|Mike Zwecher On Retirees Fearing Commitment|
|Tuesday, April 24, 2012 05:19|
What’s the right way to approach the retirement planning problem? Is there a right way? Do you need a plan that maximizes the efficient use of your assets or a plan that can withstand some hard knocks, or both?
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There will be factors specific to the individual such as the likelihood of unknowable changes in future needs, unknowable changes in the world, and the ability to prepare (rather than just plan) for the unknowable.
What about committing to a plan? For retirement, building resiliency into a plan may be more important than creating the most efficient plan. There isn’t always a conflict between the two, but let’s talk about it.
The distinction between efficiency and resiliency is important when there will only be a single play of the game, or as I described it in my previous post, one whack at the cat.
Systems designed to be efficient are often trading off resiliency by maximizing the effectiveness of the system for a particular environment. If the operating environment changes, then that which was previously efficient, may be, in a different environment, defunct.
In the run up to 2008, the operating model of funding for financial firms was very efficient, until it stopped working and short-term funding dried up. On the other hand, some systems are designed to be resilient rather than efficient. Think of the department of defense or other government endeavors.
In the military, a ‘just in time’ process for acquiring and delivering logistical support would be efficient, as would eliminating ideas like ‘every marine a rifleman’. But because the operating environment for the defense department can change rapidly and in an unforgiving fashion, resiliency is treasured.
Not to waffle too much, but there are occasions where enhancing efficiency can enhance resiliency, such as when processes are simplified or bottlenecks are removed. However, I’m trying to make a point, so let’s not quibble about the grey area. Also, before moving back to retirement, I’ll just wander towards a politically charged minefield for a moment. In a perfectly competitive environment, each firm will be efficient, though not particularly resilient. With low barriers to entry, well defined property rights, and without interlocking dependencies between firms then the system as a whole will be resilient even though no particular entity is resilient. Failure of any of those conditions opens the debate about what remedies are required. The omnipresent arguments about bank regulation tromp through this ground on a regular basis. But, wanting to keep all of my fingers and toes, I’ll leave it there.
Meandering back towards a discussion about retirement, while there were a handful of people who saw it coming, most people were blindsided by the events of 2007/2008. Many plans went out the window, but it was worse for those committed to a particular plan if that plan didn’t include surviving a dizzying economic plunge.
Personal circumstances may change unpredictably. If circumstances do change, the plan may need to be wholly reconfigured. For example, with sufficient medical insurance the death of a spouse is usually leaves the surviving spouse with somewhat lower expenses and, sadly, a half-life of about 2 years – easy to plan for. But some will rebound to start whole new endeavors or marry their 26 year-old personal trainer, in which case the expenses will rise and a wholly new plan will be needed. For someone who finds out that their life horizon is suddenly longer or shorter than previously envisioned a fixed plan may be suboptimal.
Often there is a cost to seeking resiliency. Keeping assets in the form of beans, bullets and gold may be resilient but hardly efficient. Keeping 5% of assets in cash, as a standard portfolio is constructed, may be efficient but hardly resilient.
Full scale planning is about the efficient deployment of assets to meet liabilities. By itself, planning is sometimes useful for providing a matching of needs to resources. Good planning also looks for places where flexibility can be retained, where plans may come apart and logical points where plans may need to be changed. The wisdom of committing to a particular plan, whether by being fully annuitized or allowing everything to ride on the market, may be wise or foolish depending on the likelihood of your needs changing in an unpredictable way and the ability of your lifestyle to withstand the blow.
Few people actually go through the rigors of constructing a plan. Are they unwise or is it a rational response to their perception that the environment (personal or market) will change so that any plan would be likely to go out the window? If the reason is the former, then it is a proper role to try to educate people on the value of plans. If the planning is avoided because it is perceived as being of low value, the role is to lay out an appropriate set of sustaining lifestyle through alternative scenarios. As professionals we need to try to tease out whether the client needs a plan or needs a strategic advisor. It is my firm belief, that there are resilient and reasonably efficient ways to prepare for and live during retirement. Interestingly, a plan that could/did survive was the mantra of the Retirement Income Industry Association – ‘build a floor and expose to upside’. Many efficient and resilient plans are fully elaborated in my book and the RMA curriculum. In this venue we’ll get to them over time.
Michael Zwecher, Ph.D., is the author of Retirement Portfolios: Theory, Construction and Management (Wiley Finance), and a co-author with Francois Gadenne of the curriculum book for the Retirement Management Analyst (SM) designation.