Assigning jobs to retirement portfolios

Over the next few years, you’ll see a tidal wave of prospects looking to you for retirement solutions. Will your business sink under the weight of stale retirement concepts or will your book ride the retirement wave using innovative ideas and expert research?

Some advisors may choose to retest their clients’ appetites for risk with often ineffective risk questionnaires. Others may even do some additional fact finding to determine a client’s goals in retirement.

However, these tweaks proved largely inadequate last year. If you were like most advisors, your 2008 year-end client reviews likely provided little joy for clients with moderate risk portfolios that were down by 20%. We may have compounded the issue by telling clients that although their portfolio performed poorly, they were able to beat the median manager or some blended benchmark. Most clients do not care if they beat a benchmark. They just want to know if they are going to be OK and if they can still retire in the manner they expected.

A portfolio should reflect what the money needs to accomplish. Most clients have more than one goal and each goal likely comes with different time horizons and tolerances for risk. Therefore, retirement portfolios should each come with a job description, with different risk tolerances to match the different goals the portfolio has to achieve. For retirees and clients planning to retire soon, a typical goal is to have enough money to cover the following three key costs of retirement: essentials, lifestyle and estate.

1. Essentials

The job description for the essentials portfolio would go something like this:

Help wanted: A portfolio needed to provide certainty. Duties include putting food on the table, heating the home and paying taxes.

A portfolio featuring an asset mix of 65% fixed income and 35% equity could do the job effectively. This portfolio will allow for some growth but will provide the necessary stability in down markets. A portfolio such as this would have still declined in 2008 but by a modest 6% — where as the median Canadian equity fund declined -32.5% last year.

2. Lifestyle

Lifestyle in retirement could include examples such as winter trips down south, dining out regularly, presents for grandchildren, golf and other activities. Here’s the job description for this portfolio.

Help wanted: A portfolio needed for discretionary spending. Duties include golfing at least once a week and eating at fancy restaurants. Portfolio must be generous with grandchildren. Extensive travel also required.

To give you the potential to increase the amount of discretionary income you have to play with you need to take on more risk. At the same time you do not want to risk too much or else you won’t be able to play golf at all. A 60% equity portfolio is a reasonable risk profile to achieve growth without risking the farm.

3. Estate

If you have enough money to cover your essentials and lifestyle what is left over should go to a portfolio that takes care of your estate.

Help wanted: A portfolio needed to care for family, friends, and charity. Must be willing to work long-term and handle volatility.

If your only goal is to leave money behind for your family or charity, your time horizon is approximately 30 years for a 60 year old. I would be inclined to have 100% of this portfolio in stocks. Over a 30-year time horizon, stocks outperform bonds and cash with a 99% probability; I like those odds. Even if you have a difficult year early on, you have more than enough time to make it up. Ultimately, the risk profile of your estate portfolio can be quite flexible.

Now consider the different conversation you could have had with your clients at the end of 2008. You would start by reminding them that you divided their portfolio into three separate portfolios.

The essentials portfolio is the account that you are pulling money out of to pay for their day-to-day expenses. You could tell them that the portfolio minimized risk and was only down 6%.

The lifestyle portfolio was down 20% and you may recommend that they head to Hawaii or Florida for one week instead of one month, but you can help them make appropriate budgeting decisions.

If your client is lucky enough to have estate money you can tell them that portion of their portfolio is down 45% but we have another 26 years to make it up and they will do just fine.

Each portfolio did their jobs. You did your job and provided clarity for all your clients on whether they will be OK. This is the piece of mind that clients are willing to pay for.

Keith Pangretitsch is the director of private client services at Russell Investments Canada.

(08/19/09)