Retirement income can be a challenge for many advisors, and advice given to clients has often relied on rules of thumb based on assumptions of how households spend post-retirement. Only recently has the industry been able to effectively parse real-life data to fully understand actual spending behaviors: J.P. Morgan’s analysis of over 62 million U.S. households’ spending data has revealed a number of surprising insights. These, taken into consideration alongside a prudent outlook on the macro landscape, can help inform more effective retirement income planning strategies.
- Increased spending late in retirement reverses the trend
A relatively new spending insight has been that older households tend to spend less in real terms through retirement. With more households living longer, we now can observe that for affluent households spending reverses and begins to steadily increase around age 80. It is most likely attributed to increasing healthcare, long-term care and housing needs. Unfortunately, with many Americans spending decades in retirement, portfolio values may be less than what is required.
Advisors should therefore focus on clients’ long-term care planning needs and consider incorporating higher spending beginning at age 80 or maintaining a reserve of assets to cover these potential expenses. It would also be wise to consider the role that risk plays in a client portfolio, whether that client is in retirement or not: with U.S. market valuations in extended territory and inflation running structurally hotter than in recent history, investors must become comfortable with taking more risk in their investments and lean more into equities, particularly overseas opportunities.
- “Stable vs. Flexible” is the new “Discretionary vs. Non-Discretionary”
For advisors, working with clients to separate expenses into discretionary and non-discretionary buckets is a challenge, with many spending categories hard to define and highly subjective. More to the point, a good amount of post-retirement spending, like that on healthcare, is lumpy. Nonetheless, this approach is often used to identify post-retirement spending needs that should be covered by consistent income.
Instead, Advisors should work to quantify “stable”, regular expenses and align these to a guaranteed source of income, such as an annuity. Building a portfolio that has the ability to weather changing inflation rates, including through the use of commodities, will also be important.
- A retirement “paycheck” can be incredibly powerful
Interestingly, much of J.P. Morgan’s recent research suggests that many individuals aren’t spending enough in retirement, effectively sacrificing their lifestyle quality. One potential reason for this is that retired households struggle with spending off of assets after spending off of income throughout their careers. Indeed, our analysis of “total retirement wealth” – a combination of investment accounts and the present value of retirement income sources – shows that more wealth attributable to income results in higher spending. However, given elevated valuations in fixed income that are likely to persist even as the Federal Reserve normalizes monetary policy, finding income is increasingly a challenge.
For advisors, the implication is clear: creating a ‘paycheck’ like experience can help clients spend with greater confidence. This can be achieved through solutions like annuities or monthly account transfers to a checking account. It will also require an increased reliance on income-generating assets: equities, for both derivatives and dividend income; global fixed income instruments across the credit spectrum; and, where appropriate, alternatives such as real assets.
In sum, while traditional retirement income advice has often been based on arbitrary processes, insights gleaned from real-world data can lead to a more informed retirement income strategy. For advisors looking to increase client quality of life in retirement and decrease risk of running out of funds, incorporating long-term care planning, quantifying stable spending patterns and building a ‘paycheck-like’ experience, all the while building portfolios that reflect current market prospects, are very valuable tools.
Structuring a portfolio to match investor goals in retirement
For illustrative purposes only. Fixed income is subject to interest rate risk. Fixed income prices generally fall when interest rates rise. The price of equity securities may rise or fall because of changes in the broad market or changes in a company’s financial condition, sometimes rapidly or unpredictably. Investing in alternative assets involves higher risks than traditional investments and is suitable only for the long term. They are not tax efficient and have higher fees than traditional investments. They may also be highly leveraged and engage in speculative investment techniques, which can magnify the potential for investment loss or gain.
*Equity, fixed income and cash are considered “traditional” asset classes. The term “alternative” describes all non-traditional asset classes. They include private and public equity, venture capital, hedge funds, real estate, commodities, distressed debt and more.
Source: J.P. Morgan Asset Management.