Nor does the path always apply to retirees. Those who have the option of delaying their retirement, going back to work or reducing their living expenses can modify their objectives. How about those people who can't find additional resources and need 30 years or more of income? Can they change their living expenses? Probably, but perhaps they don't want to, and it's critical for them to receive the income. If so, the restraints of the critical path should apply. Over long planning horizons, some retirees may want to hold on to some investment risk because third parties offer unfavorable guaranteed returns.
Some retirees would be better off keeping some risk to themselves. For very long-term planning horizons, they could turn to stocks, which, through the "equity premium," theoretically offer higher returns than bonds. But it must be a long term. After the stock market fluctuations and underperformance of the last decade and a 30-year bull market for bonds, investors have tended to forget the concept of the equity premium. They are asking, is it really certain that stocks will outperform current bond returns over the long haul? Should they take risks that institutions are not willing to take? Or will these stock returns be high enough to abandon a return that's guaranteed (albeit lower). Even after asking those questions, some retirees should consider saying yes to stocks.
Financial Repression
We are not in normal times. Many of the free-market functions of capitalism have been taken over by government. Monetary authorities around the world have driven interest rates close to zero, well below what they would normally be. Markets aren't serving their normal function of pricing and allocating resources. With interest rates so low, third parties can offer return guarantees based only on abnormally low interest rates. In the past, such periods of financial repression were temporary, and hopefully that will also be true this time.
How does financial repression affect the decisions retirees need to make for their lifetime income? For starters, they might want to avoid locking themselves into long-term commitments for now and stay flexible. That means the best approach might be to retain more investment risk. Later, when the economy is less dominated by government policies that keep interest rates artificially low, retirees can adopt strategies with the assurance that guaranteed rates are competitively priced.
Challenging Conventional Thinking
While the critical path is only theory, advisors can use it to help their clients challenge their basic assumptions. With it, clients can quickly grasp their limits and find the best way to free themselves from its constraints by changing their financial plans. This can mean increasing their savings, extending their planned retirement dates or curbing their retirement needs.
The critical path may also encourage advisors to challenge some of their own beliefs. The popular use of modern portfolio theory (even in an updated from) is based on the premise that all individuals can take risk. This may not be true for those on or below the critical path. If advisors accept the concept, it would mean a big shift in the foundation of their investment strategies.
Robert Kreitler, CFP, manages a New Haven, Conn., branch office of Raymond James Financial Services Inc. He spearheaded an effort with Ibbotson Associates and the FPA to create the "National Savings Rate Guidelines." He is the author of Getting Started in Global Investing. The opinions in this article are those of Robert Kreitler and not Raymond James.