hell and I’m not going to take it anymore.
Based upon their level of anger and obvious conviction that they have been given inappropriate investment advice, I expect that Jim and Joyce will file a lawsuit against the advisor. If they do, will their complaint be successful? I can’t say. Juries – assuming it even gets that far – are notoriously unpredictable. What is clear, however, is that the RIA will be faced with the financial and reputational costs and distractions that come with defending a lawsuit.
There are three issues in terms of decision-making. At least two will be difficult for the RIA to justify:
- Equity allocation of 100%;
- Failure to provide protection against timing risk; and
- No longevity risk protection.
If the RIA can get past the equity allocation issue, his failure to manage timing risk is a matter that I foresee potentially plaguing many, many RIAs whose default income distribution methodology is the systematic withdrawal plan. If market declines continue, as I believe they will, the timing risk problem in retirees’ portfolios will even more exposed. This is a devastating financial calamity that effects millions of retiree clients, and it’s a needless area of financial liability that advisors face.
Timing risk is too easy to safeguard against and, anticipating your question, an annuity is not required to do so. To learn more about timing risk and its management, download my e-Booklet.
Where annuities can and should play a role in the income planning for constrained investors is in the critical need to manage longevity risk.
Some prudent questions for RIAs to ask themselves are:
How many clients do I have who are in a similar position to Jim and Joyce?
Have I structured retirees’ portfolios to protect against timing risk?
Am I addressing longevity risk in my planning meetings with retirees?
I suspect that Jim and Joyce’s advisor did not ask and answer these questions. Had he, he would not be faced with the prospect of defending against a lawsuit. But there are many good reasons for you to do so. Here’s just one:
It protects them and you.
Wealth2k® founder David Macchia is an entrepreneur, author, IP inventor and public speaker whose work involves improving the processes used in retirement income planning. David is the developer of the widely used The Income for Life Model®, and the recently introduced Women And Income®. David has authored many articles on the subjects of retirement income planning, macroeconomics, and financial communications. He is the author of two books, Constrained Investor®, and Lucky Retiree: How to Create and Keep Your Retirement Income with The Income for Life Model®
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