A common question I receive when speaking to groups of financial advisors is whether it is a bad time for clients to purchase individual bonds or income annuities in today’s low-interest-rate environment.

My answer to this question is no. It is a tough time to retire using any strategy, and I do not think that low interest rates should discourage the use of fixed-income assets more than the alternatives. Saying it is a bad time to retire no matter what you do often draws laughter from the audience, but I do not mean this as a joke. My point is not that clients should avoid retirement. It’s a reality check about the conservatism necessary for any type of retirement income strategy today.

To understand this point, a bit of background is in order. One of my common speaking themes is the two diametrically opposed schools of thought about retirement income. I call them the probability-based approach and the safety-first approach. Probability-based approaches focus on the client’s overall lifestyle spending goals and seek to meet these goals using a conservative withdrawal rate from a portfolio of diversified financial assets with a fairly aggressive asset allocation. Assets are invested using a total returns portfolio perspective.

William Bengen developed the so-called 4% rule of thumb, which was originally the 4.5% rule. It indicates that, based on the worst-case scenario in U.S. history, an individual could have withdrawn 4% or 4.5% of his or her retirement date assets, subsequently adjusting this amount for inflation, and sustained this spending pattern over a 30-year retirement period using a portfolio of 50% to 75% stocks. Probability-based advocates are fairly comfortable linking retirement withdrawals to what would have worked historically.

Moving away from this total returns perspective, the safety-first school relies more on matching assets to liabilities. Spending needs are differentiated between essential and discretionary, with the idea that essential needs should be covered by assets that are safe and secure. This means holding individual bonds to maturity or using income annuities.

Only after covering essential needs with dedicated assets should a retiree think about investing in the stock market. Stocks would be targeted to discretionary expenses. It is less catastrophic if all of these expenses could not be met, so it is reasonable to seek greater upside potential for the risk of downside losses. Sustainable retirement income spending should not be based on what would have worked in the past using an aggressive portfolio, but rather on what the current market environment suggests is feasible.

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