Investing Specialists

A New Vocabulary for Retirement Planning

Christine Benz

When it comes to their finances in retirement, most people want the same things. They want to be able to enjoy a lifestyle on par with, if not better than, the one they had when they were working. They want to have the money to pay for travel and hobbies that give them joy without having to skimp in other areas. They want their assets to last for their lifetimes, with possibly some left over for loved ones or favorite charities. Most of all, retirees and pre-retirees want to put their money in its place: With busy lives to lead, they just don't want to worry about it.

Yet despite all of those commonalities, there's a tremendous range of opinion about specific strategies for achieving the above-mentioned goals. Battle lines are drawn between income-niks and total-return-niks, for example, and topics such as safe withdrawal rates frequently spark heated discussions about the right way to manage a portfolio in retirement.

Certainly, there's more than one way to get it done, and the fact that retirees and pre-retirees debate various strategies can signal that they have a healthy conviction in their approaches. But if you read between the lines, some of these disagreements are more semantic than they are real. And I can't help but wonder if that's because a lot of the terms we use to discuss retirement are outmoded--a vestige of the days when CDs had double-digit yields and pensions were plentiful.

The new world of retirement planning calls for more flexible and inclusive terms. Herewith, I submit some retirement terms that I'd like to see retirees and pre-retirees swap into their vocabularies, along with terms I'd like to see on the chopping block because they fan the flames of confusion.

In: Spending Rate
Out: Withdrawal Rate
"Spending rate" gets at the notion that there's more than one way to get the money you need from your portfolio in retirement. Yes, you can extract your money through outright withdrawals of principal, as the term "withdrawal rate" suggests, but you can also get it from spending your income and dividend distributions rather than reinvesting them back into the portfolio. Many retirees sensibly take a variety of tacks to generate the money they need from their portfolios, using income and dividend distributions to provide them with a baseline of living expenses and tapping principal to generate any excess income required.

The term spending rate also telegraphs the concept that total return investors withdrawing principal from their portfolios aren't the only ones who need to concern themselves with the safety and the sustainability of their spending. Income-minded investors might automatically tune out any discussion of withdrawal rates, assuming that the term refers to withdrawal of principal. (In fact, I recently heard an income-minded investor say that her withdrawal rate was 0% because she can subsist on her portfolio's income alone.) But most of the research surrounding safe withdrawal rates--including the 4% rule--doesn't differentiate about whether the retiree gets his or her money from bond and dividend income or withdrawals of principal. The effect of 4% taken from a portfolio is the same regardless of whether it comes in the form of dividend and income distributions that are spent rather than reinvested or whether it comes from withdrawals of principal after reinvesting income, dividends, and capital gains distributions.

In: Retirement Cash Flow
Out: Retirement Income
In a similar vein, retirees often obsess about generating income from their portfolios, conflating their need to replace the income they once earned from their salaries with a need to invest their whole portfolios in income-producing securities. This phenomenon probably has its roots in a more favorable yield environment: When bond yields were higher, many retirees could readily generate the cash they needed from their portfolios using money markets and bonds.

To be sure, it generally makes sense to increase stakes in income-producing securities like bonds and dividend-paying stocks as retirement draws near, as such securities often have more stability than capital-gains producers. But retirees can meet their cash flow needs from a variety of sources: Social Security and pension payments, annuity income, rebalancing proceeds, withdrawals of principal, and yes, dividend and income distributions. And the broader the base of cash-flow resources, the greater the diversification and flexibility to maximize the investment portfolio's risk/reward profile. For example, I recently argued that retirees should use the market's recent runup as an opportunity to meet their living expenses by lightening up on stocks. In so doing, they can kill two birds with one stone, both raising cash and improving their portfolios' diversification and risk/reward profiles.

In: Retirement Life-Cycle Fund
Out: Target Date Fund
The term target-date fund is so entrenched that I don't have high hopes of changing it, but it definitely has the potential to mislead. For starters, the term "target" could incorrectly promote the notion that such funds will deliver a specific level of guaranteed income in retirement. Indeed, in a Securities and Exchange Commission survey, only 36% of respondents correctly indicated that target-date funds do not provide guaranteed income in retirement.

Moreover, even some investors who own these funds appear to be confused about what "target date" means. Some of the SEC survey respondents thought target date refers to the date that the fund will begin delivering that guaranteed income stream, while others thought it was the date when the fund would reach its most conservative investment mix. Just 32% of target-date fund owners and 27% of non-owners correctly indicated that the target date was supposed to be their anticipated retirement date.

The term "retirement life-cycle fund" doesn't exactly trip off the tongue, but it helps address some of the confusion surrounding the target-date term. For one thing, "life cycle" conveys that the asset mix of the fund will change throughout one's accumulation years and perhaps even into retirement. And removing the word "target" helps dispel the idea that these funds' results are guaranteed.

In: Social Security 'Insurance'
Out: Social Security Income
Social Security is an important source of income--er, cash flow--for many retirees, and while it's not the same as an insurance policy you would buy from an agent, the program's benefits do have insurance-like qualities that are worth considering when you map out your retirement plan.

Social Security provides more than just an income stream--it's an income stream that's guaranteed throughout your retirement. That stands in contrast to your portfolio, which may at some point become exhausted due to unexpected expenses, poor market returns, or an unexpectedly long life span. Social Security will continue paying as long as you continue breathing. So, if you think of Social Security as a form of longevity insurance, it helps clarify your decision about when to start taking it. If you expect a long life span, you probably want more insurance, and that argues for starting benefits at full retirement age or later; that way you can earn a higher benefit. If you think you need less insurance, you may start taking benefits sooner.

As with an insurance purchase, a current or, particularly, future Social Security recipient will want to consider the financial strength of the counterparty (in this case, the U.S. government) and the likelihood that benefits could be effectively reduced over time. If you are notably pessimistic on this front, then you may choose to have Social Security "insurance" play a smaller role in your retirement financial plan, which may necessitate a higher savings rate leading up to retirement, or a lower spending rate in retirement.

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