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by Wade D. Pfau, Ph.D., CFA

Wade D. Pfau, Ph.D., CFA, is a professor of retirement income at The American College and a principal at McLean Asset Management. He is a two-time recipient of the Journal’s Montgomery-Warschauer Award and host of the Retirement Researcher website RetirementResearcher.com.

How should a retiree choose an initial spending rate and asset allocation for retirement? These are key questions facing advisers when working with clients approaching retirement. But answering these questions is complex and relates to multiple factors. I have tried to summarize the important factors into something I call the Retirement CARE AnalysisTM. CARE stands for Capacities, Aspirations, Returns, and Emotional considerations.

Advisers should consider these factors, as follows, when deciding on the aggressiveness of both spending and asset allocation within a retirement income plan:

Capacities (Resiliencies)

Reliable income. What proportion of the client’s spending goals are covered through reliable income sources from outside the investment portfolio that will not be diminished by market downturns?

Spending flexibility. Is it possible to reduce portfolio distributions by making simple lifestyle adjustments without significantly harming your client’s standard of living?

Funded ratio. Are there sufficient assets to meet retirement goals without taking market risk? Is there excess discretionary wealth, or is the client underfunded with respect to goals?

Availability of reserves and exposures to spending shocks. How much exposure is there to large and uncertain expenses? What insurance policies or other reserves are available to manage these shocks? Are there buffer assets? How is home equity used within the plan?

Aspirations (Goals)

Lifestyle. What is the retirement budget? How does it change over time? How closely connected is it to consumer price inflation?

Legacy. What are the legacy goals? How important is legacy relative to other goals?

Returns (Assumptions)

Capital market expectations. What are reasonable market return assumptions for different asset classes and inflation to guide simulation of the retirement income plan? How are returns impacted by investor behavior, fees, taxes, inflation, and investment vehicle choices?

Emotional Comfort (Constraints)

Traditional risk aversion. How much short-term portfolio volatility can your client stomach before it affects his or her sleep and leads to panic and changing course if markets are down?

Longevity risk aversion. How fearful is your client about outliving his or her investment portfolio? Greater concern means more longevity risk aversion, implying that the adviser should build in a higher planning age.

Financial tool aversion. Is the client (and adviser) willing to consider different types of retirement tools, such as annuities and reverse mortgages, or are some tools simply nonstarters for the discussion?

Susceptibility to behavioral mistakes. When it comes to investing and long-term planning for complex situations, how prone is the client to making a variety of behavioral mistakes? Will the client be able to stick to his or her financial plan? Does the adviser have the capacity to provide advice and support late into the client’s retirement?

Financial plan complexity. What is the acceptable degree of complexity and involvement needed to manage the client’s finances? Do they enjoy the planning process, or would they prefer to outsource much of management to others? Would they prefer simpler set-it-and-forget-it types of solutions?

Financial savvy of all household members. How is financial planning knowledge and savvy distributed among household members? What is the degree of vulnerability of others in the household if the more financially savvy member experiences cognitive decline or an unexpected death?

In answering these Retirement CARE questions, a more conservative client will experience some of the following characteristics:

  • Fewer reliable income sources outside of the investment portfolio to help cushion the impact of market volatility on lifestyle;
  • Less flexibility to make spending reductions because spending goals are fixed and adjust with inflation;
  • Fewer reserves, buffer assets, or insurance policies to help cushion spending shocks;
  • A greater desire to build in a margin of safety for the financial plan;
  • Greater worry and stress about short-term market volatility; and
  • Greater worry and stress about outliving his or her retirement assets.

Meanwhile, a more aggressive retiree will tend to fall in the opposite direction on these matters, highlighting the highly personal and complex nature of these decisions. It is only after thinking about these different types of questions and assessing assets and liabilities on the retirement balance sheet that clients are able to fully determine their appropriate asset allocation and withdrawal rate decisions.

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