In an ideal world, everyday Americans would march steadily through life, saving diligently and making rational investment decisions.
But every adviser can attest to the fact that the reality is considerably messier. Many people save too little, shun strategies that are good for their financial health and fall short of their goals.
Consider the most important goal of all: retirement. Over the years, massive brain and computer power have been thrown at the problem, so we have a solid idea of what Americans should do to ensure a comfortable retirement.
Yet many potential clients choose a less-advantageous path, which means that there is a great opportunity for advisers to add value. But doing so often means devising strategies that clients will find palatable and that will work with their shaky finances.
Reality No. 1: Clients retire with the nest egg they have, not the one they want.
Advisers who spend a few minutes with a financial planning program or even a simple online calculator, can get a handle on how much clients need to save every month for a comfortable retirement. Yet there is a good chance that clients will retire with less than their target nest egg, for several reasons.
They might earn a lower rate of return than assumed, especially after figuring in investments costs. Also, even if they are committed to saving the necessary sum every month, there will be times when they save less because major expenses crop up or they have stretches when they are out of work.
In addition, most people end up retiring earlier than planned.
The Employee Benefit Research Institute’s 2015 Retirement Confidence Survey found that workers planned to retire on average at 65, and yet the typical retirement age turns out to be 62.
Advisers should push clients to save as much as they can whenever they can, so that they are in better shape if the unforeseen comes to pass.
What if the bad stuff doesn’t happen and clients end up saving more than is necessary? When advisers tell them that they can retire early, it is unlikely that they will be too angry.
Reality No. 2: A withdrawal rate of 4% or less might be prudent, but it simply isn’t enough. In 1994, financial planner William Bengen published his famous study, which illustrated that if retirees wanted to be confident that their investments and savings would last through a 30-year retirement, they should limit their first-year withdrawal rate to 4%. The study was a wake-up call for advisers, many of whom were recommending 6% or more.
Recent research has suggested that even 4% may be too aggressive.
A 2015 study by American College of Financial Services Professor Wade Pfau analyzed a variety of strategies and found that the safe withdrawal rate could be as low as 2.85%.
These studies are fascinating. But no one envies the adviser who tells a 65-year-old couple that their $1 million will generate first-year retirement income of $28,500, putting them uncomfortably close to the federal poverty level.
Instead, go for the common-sense conversation.
Start by mentioning the studies, so clients know that anything above 3% or 4% is risky. Advisers might then suggest that clients opt for 5% but stand ready to slash their spending if the markets go against them, especially during the early years of retirement.
The ability to vary spending is a great financial advantage, but it is a lever that is too rarely used. To make sure that clients have the financial leeway to lower spending, counsel them to keep their fixed living costs low.
Reality No. 3: Retirees are still coupon clippers at heart. This doesn’t mean the supermarket variety of coupons. Rather, it is a reference to old bond certificates that came with coupons that holders would use to claim their regular interest payments.
Many retirees are still inclined to invest for yield, while hewing to the principle that they should “never dip into capital.” This might sound prudent, but it is often a recipe for disaster.
Consider last year: Those who reached for yield by purchasing master limited partnerships and high-yield bonds ended up suffering mightily.
Instead, the truly prudent strategy for retirees is to invest for total return, while also annuitizing part of their savings. Neither approach is popular.
Many advisers use a variation on the cash cushion approach. They figure out how much clients need to spend from their portfolio over, say, the next five years and then allocate that money to short-term bonds and cash investments.
That frees up clients to invest the rest of their portfolio in stocks and riskier bonds, knowing that they have enough cash set aside to carry them through a long bear market. But clients often push back against this approach because they are unnerved by having so much of their money in volatile investments.
Although many retirees are reluctant to invest substantial sums in stocks, that reluctance turns to outright resistance when it comes to annuitizing.
Advisers should train clients to worry less about dying early during retirement and more about living longer than they ever imagined. But this is an uphill struggle, which shows up in two ways.
First, almost half of retirees claim Social Security at 62, the earliest possible age. Yet delaying benefits, thereby getting a larger monthly check, is often the smartest move that a retiree can make, especially if the retiree is the family’s main breadwinner.
That larger check can provide insurance against outliving other assets. If the retiree is married, it can also ensure a handsome survivor benefit for his or her spouse.
That brings us to the second sign of resistance. Sales of immediate fixed annuities ought to be booming, as cash-strapped baby boomers look to squeeze maximum lifetime income out of their skimpy nest eggs.
Yet in the first nine months last year, total sales were just $6.5 billion, according to LIMRA Secure Retirement Institute.
Compare that with ETFs, which hauled in $140 billion over the same stretch, according to the Investment Company Institute.
It is hard to come up with a killer argument that will persuade clients to allocate part of their savings to immediate fixed annuities. But advisers might suggest that clients make modest purchases over five or 10 years.
That may ease their fear of buying and then immediately dying, plus their enthusiasm could grow as they become accustomed to the healthy income stream that annuities can generate.