A new approach to retirement planning
Current thinking around retirement planning needs to change to more realistically meet the objectives of people both saving for and in retirement.
Thinking around retirement planning generally focuses only on saving for retirement, which will occur on a specific date or age. The aim is to accumulate a targeted capital value. However, no thought is given to the sustainability of the capital after one retires or the level of income that the capital is able to support, hence there is a disconnect in retirement planning.
This has resulted in a crisis in retirement planning. Robert C Merton, author of ‘The Crisis in Retirement Planning’1, states: “Our approach to saving is all wrong; we need to think about monthly income, not net worth.”
So currently, the conventional planning approach in both the pre and post-retirement phases does not take into account volatility, sequence, annuity or valuation risk. The planning is simply based on a linear growth projection without taking these risks into account.
When risk is considered it usually takes a market view, which simply looks at short-term price volatility, and not the real long-term risk for South African investors, namely inflation.
To address one of these disconnects between pre and post retirement thinking, it is essential to incorporate both pre and post retirement phases into the financial plan. This requires looking through retirement rather than to retirement.
Prior to retirement, the focus should be on producing and building up a monthly income that will support the retiree during retirement. John Rekenthaler, VP of Research for Morningstar, said, “For investors approaching (or in) retirement, the better way to think about progress is the growth (or shrinkage) of projected income. …Projected retirement income is superior to total return for conveying to investors how they are progressing toward their goals2.”
More recently, Chip Castille, MD of BlackRock US DC Group acknowledged that: “We need to shift our focus away from the total value of the nest egg, and instead toward the annual income it could provide.”
To address this need requires a different way of planning and investing both for and in retirement. From an asset management perspective, in the words of David Blanchett, CFA, Head of Retirement Research at Morningstar, this requires the introduction of “A new optimisation method for building income efficient portfolios.”
In recent years, Grindrod Asset Management has introduced Income Efficient Portfolios™ for these reasons. These portfolios offer three important elements for current and future income requirements, namely:
- Reliable income yield
- Annual growth in income of close to CPI
- Long-term capital growth (Total Return) at/above CPI to sustain income for up to 30 years
These portfolios close the gap between pre and post retirement thinking and reconnect asset management with client outcomes by providing portfolios that produce reliable income now, future income growth at or above inflation, as well as long-term capital growth. They do this by investing in growth assets like equity and listed property that produce high and growing income. This enables financial planners to adopt the actuarial approach of asset liability matching to retirement planning, thereby addressing the core objective of inflation hedged income in retirement.
In addition, retirement planning should not be done using simple linear calculations, which completely ignore market volatility and investment risk. A planning model which simulates multiple possible outcomes that incorporate these risks is a more realistic way to assess the likelihood of achieving the long-term goal of inflation hedged income in retirement.
The disconnect between asset management and retirement planning is thereby best addressed by viewing pre and post retirement planning holistically, as well as combining Income Efficient Portfolios™ with the actuarial approach to planning. This should lead to improved outcomes for retirees.
