The Retirement Shock Absorber®

Most of our clients are in or near retirement. Often their biggest concern is being able to maintain their financial independence at their current standard of living without running out of money. We acknowledge that we cannot control, or consistently predict, the inevitable short-term ups and downs in the markets, so we developed a proprietary methodology called The Retirement Shock Absorber® to address this concern. Applying this strategy as part of a client’s comprehensive financial plan helps the plan absorb portfolio fluctuations. The Retirement Shock Absorber® methodology is illustrated and explained below.

The red line represents the minimum amount of capital required by a hypothetical client in order to maintain their lifestyle through retirement. The yellow line represents the hypothetical client’s investment portfolio and is a dramatization of the potential fluctuation in the markets. During a market decline, the graph illustrates how the value of the client’s investment portfolio can fall below the capital needed to meet their retirement income needs. It is at a time like this that investors can fall victim to their emotions and make decisions that potentially prove to have long-term negative ramifications on a portfolio.

Hypothetical Portfolio without The Retirement Shock Absorber®

without-retirement-shock-absorber

Hypothetical Portfolio with The Retirement Shock Absorber®

In this second chart, the blue line represents a plan with a 20% cushion built-in, or Retirement Shock Absorber®. During a market decline, a portfolio with The Retirement Shock Absorber® is less likely to fall below the amount of capital needed to sustain the client’s standard of living. With The Retirement Shock Absorber® in place, we are able to prove to clients that they have enough money. It helps prevent them from making rash decisions because they can feel secure in this knowledge.

with-retirement-shock-absorber

retirement-shock-absorber-blue-line Retirement Shock Absorber Red Line Retirement Shock Absorber Yellow Line

Portfolio with a 20%
Retirement Shock Absorber®

 Minimum capital required
to maintain lifestyle.		 Representation of
market fluctuations.

 

Why do we use 20% as the amount of recommended buffer?

While the greater the buffer the better, we recommend at least a 20% Retirement Shock Absorber®.  A good example of why we recommend a minimum of 20% is the calendar year 2008 and what happened to the capital markets and portfolios during that timeframe.  In 2008, which we considered an ‘outlier year,’ the S&P500® Index declined -37.29%, while the Barclays Capital U.S. Aggregate Bond Index was up 5.55%. For a hypothetical portfolio allocated 60% to stocks and 40% to bonds, this translated into an overall decline of -20.15%.   If you have at least a 20% Retirement Shock Absorber®, your portfolio will be able to withstand declines of the same magnitude without jeopardizing your retirement.

Source: Data for calculations obtained from Morningstar, Inc. The S&P 500(R) Index is an unmanaged group of securities and considered to be representative of the stock market in general. The Barclays Capital U.S. Aggregate Bond Index is a broad base index often used to represent investment grade bonds being traded in the United States. An index cannot be invested into directly.

Why an 8% average rate of return over time?

Most often, our clients who are at or near retirement have portfolios that are allocated 60% to equities and 40% to bonds. Looking back over a long period of time of hypothetical portfolio returns: 

  • a portfolio invested 100% in stocks had a compounded annual average return of 9.8%
  • a portfolio invested 100% in bonds had a compound annual average return of 5.4%
  • a portfolio allocated 60% to equities and 40% to bonds had a compound average annual return of 8.0%

Source: Morningstar, Inc. These returns assume reinvestment of income and no transaction costs or taxes. Stocks in this example are represented by the Standard & Poor’s 500®, which is an unmanaged group of securities and considered to be representative of the stock market in general. Bonds are represented by the five-year U.S. Government Bond. An investment cannot be made directly in an index.

WHAT DRIVES THE CONSTRUCTION OF PORTFOLIOS TO ACHIEVE AN 8% ANNUALIZED RATE OF RETURN?

Portfolios are constructed in different manners in order to help achieve the desired results. There are several drivers that we take into consideration in the management of the portfolio, in order to pursue the goals of the Wealth Plan. These include: Actual Inflation, Investment Returns, Repositioning / Rebalancing and Withdrawals.