Culminating in the present economic meltdown, here are six lessons to be learned about retirement income planning and the events of the past decade, courtesy Still River Retirement Planning Software Inc.:
- Most retirees should keep enough assets in safe, liquid investments to cover at least three years of living expenses – "For retirees who have several years' worth of assets socked away in certificates of deposit or similar instruments paying 4% or 5% or 6%, their money is still intact (federally guaranteed in the case of CDs, if not over-concentrated in one bank). More importantly, when these retirees also have a significant amount invested in marketable securities, they can leave their securities untouched until the market recovers, while they live off their safe savings. They will then get the full benefit of the upswing when it comes – and they may well come out ahead in the long run."
- The old-timers were right: Retirees, and near-retirees, should invest more conservatively – "Older people who have enough assets that they are not at much risk of running out of funds can afford to take investment risk and become even wealthier if they have the stomach for the ride. But those who are already at risk of running out of money cannot decrease their overall risk by taking on still more risk in the form of aggressive investing."
- Systematic withdrawal models are unreliable – "The typical investment firm (and 401(k) plan provider) attempts to serve its retiredpatrons by advising them how much they can safely withdraw from their portfolio on a regular basis, with an acceptably low risk of running out of money before death. To determine this supposedly safe level of withdrawals, they usually rely on Monte Carlo analysis and other similar mathematically sophisticated models. But these models provide results that have very little application in the real world…They are, in fact, worse then pointless, because they tend to encourage people to start out withdrawing either too much (increasing the likelihood of running out of money) or too little (unnecessarily crimping the retiree's lifestyle).
- Retirees need a financial cushion for contingencies – "Even if several years' worth of expenses are in safe, liquid investments and even if most or all of a retiree's assets are conservatively invested, there still must be an allowance in case things go bad."
- Market guarantees are a time bomb – "Even if the new products come with guaranteed withdrawal options or guaranteed floors for investment performance, the cost of these options makes them less desirable than diversification in conservative investments as a way to reduce risk. Retirees who bought such products might be feeling pretty good right now – though mainly because they don't know they could have done as well or better with a less expensive strategy. But the big losers here are the insurers, and if there is a silver lining, it's that these products haven't been around long and they haven't sold well."
- Monte Carlo doesn't cut it – "The models are fundamentally flawed because they rely on a base of historical data that is not extensive enough to measure investment risk at all accurately; they are not suitable for retirees because they do not take account of all the risks that retirees face; and they tend to promote as acceptable risks that are actually quite high."
