The last 40 years of the 20th century saw an economic boom driven primarily by demographic shifts that have expanded the labor market and declining interest rates. During this boom time, higher portfolio returns came to feel like the norm. Now, after 15 years of low interest rates, rising debt and a demographic shift that’s reducing the overall size of the workforce, the landscape looks completely different. While the bull market has persevered through these headwinds, seemingly unscathed, more and more clients are starting to think about what will happen when the longest-running bull market in history finally does come to an end.
While financial professionals may not be able to help their clients completely “recession-proof” their portfolios, they can help them mitigate the impact.
Rewrite The Drawdown Playbook
The retirement portfolio playbook your clients might be accustomed to needs to be rewritten. The “four percent rule” —which held that a retiree could safely withdraw four percent from their retirement account each year and still preserve their account balance—was developed midway through the prosperous period in the late 20th century when annual portfolio returns in excess of 7% were the norm. That assumption no longer seems reasonable in today’s macro environment. As a result, financial professionals need to help their clients think of accessing income from their accumulated assets in a different way.
Use Diversification To Meet Income Needs
Though your clients likely understand the benefits of diversification to help mitigate risk, showing them how an asset allocation strategy maps to their retirement income needs will get them to start thinking about diversification in a different way—and feel better prepared to manage money in multiple environments.
A balanced asset allocation approach will consider equities, bonds, real estate and alternative investments. However, don’t underestimate fairly-priced annuities from strong insurance companies as another asset class. Annuities from a stable life insurance company provide a guaranteed, predictable stream of income that isn’t necessarily dependent on market performance and can be helpful in creating a level of reliable income in retirement, depending on the type of annuity and its features. (Clients should understand that diversification does not guarantee a profit or protection against loss. All such guarantees are based solely on the claims-paying ability of the issuing life insurance company.)
In addition, a sound tax diversification strategy is important. It’s impossible to predict which tax laws will be in force when a client retires; working with your client to determine the appropriate mix of after-tax, tax-free and tax-deferred investments is time well spent. There, too, annuities can play a role in creating tax-deferred funds.
Income diversification brings it all together. Here’s one way to break it out:
• Liquid reserves—cash, money market accounts and CDs help your clients cover day-to-day expenses and provide a ready source of contingency funds in adverse markets or in cases of unexpected expenses.
• Basic income—Social Security benefits, pension distributions and guaranteed annuity income help your clients meet their monthly budget expenses: food, housing and health care. Ensuring basic expenses are covered with protected income can help put clients’ minds to ease should a recession or a volatile market take hold.
• Inflation-addressing investments—traditional and Roth IRAs, mutual funds, 401(k)/403(b) accounts and other investments can provide your clients with discretionary funds for that dream vacation, help meet legacy planning needs and potentially keep up with inflation.
Use Tech To Optimize—Not Replace—The Client Relationship
Much has been made of the influx of robo advisors in recent years, and while they may have a place for simple accumulation strategies, they may not be nuanced enough to handle complex situations—such as when investors are dealing with sudden volatility, or trying to manage longevity risk and income protection, or managing a unique approach to drawing down assets in retirement.
When used correctly, other technological advances are widely beneficial to supplement personalized advice that financial professionals can give. Fintech companies, for example, provide mobile apps, back office automation, suites of analytics and customer relationship management (CRM) capabilities—which enable financial professionals to create personalized plans faster, and allow more time for client discussions and value-added activities that significantly enhance the client experience. This allows you to focus your energy on what matters most: helping your client to create a financial plan that considers your clients’ unique needs, goals, dreams and challenges while seeking to minimize risk.
No portfolio is truly recession-proof, but every client can be better prepared for the future, no matter what it holds. By taking full advantage of all available resources, a holistic approach that includes highly personalized accumulation strategies, diversification of income strategies, which includes protected income, advisors will be better able to manage their practices to meet a broader range of client needs, for every stage of life.
Graham Day is managing director of individual retirement at Equitable.