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A Fitting End

11/10/2012

The last day of my investment conference this week was unusual — we studied the problems of longevity.

When I was certified decades ago, it was considered prudent to estimate 7% annual income from a balanced portfolio of stocks and bonds.  That’s means a person with a $100 thousand portfolio can reasonably assume an income of $7,000 annually to live on.  If that was not enough, they could take some of their principal — but not enough to run out before they reached age 80, when most everybody would be dead anyway.

My, how the world has changed!  One of the most contentious subjects among financial advisors today is how much income can safely be distributed to clients and how long should we assume the client will live.

The “prudent” annual income level to be distributed dropped to 6%, then 5%, and then 4%.  In this class taught by actuaries, they recommended only 3.6% — a huge drop in income from 6%.  Mostly, this reflects the lousy bond market interest rate environment, as well as the unusually volatile stock market in recent years.

And, if that isn’t enough income, how much principal should we distribute to clients based on their life expectancy?  The good news is that people are living longer.  The bad news is that they are out-living their money!

Assume a person retires at 65 and that I will need to distribute some principal for the person to live on, I can divide his/her portfolio by 15 to loosely estimate how much principal I can distribute to him/her each year.  If I assume the person will live to age 90, I must divide the portfolio by 25 — a big decrease in how much I can send him/her.

The actuaries recommend that we now assume the client will live to be 100 years old — another big decrease in their annual spending ability.

Everybody likes to think they can cut their living expenses enough to compensate for decreased income, but I have never seen that happen.  People underestimate both the difficulty and time required to accomplish that.

It is clear that people need to work longer, save more, and take greater responsibility for managing their own health — to ensure you can work longer.  It is not enough to wish for good health.  It takes a plan.  Health becomes another risk factor, just as a stock market crash, low interest rates, death of a spouse, etc.

When I was certified decades ago, I never suspected a good financial planner would have to involve himself in how well clients manage their health.  But, it does impact the way I should manage their portfolio!

Your homework assignment is to visit www.livingto100.com and take the examination to estimate your own life expectancy.

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