Five key retirement risks

According to Peter Drake, the vice-president of retirement and economic research at Fidelity Investments, there are five key risks to retirement income: longevity, asset allocation, inflation, excess withdrawal and health-care spending. It’s up to advisors to help their clients cope with these challenges to ensure they have income to last them through their retirement.

If anything, advisors need to be steering their clients away from having too conservative a portfolio. That was one of Drake’s main messages as he spoke at one of the final stops of the fund company’s latest road show last week.

“One of the old myths is that when you’re in retirement, you go for fixed income,” he said. Today, he adds, that myth is severely damaged if not destroyed. “When you look at what that will do for portfolio life, it’s not a whole bunch compared with a more aggressive portfolio.”

Indeed, according to Drake’s research, when it comes to providing retirement income, there is very little difference between the projected life of the most aggressive portfolio and that of the most conservative one during an extended down market. The most aggressive portfolio, with 85% in stocks and the rest in bonds, in this scenario would last 22 years during an extended down market with the client withdrawing 4% per year.

A more conservative mix of 60% stocks, 20% bonds and 20% cash isn’t much better. The average life of this type of portfolio would be only four years longer in an extended down market, again with the client counting on a withdrawal rate of 4%.

There are, however, major differences between the projected lives of these portfolios during average market conditions. Under average conditions, Drake found the most aggressive portfolio would have a projected life of 88 years with a 4% withdrawal rate. The most conservative portfolio would last 33 years under the same conditions — only seven years longer than it would in a down market.

When people enter retirement, they are looking for income; fixed income is no longer able to cut it as it once did. “The urgency of our research efforts and everybody else’s is borne out by this whole income-trust thing,” he says. “Why was it so popular? Because of the old days of the high interest rates.”

In the 1980s, Canada Savings Bonds had a first-year coupon of 19.5%; today, the 10-year bond rate is down to 3.99%.

This presents both a huge opportunity and a monumental challenge for financial advisors, he says. The opportunity comes from the sheer number of boomers and their combined wealth. The concentration of Canada’s wealth is already tilted in favour of the 55 and older set. Although they number about two million, they control 63% of the wealth. Their numbers will continue to swell, and by 2014, they will account for 72% of the wealth.

“You might want to ask whether there is more room in your book to accommodate boomers,” Drake says.

Asset allocation alone is not the only answer to devising a plan to provide retirement income. Annuities will also play a big role, says Drake, although he notes there are some pros and cons that need to be considered here as well.

“The great thing about annuities is that they are predictable … you have a secure source of retirement,” he says. “But the downside is it doesn’t take into account that one of the key risks is inflation.”

Even a low rate of inflation can do a huge amount of damage to a retiree’s purchasing power over 25 years, he says. The other concern is that a retiree who owns an annuity loses control of the assets.

“Like so much of this business, there are great tools to use and great techniques, but every client has to look at this with their advisor to find out what works.”

Filed by Mark Brown, Advisor.ca, mark.brown@advisor.rogers.com

(11/21/06)