There’s a big difference between retirement income and decumulation, and planners who can effectively explain that difference will have much more productive conversations with their clients, said Moshe Milevsky, finance professor and author of "The 7 Most Important Equations for Retirement."
In a session at the Investments & Wealth Institute’s annual forum in Tampa, Fla., last week, Milevsky emphasized that since the financial risks are different in these two scenarios, the language needs to be as well.
“Some of you might have been using this language interchangeably. I think these are two very different concepts,” he said. “Someone that’s interested in retirement income is someone who wants their wealth over time to roughly look like [a straight line forward]. ‘I want to generate income from my portfolio, but I don’t want my wealth to decline. I just need to generate more income because I’m in retirement and I’m not working.’ Decumulation is a process where your wealth is declining over time, and there is a risk that at some point there won’t be enough. That’s the event we want to make sure doesn’t happen.
“So who is your client?” he continued. “A decumulator or a retirement incomer? Once you get a sense of which group they’re in, you can have effective conversations.”
Milevsky’s presentation was pegged to his book, but with a twist. His book highlighted the work of seven historical scholars whose equations shaped the world of retirement planning as financial planners know it today, including Solomon Heubner, Benjamin Gompertz and Leonardo Fibonacci. But more important than the equations themselves are the conversations they should inspire, he said.
For example, Heubner’s promotion of insurance that surgically targets specific risks should lead to a conversation about a client’s highest risk scenarios, and then an understanding that an optimal retirement for either a decumulator or a retirement incomer leverages insurance premiums to cover those risks.
“Certainties you budget for,” Milevsky said. “Uncertainties you insure.”
Milevsky’s second “hero” of retirement planning was Gompertz. From him the planning industry got the concept of longevity risk through his formula for the analytic law of mortality. From there, an advisor can talk to clients about longevity, mortality, and diversifying, insuring and hedging, he said.
Finally, the third hero of the day was Fibonacci, who discovered the technique still used to express the time value of money, Milevsky said.
“One of the many problems in his text book, in the 12th century, in Latin, was, ‘Imagine that you have a sum of money. A thousand bezants,’” he recounted. “’Then every year you pull out four bezants from your portfolio. In how many years will there be no more bezants left?’”
It might have been the 12th century, but the formula he came up with was the one used today to talk to clients about drawdown rates, Milevsky said, and that’s exactly what advisors should be doing. The key to clients understanding this concept is working out the problem with the client in the room so they can see the potential problem: longevity deficit.
“’Mr. and Mrs. Client, your money will last 13 years, but you will last 25 years. There’s a deficit of 12 years. What do you want to do about the deficit?’” he said. “You’ve got to solve this problem. They’re paying you to solve this problem. This is Conversation 101 before you go to Monte Carlo and fancy probabilities.”
The advisor adds value by helping extend the longevity of a client’s nest egg and reducing longevity deficit, he said. In addition, the advisor does this by communicating and educating in small, digestible wisdom nuggets. There’s no need to dump a lot of information all at once on a client, even if that’s the whole truth. It’s far more beneficial to start small and dial up one click per meeting.
“It is unbelievable how low the level of financial and numerical literacy is. Don’t overestimate the knowledge of the person. Start from the very, very basics,” he said. “You have no idea how educated you are about retirement income relative to the groups that you’re going to be talking to. You have to simplify it to the point you’re sort of lying, but at least they understand something and you can then move them in the right direction.”