Lewis Schiff
Lewis Schiff
Best Practices for Retirement Income Portfolios

A new study takes a broad look at the tactics employed by advisors who specialize in retirement planning — and how their thinking has changed in the last year.

February 18, 2010
by Lewis Schiff

In an earlier column, I revealed how retirement planning specialists with a significant list of near- and post-retirement clients deliver their services. These advisors, for example, responded to clients’ feelings of uncertainty about ending their work life and beginning their retirement years by adding more lifestyle services.

In a follow-up survey of 500 advisors, the same researchers found that advisors view building retirement income portfolios as much an art as a science. “The emphasis of advisors is on integration of investment tools, rather than on just products,” observe Dennis Gallant of GDC Research and Howard Schneider of Practical Perspectives in Examining Best Practices in Constructing Retirement Income Portfolios: How Advisors Support Retirement Clients. “Few advisors use a cookie cutter approach to retirement income support, believing that solutions must be tailored to meet the particular needs of individual retirement clients.”

As one advisor characterized the steps, “Creating retirement income portfolios is all about the assembly of tools, not the tools themselves. Numbers are the easy part most of the time. It is the process that is complicated.”

Solving the Retirement Income Puzzle

“Advisors now are focusing much more on solving the income needs puzzle for clients,” notes Schneider. “When we talked to them for the previous survey, they discussed solving for cash flow for clients, merging together income needs and income wants.” Income needs include mortgage payments, daily living expenses and healthcare. Vacation trips, hobbies, gifting that isn’t part of a larger estate plan and other lifestyle expenses were typically lumped in with income needs. Today, more advisors are stripping out the difference between the minimum clients need to main their lifestyles and separating other expenses —such as such as expensive travel and substantial gifts — as discretionary expenses.

According to one advisor interviewed for the study, “The key to retirement portfolios is managing the retiree. To do that you need to educate, educate, educate. I explain that retirement income needs to be considered in a minimum of three categories:

  1. Is the core expenses that have to be paid.
  2. Is the quality of life things we want to do.
  3. Is the frills that we do because we can and that includes what is spent on children and grandchildren.”

In general, advisors have adopted methods to allow them to scale portfolio management, such as using model portfolios or third-party guidance when developing asset allocations, researching investments and selecting specific portfolio components. Most advisors have typically relied upon U.S. equities and fixed income investments when building retirement income portfolios — with less going to international equities and cash. Not surprisingly, the tumultuous economic environment pushed advisors to change asset allocations. Many advisors chose to reduce exposure to US and international equities, while increasing allocations to cash and US fixed-income investments. Non-traditional strategies such as real estate, commodities or hedging strategies or other types of alternative investments saw only a modest change.

The advisors responding to the survey didn’t follow a single method for building retirement income portfolios or sustaining income. The two main approaches are risk-adjusted total return, which emphasizes diversification, performance and risk management across the entire portfolio and the more income-oriented pooled or bucket process, which establishes specific pools of assets that each have a particular objectives, time horizon and risk/return target.

Practice Differences

The study found a couple of insightful distinctions in the practices of these retirement specialists. First, there were significant differences across the channels. Registered Investment Advisors (RIAs), for example, are more likely to handle manage investments internally, including asset allocation, research and investment selection. They are also more likely to take a total return approach. Wirehouse/regional brokers and bank/insurance advisors are much more likely to seek additional investment guidance. Independent broker advisors are more evenly divided in using their own allocation and relying on third parties.

There are also differences among advisors based on the amount of their practice devoted to retirement income planning. At one end are the “committed” advisors who have 60 percent of their list identified as retirement income clients. At the other end, are the “fledgling” advisors with 20 percent or fewer of their client lists devoted to retirement planning. As might be expected, the number of years of experience relates to the degree to which advisors devote their practices to retirement income planning. The committed group tends to have the most experience and the older clients — 52 percent had over 20 years of experience while 24 percent had 10 years or fewer. In the fledgling group, only 29 percent had more than 20 years of experience and 41 percent had 10 years or fewer. The remainder of the survey group fell into the middle.

What’s Important

Although business models and methods of creating and managing portfolios demonstrated a broad range among advisors, some important themes remained consistent:

  • Differing views on the construction of retirement income portfolios
    As mentioned, most advisors use risk-adjusted total return or the pooled (bucket) method. The researchers found that the preference for one over the other derives more from personal experience and beliefs than from the type of practice or client served.
  • Complex and customized approach to portfolio construction
    Regardless of the approach, advisors describe a highly detailed, customized solution involving a deep understanding of clients’ needs and goals
  • Emphasis on process not products
    Advisors see their process of portfolio construction as the real value they provide clients, not the retirement income products they might use. The retirement income process is dynamic, requiring regular monitoring.
  • Follow a formal process with a focus on ongoing monitoring
    While there is a wide range of processes for building and maintaining a retirement portfolio and providing ongoing oversight from practice to practice, advisors tend to take the same general path with each client. The steps typically include: Client Discovery, Investment Planning, Implementation, Monitoring and Adjustment.
  • Target an annual withdrawal rate of between three percent and six percent
    Regardless of the portfolio construction or drawdown method used, the vast majority of advisors use this goal for generating cash flow from the investments.

Challenging Clients

Some of the biggest challenges to building effective retirement income plans arise during the discovery phase. Clients may need even the most basic education in investments, which can also come with unrealistic expectations about retirement income and flexibility to absorb discretionary expenses. Advisors try to screen for these problems while maintaining a lifestyle spending level without exceeding it.

One advisor described his biggest challenge this way: “The number one obstacle is the client themselves. They need to let me do my job as a professional. Too often, clients can’t comprehend issues related to retirement or variables that will change things down the road. Many can’t comprehend longevity or the impact of inflation, the coming Social Security crisis or medical cost increases can have on a portfolio. There are so many intangibles that will diminish income people receive, yet they don’t understand most of it.”

Additional Resources: www.aicpa.org/PFP/Roth. The AICPA PFP Section provides information, tools, advocacy and guidance to CPAs who specialize in providing tax, retirement, estate, risk management and investment advice to individuals and their closely held entities. All members of the AICPA are eligible to join the PFP section. For CPAs who want to demonstrate their expertise in this subject matter apply to become a PFS Credential holder.

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Lewis Schiff is a senior managing principal of Advanced Planning Group, a family office network for advisors.