Retirement income is one of the most critical trends in the mutual fund industry right now-and yet, experts say few firms are getting it right.
Rather than relying on the traditional risk/return tools used in the accumulation phase, fund companies and financial planners need an entirely new set of tools that take a host of "decumulation" variables into account, such as inflation and withdrawal rates, along with rising longevity and healthcare costs, market risks and an individual's unique needs.
Effective retirement income plans need to be personalized, actively managed, diversified and realistic about a retiree's needs.
As the Baby Boomer generation nears retirement and life expectancy continues to grow, the prospect of a potential 30 to 40 years of retirement means there is a real risk of outliving one's assets. For a retirement plan to last 30 to 40 years, income needs to double to keep pace with a 3% inflation rate, according to information from the Retirement Income Industry Association of Boston.
Financial consultants say retirees can no longer just "set it and forget it," but should actively manage their portfolios by revisiting their holdings quarterly and their goals annually to take into account higher healthcare costs and market changes.
"Every good retirement plan should be regularly monitored," said Luis Fleites, vice president and director of retirement markets at Financial Research Corp. in Boston. "Solid planning is essential to make these funds last as long as possible."
Richard K. Fullmer, CFA, a senior portfolio strategist at Russell Investments in Tacoma, Wash., is one of a growing chorus of voices calling for a new approach to retirement planning.
"The purpose of accumulation is to acquire wealth," Fullmer explained. "The purpose of decumulation is to achieve lifetime cash flows from the portfolio. Conventional approaches often fail to properly define the investment problem," he said.
"To be effective, it is important to fully address longevity risk and use appropriate and complete measures of risk and risk aversion. For this problem, modern portfolio theory is an inadequate framework for portfolio construction," Fullmer said.
Yet a survey by the Financial Planning Association of Denver found that of the 75% of financial planners who use retirement planning software, 66% of those programs are modified accumulation programs or designed by the planners themselves. Another industry study found that less than 20% of retirees even attempted to map out a spending plan.
Fullmer explained that the investment problems of accumulation and decumulation are significantly different. Traditional formulas often suggest reducing future spending in the event of poor markets and/or unexpectedly high inflation, he said.
"This amounts to managing longevity risk through spending management," he said. "This approach sacrifices the investor's standard of living in the event of poor market returns."
A better approach, Fullmer suggested, is to manage longevity risk through portfolio management. The portfolio, rather than the investor's standard of living, responds to market performance and economic conditions.
Fleites said many firms are putting a lot of effort into retirement income planning. He said the mass market will probably come out with a lot of new products in the near future for retirees to give them the flexibility to enjoy their retirements and make their nest eggs last.
For now, a few financial software firms and mutual fund companies have begun offering a new generation of retirement income planning tools. SunGard recently brought the Retirement Income Simulation Expert to market, while FundQuest, eMoney Advisor, Merrill Lynch and Fidelity Investments are also making a push into the arena. Financial consultants in particular point to Fidelity, which last month launched the web-based Fidelity Retirement Income Evaluator to support 135,000 advisers, is one of the leaders in the space.
"A portfolio can vary distinctively, based on where an individual is when they set up an account," said Dave Liebrock, executive vice president of retirement for Fidelity.
He said there is no single investment product that works for everyone because people have different needs.
"We have to understand what the needs are before you can put the portfolio together," Liebrock said.
He explained that continuing to actively manage a retiree's portfolio is critical throughout retirement, especially if the investor leaves the workplace before Social Security kicks in. A good retirement income plan will allow the individual to participate in the marketplace and incorporate a growth strategy to guard against the risks of inflation and longevity, he said.
Liebrock said the average expenditure rate in retirement isn't a flat line, but more of a curve. Retirees typically have more expenses during the first few years when they are active and want to travel. Expenses drop and level out when the retiree slows down, and typically increase again at the very end to cover increasing healthcare expenses, he said.
Fullmer agreed that by continually monitoring the portfolio, investors can adjust to unpredictable market changes early on and avoid having a portfolio go broke before the markets recover.
Jim Graves, managing director of marketing for FundQuest, said the complexities of retirement income are so different that planners can't just use wealth accumulation tools anymore.
Graves said FundQuest's retirement income planning platform is distinct from others because it makes very specific investment recommendations based on personal preferences, and then follows through to make sure the plan is implemented and continually monitored.
The FundQuest system considers the impact of both inflation and withdrawals within its Monte Carlo analysis, he said. Inflation is considered in various forms, including its impact on rising expenses, its cost-of-living adjustments on income and to the changes in the tax tables over time.
While annuities are beginning to catch investors' attention as a way to guarantee lifetime income, Fullmer said many may want to delay annuitizing their retirement savings for a few years to give them more control over their investments. Annuitizing provides the guarantee of lifetime income, but no one knows how long they will live, he said. "I'm not saying everyone should delay," Fullmer said. Few people choose to annuitize everything or immediately annuitize because they don't like the idea of giving up control. On the other hand, "if someone says, I'm not willing to take the risk of running out of money,' it may be worth it for them to annuitize [earlier]," Fullmer added.
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