Comfortable aging: your retired clients' portfolios: should there be a difference?

• Author: Freedman, Mitchell
• Position: Financial planning

As individuals age, the traditional historic approach to portfolio construction has been to reduce equity and other "risky" investments and increase fixed income investments. In a simplistic illustration, some use the following rule of thumb: Subtract your client's age from 100 and the result is the amount that should be invested in equities, with the balance invested in fixed income. A key question is: Would such an approach be in your client's best interest? Adhering to this method may reduce market risk, but it may not provide sufficient income and growth for those who are aging to ensure that they don't outlive their assets.

Over the years, investment management and personal financial planning thought leaders have challenged this traditional way of doing things. Their academic studies and resulting opinions call into question the conservative approach. Within this article I will explore this issue, discuss client behavioral considerations and offer my own opinions.

Client Behavior

Individuals are living longer in the United States and other parts of the world. In 1940, when Social Security benefits were first paid, a 65-year-old typically lived about 12.5 more years. Today, a 65-year-old can expect to live about 18.5 more years. Longer life spans mean retirees need more assets and longer lasting income streams.

How do retirees behave regarding their spending? Bud Hebeler, a retired engineer who has written extensively about elders investing and spending, says "People have to be aware that there is a large degree of uncertainty in their future financial situation. That includes uncertain returns, inflation, tax rates, health and many unknown events that escape foresight." There's also an assumption that the elderly spend less than those who are not in retirement. "The elderly who have the money spend it," says Hebeler in an article titled "The Biggest Retirement Plan Myth."

Based upon my experience, and that of my peers who have served with me on the AICPA Elder Care Task Force, as people age and have less physical agility and mental cognitive ability, they don't spend as much money on such things as travel, entertainment, hobbies, country clubs, etc. However, costs of medication, medical care and long-term care can dwarf other such expenditures.

Breaking Tradition

So, what if the "traditional" stock/bond equation (or asset allocation) yields the wrong answer? Meaning, what if more total return is needed than can be provided with a...