wealth distribution

RIAs Must Pivot or Face ‘Certain Decline’ | ThinkAdvisor


Phil was no longer surprised by the substantial amounts of investable assets that some Constrained Investors control. This really hit home early when his biggest clients, Brad, and Michelle, who have $12 million with Phil, stated that they need income of $48,000/month. With an Income-to Assets ratio of 4.8%, Phil realized that even Brad and Michelle needed an income plan that prioritizes risk mitigation.

Income-to-Assets Ratio

 The income-to-assets ratio provides an uncomplicated method to determine if an individual is a Constrained Investor. Simply divide the annual income to be produced by savings by the total amount of savings available to produce income. If the resulting percentage is 3% or more, the individual is a Constrained Investor.

What does that mean in practice? Caution. Never forget that Constrained Investors have an unconditional reliance upon their savings to produce “must have” retirement income. They have little or no margin for error in terms of making investing mistakes, thus they need a framework that imposes investment discipline.

The Constrained Investor planning framework, which combines continuing safe monthly paychecks with long-range exposure to equities, enables them to remain fully invested through all market conditions.

Let’s say Molly, a 66-year-old widow and recent retiree, has savings totaling $1,325,000. She requires $5,000 per month to supplement Social Security.

  • Molly needs her saving to produce: $5,000 x 12, or $60,000 annually
  • Required Annual Income ÷ Total Assets Available to Produce Income = %
  • $60,000 ÷ $1,325,000 = .0452, or, 4.52%
  • 4.52% is greater than 3%, making Molly a Constrained Investor

In counseling Molly, the advisor’s first priority is to mitigate risks that can reduce or even eliminate her retirement income. Two paramount risks that RIAs must not ignore when working with Constrained Investors are timing risk and longevity risk.

Never Neglect Timing Risk

The income-destroying potential of timing risk is devastating to retirees whose unlucky choice in the timing of retirement proves catastrophic to their income generation capacity. Here’s an example:

Imagine 10 financially identical people. All have the same savings of $500,000. They have identical investment portfolios. They will retire and withdraw the same amounts of income. What is different? Only the timing of retirement.

To demonstrate the danger to a retiree’s income, rather than retire all 10 the same day, we will separate them by one calendar quarter. About every 90-days, another individual will retire in this sequence: Jan 1, Apr 1, Jul 1, and so on, until all 10 are retired. We will use an historical two-year period, from 1968 to 1970, and actual market values.

Let’s assume the portfolio has an asset allocation of 42.5% large company stocks, 17.5% small company stocks, and 40% intermediate-term government bonds and is rebalanced annually. The individual retiree withdrew the same dollar amount within each calendar year and adjusted annually for the prior calendar year’s inflation rate. The cost of funds in the portfolio is 100 bps annually.

Ben retires first on Jan. 1. Three months later, on April 1, Susan follows Ben into retirement. Would you believe that a 3-month difference causes Susan to end up with nearly $1million more than Ben?

But it’s even worse for Kathy, the fifth person to retire, is a case of  “portfolio ruin,” No money. No income. Just bad luck. However, the 10th retiree, Jerry, was lucky. He received 30-years of inflation adjusted income plus a pile of cash equal to $2.6 million.

They started equally. Jerry is rich. Kathy is broke. The lesson is, when working with Constrained Investors, RIAs cannot fail to mitigate timing risk

Mandatory: Longevity Risk Protection

Financially, nothing is more important to a retiree than his or her income. Economist and Nobel Laureate, Robert C. Merton, said: “In retirement, it’s your income, not your wealth, that creates your standard-of-living.” Think about that.

I like to say, “No retiree stops needing income.”

Let’s go back to the example of our Constrained Investor, Molly. This is a woman who knows something about living a long time in retirement. Molly’s mom passed away at age 95. Remaining financially secure in her old age is a concern that is always in the back of Molly’s mind.

At age 66, Molly is healthy and vibrant. Do you agree that Molly could outlive her mom by, say, six years? Certainly. This means that Molly would need you to provide for her monthly income to last until her age 101. There’s only one financial instrument that will provide lifetime, guaranteed income. You know what it is.

Annuities and You: A Reckoning

RIAs who continue to refuse to recommend lifetime income annuities should just give up any hope of keeping all their Constrained Investor clients, not to mention having any realistic chance of  attracting new ones.

I make this statement for two reasons. First, the “Ken Fisher” type of condemnation, criticism, slur, complaint, objection, and grievance against annuities has been rendered moot.

Today, it is easy for RIAs to access no-commission/no surrender charge annuities across a wide range of contract structures. Moreover, these annuities harmonize with the RIA business model. Their values report into your portfolio management system, no different than any “wrapped” investment. As tools able to introduce risk mitigation dynamics into the larger retirement income investing strategy, annuities are invaluable.

An annuity recommendation is not required to mitigate timing risk. Just use investments with no principal risk to provide the client’s income over the first 10 years of retirement. That said, a single premium immediate annuity/multi-year guaranteed annuity combo is an easy and bullet proof solution for managing timing risk, one that delivers 120- months of guaranteed paychecks.

Clients love this. Providing predictable monthly paychecks is integral to building a framework for investment discipline that keeps clients fully invested.

In terms of the recommendation of annuities, longevity risk is another matter. There is no optionality here. When working with Constrained Investors who have at least a normal life expectancy, RIAs breach their fiduciary if they refuse to recommend guaranteed lifetime income.

Time to move forward, RIAs. With this type of client, you cannot ignore the most important retirement income security tool ever created, As I said above, no load/no commission annuities are easily accessible.

How to Assure RIA Growth

I realized early in my career that “distribution”  was a distinct planning specialty and not a simple reversal of dollar cost averaging.

Retirement income planning is equally sensitive to asset allocation and product allocation. The techniques and insights it demands are different than those used to accumulate assets. The negative effect of  investment losses in the distribution phase are orders of magnitude more serious.

With virtually the entire RIA channel misaligned to meet the market need, I say something has to give. If you wish to ignite robust growth in your practice via the lucrative market for retirement income planning, what should ”give” is:

  1. False confidence in confidence rates,
  2. Reluctance to recommend annuities that provide lifetime guaranteed income,
  3. Investment strategies that fail to promote durable investment discipline through the provision of safe monthly paychecks and
  4. SWP in the context of Constrained Investors’ income planning.

I’ve seen an enormous number of examples of income distribution specialists taking clients and assets away from accumulation-focused advisors. This trend is accelerating due to the impact of boomer-aged women gaining control of most wealth assets.

Right now, supply and demand are mismatched. Change that. Constrained Investor is key to aligning your supply with the market demand. It is the path to a…


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