This is the first of two Posts on why a greater focus should be placed on generating a level of income in retirement as an investment goal.
This Post outlines why income matters as an investment goal and the second Post covers why variability of retirement income is a better measure of risk rather than variability of capital.
A greater focus on income is different to the current industry approach, where accumulation of wealth has a higher priority. This is important of course. Yet a greater focus on generating income as an investment goal is not that radical. It is consistent with the age of the Defined Benefit investment solution. Therefore, it is not a new concept.
The rationale for the focus on income is provided below.
The inspiration and material for these Posts comes from a Podcast between Steve Chen, of NewRetirement, and Nobel Prize winner Professor Robert Merton. The Podcast is 90 minutes in length, full of great conversation about retirement income, and well worth listening to.
During the Podcast discussion on why the focus should be on income and not accumulated wealth a definition of the standard of living in retirement needed to be determined.
From this perspective, Merton argues a standard of living in retirement is better defined as an amount of income, not a pot of money (accumulated wealth).
He argues the focus on income is consistent with what the Government provides you in retirement, a level of income. It is also much like a Defined Benefit where a level of income is provided and not a pot of money.
Also, the concept of income is easier to understand. You can see how rich I am with X amount of capital, but when converted to income that can be generated from that capital one can quickly see that the amount of capital may not be sufficient to support a desired standard of living in retirement. This is a key point.
Merton makes a strong case income is what matters in retirement and not how big your pot of money is.
As he says, people say, “If I have enough money, I’ll get the income. It will be fine.”
This may be true for the super wealthy but is not reality for many people facing the prospect of retirement.
Merton provides an example: twelve years ago in the US, if you had a million dollars you could generate $50k in interest, three years ago you could get a tenth of 1%, an income of $1k per million.
You’ve lost 98% of your income. As Merton says, what would you do if I lost 98% of your wealth!
The point being, knowing you had a million dollars did not tell you about a lifestyle that could be supported in retirement.
Merton is more direct with the following: “Let’s be clear the goal, the purpose for retirement. Not for the silly other things but for retirement is a stream of income sufficient to sustain a standard living and that standard of living is measured by income.”
“Just knowing the amount of money you have doesn’t tell you how you can live. That’s the message and we have to get that clear both so that savers and people in plans are trying to figure out how they’re doing. We need to tell them the amount they can buy as an indicator of how close to where they are.”
What Merton is saying here, is we should let people know what level of income can be generated from their pot of money. This provides a better measure and insight as to how they are placed for retirement.
Further to this point, volatility of accumulated wealth is not a good measure of how well we are doing.
More importantly, we should focus on the volatility of expected income in retirement, not current volatility of capital. This is covered in the next Post – What matters for retirement is income not the value of Accumulated Wealth – Focus on likely variability of Income not variability of Capital
For the time being: “What matters for retirement is income not the value of the pot of money” Merton.
The investment knowledge is currently available to design investment solutions that can better meet client’s income requirements in retirement to support the standard of living they wish to attain. It will result in the implementation of different investment strategies based in Liability Driven Investing (Goal Based Investing). A more Robust Retirement Income Solution is required.
The benefit being, there will be an increased likelihood that investment outcomes are more consistent with Client’s retirement objectives.
Global Investment Ideas from New Zealand. Building more Robust Investment Portfolios.
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