When it comes to retirement, perhaps risk is as important as reward.
Edward Farrington, executive vice president at Natixis Global Asset Management, says that when he reads about client attitudes toward retirement planning, he finds a glaring contradiction: Most investors, almost 80 percent, say they understand their financial needs for retirement, but less than half that percentage, 36 percent, feel comfortable in their current strategy.
“We looked at these numbers and it seems like investors know what they need for retirement, but they might not understand how they’re going to get there,” Farrington said. “It’s because, for the most part, they’re thinking of their retirement needs in terms of cash flow. Therefore, we felt like retirement planning should be thought of as a cash-flow problem instead of an income problem.”
In response, Natixis in May launched a new type of retirement account that offers inflation-adjusted payments over a client’s lifetime. Unlike annuities or managed payout funds, these offer 4 percent to 5 percent withdrawal streams pegged to inflation, not changes in the portfolio’s value.
Called “Retirement Spending Accounts,” these reflect the continued demand Farrington and others have seen for products that mimic the guaranteed retirement income once supplied by traditional pensions.
The most common path to income security in retirement is still the annuity, but many balk at their illiquidity, complex terms and high fees. Over the past decade, managed payout funds have also attempted to meet income demand, but they never gained popularity -- in part because the funds have a limited time frame and are susceptible to longevity and inflation risks.
In creating the new accounts, Natixis focused more on a structure that addressed clients’ asset liability management.
“There’s only one sure way to avoid risk -- take no risk,” Farrington said, “and for most people, that’s not a great option. They can’t afford to keep their retirement accounts in a mattress. So to fight inflation and longevity risk, you take on market risk, and in doing so, you invite in sequence of return risk -- the possibility that in the first three to five years of your retirement, your portfolio suffers a dramatic downdraft in valuation. If you’re already taking money out of your account, you’ve suffered a permanent loss of capital.”
Natixis tries to confront the risk of that early downdraft by beginning with a conservative asset allocation. The company then slowly increases the allocations to riskier assets for a period of time before decreasing risk as investors move toward the end of their life and deal with increased health care needs or legacy issues.
“We know that during retirement, accounts have to accept some risk to account for inflation, but they don’t need to take that risk immediately,” Farrington said. “We term that an adaptive retirement income glide path, the allocation changes to address challenges at different stages of your retirement.”
When clients open these accounts, they consist of a mix of bond funds, other mutual funds and ETFs. Over the first 15 years, the glide path increases the proportion of stocks, which provide bigger returns in exchange for higher risk, in lieu of bonds. As investors continue to age, the portfolio becomes more conservative again, theoretically stretching out the longevity of the account.