By Allen Giese, CLU®, ChFC®, ChSNC®
At Northstar, we help our clients plan retirements—hopefully, long retirements. To that end, we put a great deal of thought into life expectancies and how money will hold up over that time frame. Evaluating various risks becomes important: The risk that inflation will be higher than expected. The risk that markets will be worse than expected. And the risk that our health will be better than expected.
At first glance, that last one hardly seems like a negative impact. Wouldn’t that be a good thing? That we live longer and healthier than the average? Isn’t that kind of the goal?
When it comes to retirement planning, “longevity risk” is the threat that we’ll live longer than our money lasts. It’s a risk that I believe is often overlooked and misunderstood. Because in long retirements, the cost of living doesn’t just drift upward on a nice gentle slope. It compounds. And the dramatic effect of that compounding in our later years is something most people just don’t see coming.
The risk is perhaps more threatening for our clients by virtue of their education and experience. The truth is, and with the possibility of sounding a bit elitist, those in the investor class tend to have higher education levels and better lifestyles. They tend to take care of themselves better, go to the gym more, get regular medical checkups, do what their doctors recommend, and take their meds. They live healthier and longer. They tend to crowd over to the right side of the life expectancy bell curve.
In client meetings, it can often be a struggle to shift our focus from the short-term randomness of economies and capital markets to this much more impactful threat to a long retirement—longevity and inflation. And for those who consider legacy one of their most important goals, this threat becomes even more significant.
Once we realize that longevity sits at the top of the list of potential dangers, equities become a more important component of our investment plan. Because it’s equities that have proven themselves to be the inflation beater that can provide the income and capital appreciation we need for long retirements.
I’ll venture a guess that I know what you’re thinking. Equities come with a downside: volatility. And that volatility is why we get paid more over the long term for being there. We just need a way to deal with the volatility over the relatively short periods that it becomes most bothersome. A globally diversified portfolio containing multiple asset classes with less-than-perfect correlation to one another is a big step in the right direction. A portfolio centered on equities but containing enough fixed income can help get us over those rough patches that equity markets inevitably produce.
Rather than viewing equities as “aggressive,” we need to look at them as being the most compelling solution we have toward growing our investment portfolio at a pace better than inflation. Over the past 100 years or so, equities have grown at roughly three times the rate of inflation. They can give us the opportunity for a lifelong stream of income that will grow over the years at a pace matching (or preferably beating) inflation.
We’re goals-based investors at Northstar. Pre-retirement, the goal is typically a target-date, dollar-specific accumulation plan that will provide enough capital at retirement to provide a constantly increasing stream of income that can be drawn on for 30 years or more. Post-retirement, that goal often becomes a plan that contains enough equities to maximize the probability that our clients can withdraw an inflation-adjusted income for the rest of their lives without running out of money. In both cases, equities play the most important role.
Focusing our client meeting agendas on variables we can’t control is a waste of time. Forecasting economies and markets, which we have no control over, instead becomes about figuring out what you’ll be living on when you’re in your 80s or 90s. That’s what should concern you the most, and fortunately, it’s something we can have a lot of control over if we keep our focus on it.