A successful retirement strategy's main objective is to ensure that a client's cash flow requirements are met and that they do not run out of money too soon.
Retirement income strategies used to be relatively straightforward. The financial adviser's traditional approach would be to transition retirees to a more defensive income-producing asset allocation to preserve capital over the long term. However, today's market dynamics mean such a strategy is unlikely to protect retirees from longevity risk or generate sufficient returns to fund their lifestyle needs. The changing environment has compelled financial advisors to rethink how they plan to deliver a secure retirement for their clients.
Real returns from cash and bonds are currently minimal, if not negative in real terms, due to historically low interest rates. These conditions make it challenging to generate adequate income or investment returns. Some advisers suggest that retirees compensate by pursuing greater exposure to increasingly volatile and expensive markets, such as equities and property. But this could have significant detrimental consequences if markets experience difficulties, which they inevitably will at some stage. Also, traditional defensive assets that seek to reduce volatility could be rendered ineffective if inflation re-emerges. This is because the enormous fiscal stimulus used to support economies during the COVID-19 pandemic is likely to increase the correlation between bonds and equities, as has happened during previous periods of inflation.
These circumstances make it very difficult to ensure the financial wellbeing of retirees. They also expose advisors to the risk of not fulfilling their best interest duty should their advice fail to leave retiree clients better off.
Astute advisors will adjust their portfolio management strategies. A simple but effective solution is to use a goals based investment approach, where 'bucketing' for liability and cash flow matching can separate a portion of the capital for cash flow needs – as distinct to income needs. This income-layering technique aims to meet different cash flow needs across different timeframes within each bucket.
Portfolio bucketing enables advisors to manage cash flow and risk-adjusted returns over specific timeframes independently.
From a client management perspective, once the client feels assured that the strategy will meet their cash flow requirements, they can more readily accept higher investment risk in longer-dated portfolios. This ensures they are reducing longevity risk without selling down volatile assets to meet their cash flow needs.
By blending various cash flow matching buckets with longer-term risk managed or return-seeking portfolios, advisers can better meet their retiree's cash flow and longevity aspirations without exposing their clients to sequencing risk through higher-risk investments.
Goals Based Investing also embraces alternative assets, such as commodities, currencies, private equity, and various investment strategies, including short selling, to access opportunities not afforded by traditional asset classes. Utilising alternative assets beyond stocks, property and bonds saves the need to stick with poorly performing markets or chase in-demand assets that may be mispriced. This makes it possible to achieve target returns while minimising volatility and, coupled with dynamic asset allocation and managed account services, enables a swift reaction to changes in market conditions.
In summary, this approach allows advisors to optimise portfolio management for the specific needs of retirees. You can explore Portfolio management further in our article: Managing Portfolios in 2021: The Total Portfolio Approach.
Dynamic Asset is here to help you design an exceptional retirement portfolio for your clients; to discover how contact us today.
