I recently read an article in which a couple in their early fifties had accumulated $1 million that they hoped would grow and allow them to receive $80,000 a year when they retired. The money was allocated 80 percent to government bonds and 20 percent to stocks because the couple had a very low risk tolerance. The couple’s advisor is quoted as saying that if the couple didn’t change their allocation they might run out of money in their eighties. The advisor’s statement illustrates an issue that often affects retirement income planning—trying to get people to act as the computer model says they should.
A typical retirement planning model uses a world that consists of stocks and bonds, plugs in their historic returns and looks at a variety of allocations to see what results are produced. What is found is that putting too much money in bonds increases the likelihood that the allocation mix will not last long enough to produce retirement income for a lifetime, but that increasing the allocation of stocks often does. The model is clear—own more stocks. However, the risk of principal loss is greater with stocks than bonds, and that makes many people averse to stocks.
When the advisor told the couple they could potentially earn a higher return if they would accept more risk, I doubt the couple simultaneously smacked their palms to their foreheads and said, “Wow, we didn’t know that.” Any couple with a million dollars is aware of the concept of risk-reward. This couple has clearly shown they don’t want more risk, but the advisor ignored this because it didn’t fit the model.
During our coming of age years—the time roughly between age 17 and 23—our beliefs on fairness, our political views, and views on money and risk are solidified. Although these beliefs can moderate over the years, our original core values hold a lot of power over us. It’s important when working with clients on financial matters to understand what their financial beliefs are and that an advisor is unlikely to change those beliefs.
In short, the person is usually not going to act like the computer model says they should act. Because of this, the advisor needs to deal with the reality of the client’s beliefs and try to find solutions that don’t contradict them. When the problem is a low tolerance for risk of loss, often an annuity is a solution.
The goal here is to produce an income of $80,000 that lasts until the death of the surviving spouse. One way to do this would be to take a part of the money and buy a deferred income annuity that starts payments roughly 30 years from now. Another would be to take the million and put it in some fixed index annuities offering lifetime income benefits with an increasing payout. I spent 20 minutes and found a few fixed index annuities that would guarantee a joint lifetime income of at least $80,000 starting in 13 or 14 years—when the couple said they wanted to retire—and the income is guaranteed to increase in future years. The annuities are fixed, so there is no market risk to principal or credited interest, which should be a better fit for their risk tolerance.
The problem with many model solutions is that they ignore the realities of the way people really are and how they make decisions. To have a shot at being used, the advisor needs to try to fit the model to the client’s reality and not the other way around.
