The approach that a financial adviser takes in constructing a retirement portfolio depends on whether the client is content living modestly in his or her early years of retirement or wants to enjoy those days to the fullest, potentially having to cut back in later years, a well-known retirement scholar said.
The probability-based school of thought would allow for a certain annual withdrawal rate to accommodate the client's lifestyle spending, Wade Pfau, professor of retirement income at The American College of Financial Services, said at the National Association of Personal Financial Advisors' national conference in Philadelphia last Wednesday.
The potential pitfall, however, is that the client could run out of money and then have to live off Social Security, he said.
The safety-first approach, on the other hand, would invest client funds according to whether they must be used for basic needs, emergencies, discretionary spending or legacy goals.
For example, 75% of a portfolio may be used to fund an annuity or a ladder of Treasury inflation-protected securities that pays an income that covers needs, leaving 25% of assets to be invested to cover the cost of life's enjoyable extras, Mr. Pfau said.
“This approach eliminates the upside, but it helps to eliminate the downside, too,” he said.
Advisers can decide the right approach for clients by asking them about their budget and seeing how they react to suggestions about cutting back on certain lifestyle costs, such as their country club membership, Mr. Pfau said.
They also should take an approach that allows for periodic changes, taking into account that some research suggests discretionary spending declines in the older years.
Of course, health care costs are the potential deal breaker with that theory, Mr. Pfau said.