Part III: Shaping the Solutions

As advisers, it is essential that we master the effective use of various strategies to maximize the retirement resources of our clients in this revolutionary age of retirement. These chapters emphasize the challenges to advisers, who must synthesize vast quantities of information and creatively design solutions to meet the clients' current and future needs. The task is complex. But with these tools in your retirement toolbox, you'll be able to effectively guide clients through this important next stage of their lives.

Moshe A. Milevsky With Anna Abaimova

Moshe—a contributor to The Investment Think Tank—and his coauthor Anna remind the reader that planning for retirement is fraught with risk—portfolio risk, consumption and inflation risk, and mortality and longevity risk. Noting the oft-quoted statistic that life expectancy at birth is between 78 and 82, the authors remind us that although that's true, it's not particularly meaningful for planning purposes. For a married couple, each age 65, there is a better-than-even chance that at least one partner will live another 25 years. Add to this sobering fact the reality that inflation for the elderly exceeds the standard CPI measure by 0.5–1 percent, and it's obvious that retirement may be hazardous to financial health. Introducing the concept of a "retirement collar," Moshe and Anna provide a strategy for the evaluation and selection of immediate annuities as an essential element in managing the risk of providing lifetime income.

Harold Evensky

This chapter presents an implementation strategy to balance your client's cash flow requirements, longevity risk, behavioral factors, and portfolio volatility. As a retread engineer, Harold reiterates many of the concerns raised by Bob Curtis regarding the naive reliance on Monte Carlo analysis. He proposes instead a simple yet elegant distribution strategy. Supporting the credibility of his strategy with analytics, he demonstrates its viability during various difficult market periods. The goal of his chapter is pragmatic— to provide you with a practical and client-tested strategy for cash-flow distribution. Indeed, our firm has used this method, the Evensky & Katz Cash Flow Reserve Strategy, for almost 20 years—and it works.

Laurence Booth

Given that Professor Booth holds the CIT Chair in Structured Finance, you won't be surprised at the impressive formulae supporting his discussion; you may be surprised—and will certainly be rewarded—by his very practical ideas regarding the management of your clients' portfolios. Focusing on what he calls the three iron laws of finance—the laws of time, tax, and risk—he shows how an understanding of the primary issues (time value of money, tax value of money, and risk value of money) can help in structuring the solution to investment uncertainties and their impact on planning for retirement income. One particularly insightful framing strategy is to eliminate the commonplace aim of replacing 70 percent income at age 65 with a retirement target that incorporates uncertainty, such as "70 percent of 70@65," meaning a 70 percent probability of achieving 70 percent income replacement at age 65. As he concludes, implementing solutions to retirement-income problems by using objectives such as this will go a long way toward realistically addressing the uncertainty in investment returns.

William P. Bengen

If anyone can lay claim to "inventing" the subject of sustainable withdrawal, it's Bill Bengen. We couldn't have conceived of this book without a contribution from Bill. If you've not yet read his seminal piece, "Determining Withdrawal Rates Using Historical Data," you should now. First published in the October 1994 Journal of Financial Planning, it was reprinted in the March 2004 issue and can be found on the Journal's website. Bill's thesis in his original article, as well as in this chapter, is that market declines are powerful enough to overwhelm a portfolio already stressed by withdrawals. In short, secular bear markets cannot be ignored. In this work, Bill introduces the powerful planning and behavioral concept he calls "safemax"—that is, the maximum safe initial withdrawal rate, which historically has always resulted in a 30-year portfolio longevity, regardless of the year of retirement. Using his safemax concept, Bill evaluates alternative withdrawal schemes and the influence of varying equity allocations, providing practitioners with thoughtful and sound guidelines for designing and implementing their own distribution strategies.

Robert P. Kreitler

Harold thought that including a single strategy might be adequate (namely his); however, his coeditor reminded him that there were other practitioners with equally good (maybe even better) ideas. Consequently, we wanted to include a contributor who had a significantly different approach, whose strategy was practical, who had significant professional credibility, and who could effectively communicate ideas to the reader. We didn't have to look long; our obvious first choice was Robert Kreitler. Bob's chapter delivers on all points. His "tools and pools" strategy incorporates the behavioral "separate pocket" math discussed by Joel Bruckenstein, addresses the funding, investment, longevity risk, catastrophic risk, and "bad luck" risk noted by others, and provides for the flexibility necessary in an uncertain world.

