As I continue my education in personal financial planning and advice, I hope to share insights that I believe will be valuable to people in my network. I’m in the process of reading Michael Zwecher’s relatively new book, Retirement Portfolios, and I’d like to share some of his sage advice.
Now, most of you will say “I’m too young to be thinking about financing retirement”. Well, if you read this book, you will be convinced that the sooner you begin to plan how to meet your retirement consumption liabilities, the better off you will be. And it’s not just about saving more (although savings is a big piece of the puzzle).
Zwecher’s premise is that most people are pursuing an investment strategy of “hopeful accumulation” which is way too uncertain. You know what most of the more enlightened financial advisers say: diversify across a broad set of asset classes with low correlations in a tax efficient manner. Simple as that. So allocate 60% to equities, 30% to fixed income, and 10% to cash, and more than likely, things will work out and maybe you’ll build great wealth. Or maybe not.
Hmm, well that makes sense, right? Well, if you’re an ultra-high net worth household, it might. But if you’re like the other 99.5%, it does not really make sense. Why? Because you will have basic consumption needs that must be financed as long as you live. You need guaranteed sources of income – not 62% or 90% probable.
As individuals, we spend so much time researching the products we invest in and so little time thinking about the best way to secure a good lifestyle for the rest of our lives. So here are a few tidbits of advice that come from Michael Zwecher and that I think make a whole lot of sense:
1) It starts with building a floor. That’s right, understanding your consumption needs for the rest of your life, particularly when you stop working (if you can). The basics, nothing extravagant. You need to lock up that floor of guaranteed income as soon as possible and you can begin as early as your 30s or 40s. The earlier, the cheaper the cost of the floor. You lock it up by building a flooring portfolio that delivers the guaranteed income when you need it.
2) You can build a floor with capital market products, insurance products, or a hybrid. And social security and pensions count too. Insurance products are highly efficient because you benefit from mortality credits – you know, those who live long get the money of the people why die young; but you lose a lot of control because you make a lump sum payment to an insurance company (note that there is some carrier risk and it may be best to diversify). Think strips, zero-coupon bonds, TIPS, fixed and variable annuities, longevity risk insurance. The choice between insurance and capital market products is an important decision that is best made early.
3) Once you build a floor, build a cushion just in case things go wrong. Not a big cushion – just a layer between your floor and your upside portfolio layer.
4) Then build an accumulation portfolio, your upside layer, which now can be structured in a more aggressive manner because you have a floor that protects you, potentially leading to great upside because you can now take more risk.
5) Remember, once you build your floor, most of your worries about financing your retirement will disappear. After that, it’s all down hill.
That’s all for now.