Louis P. Stanasolovich

Lou is a good friend and an original member of the Alpha Group, a professional study group we've participated in for more than a decade. Our Alpha meetings and interim discussions with Lou have convinced us that he is one of the more creative thinkers in our field. During the last few years, he has been developing and improving his concept of a low-volatility portfolio, sharing with us his thought processes along the way. When we envisioned this book, we recognized that a key factor in extending the likelihood of distribution survival is the portfolio's volatility. So we asked Lou to share his insightful intellectual capital with our readers. Although Lou has devoted untold hours to the development of his strategy, it was no surprise to us that he readily agreed. Lou's premise is that strategic asset allocation in most portfolios is poorly devised at best, because the portfolios tend to be constructed solely from traditional capitalization-weighted asset classes that are highly correlated. In this chapter, he provides a detailed discussion on how to break out of the style-box paradigm and design a portfolio with significantly lower volatility.

Roxanne Alexander and Michael J. Anderson

We're especially proud of this chapter. As with life settlements, we've not yet recommended reverse mortgages to our clients; however, we believe that in the future they will play a significant role in distribution planning. We also had limited knowledge of the subject. So we searched for an authoritative expert. We never found one. During the process, we sought the assistance of our associates to help in the search and, having had no luck, two of those associates suggested we let them tackle the job. We did. In delivering their chapter, Roxanne and Mike did what we all hope to do for our clients—they exceeded expectations. Drawing on their educational backgrounds (business, planning, and law), their academic bent, and their practical experience in dealing with clients daily, they provide an unbiased and comprehensive introduction to the complex world of reverse mortgages.

Douglas Head

Although we have not yet used life settlements in our practice, we believe they will become a significant strategy in a practitioner's arsenal of distribution solutions. But we're embarrassed to admit we had little knowledge regarding the subject. In conversations with other advisers, we found we were not alone—all the more reason to include the subject in this book. And all the more reason to select an exceptionally knowledgeable contributor to address it. Consequently, we went to the source. We were delighted when Doug Head, former chair of the legislative committee, secretary, and president of the Life Insurance Settlement Association and now executive director of the association, agreed to participate. Doug's chapter frames the concept of life settlement by noting that although the idea behind life insurance for many generations has been to manage the risk of "premature" death by spreading the risk, the fact is that large numbers of insurance policies lapse with no claims ever being filed. The first recognition of this disconnect arose in the early '90s due to the tragedy faced by those with AIDS. That realization led to the emergence of the viatical industry. By 2005, the nascent viatical industry had morphed into a viable and growing life-settlement business. Doug introduces us to the concept and the industry, describes how they work, and explains the circumstances in which this evolving strategy may be appropriate.

Roger G. Ibbotson, Michael C. Henkel, and Peng Chen

A cadre of coauthors doesn't get much more blue blooded than this. Having had the honor of their contribution to our last book, The Investment Think Tank (Bloomberg Press, 2004), we couldn't resist inviting them to join us once again. In brilliant form, they extend their previous effort to focus on a key element in distribution planning—longevity risk. As many other contributors note, the Ibbotson team concludes that a significant strategy for managing this risk will be the inclusion of immediate (lifetime) annuities in the asset-allocation process. Based on their extensive personal knowledge and years of research on issues related to the integration of immediate annuities in the planning process, their chapter addresses the pros and cons of this vehicle and the significant factors a practitioner should consider in the implementation process.

R. H. "Rick" Carey and Jeffrey K. Dellinger

For variable annuities, we turn once again to the experts. If one were to compile a list of the people most knowledgeable about this subject, Rick and Jeffrey would rank at the top. Instrumental in the founding of the National Association for Variable Annuities (NAVA) and founder of Variable Annuity Research & Data Service (VARDS), Rick has been involved in the universe of VA for almost 20 years. Jeffrey is a fellow of the Society of Actuaries and a 30-year veteran of the financial-services world who is active at a senior level in all aspects of the annuity business. The two provide a definitive overview of a product we believe may be the single most important element in distribution planning—immediate annuities. As they note, "an immediate variable annuity is the optimal instrument for maximizing retirement income while minimizing—to zero—the probability of outliving that income." We agree and believe that all practitioners owe it to their current and future clients to carefully read the ideas presented in this chapter and learn from these experts.

Joel P. Bruckenstein

In the universe of financial-planning software, if Bob Curtis offers us the best-of-the-best in the developers' universe, Joel represents the best-ofthe- best in the world of practitioners. He spends a good deal of his time thinking about software from the practitioner's view, so when he offers suggestions regarding how one might model retirement-planning analysis, as he does in this chapter, the reader is in for an informative treat. One of his most interesting insights, and an issue that we'll be considering further in our practice, is balancing the financial logic of holistic distribution planning (in which the total portfolio serves as the source for all income needs) and the behavioral reality of our clients' mental math that leads them to think in terms of separate portfolio buckets, each designed to provide income streams for different goals (for example, a college-funding portfolio or a retirement portfolio). On this and the many software issues he addresses, he is a model of wisdom.