OCEAN CITY – While retirement can be a time for exploration, the element of surprise should be reserved for new life experiences — not for managing your assets and income. The unique financial challenges that retirement presents can often jeopardize your cash flow and your goals if you don’t plan carefully. Short- and long-term financial needs could be competing for the same resources in your retirement portfolio, and a curveball, such as a health crisis or overspending in the early years, could make dramatic lifestyle readjustments necessary down the road.
To meet both the challenges and the opportunities of retirement head-on, investors need to take a more holistic approach. In response, Merrill Lynch has launched its new Retirement Income Framework. This comprehensive approach to retirement planning takes into account your full financial picture, measuring your risk tolerance, carefully mapping retirement consumption goals and maintaining an asset allocation that can help deliver the kind of income you need.
The first step in applying the framework is an in-depth discussion with your financial advisor to assess your retirement situation. You’ll discuss your spending — broken down into your needs and your more ambitious goals — and together you’ll estimate your basic lifestyle expenses, as well as make provisions for the unexpected, such as a health problem or changes in the tax code that could affect your income. You’ll also decide whether you want to pass your wealth on to heirs or to a cause and how large that bequest should be.
Once you’ve struck a balance between your needs and your likely future sources of income, you and your advisor will build an investment plan, with an eye on your capacity for risk. Step two of the Retirement Income Framework allocates your retirement assets into three distinct portfolios — each designed with a different objective and investment strategy and each built to help hedge against a set of risks. Together the discrete portfolios are designed to fund current lifestyle expenses while seeking to grow the assets to meet longer-term needs, which might include unexpected health care costs or funding a grandchild’s education.
The short-term portfolio is intended to meet day-to-day expenses, supplementing such other income sources as Social Security and pensions. The goal is to produce an income stream so you won’t have to tap your longer-term portfolio when the market is unfavorable.
"Think of the short-term consumption portfolio as a shock absorber," says Michael O’Keeffe, Chief Investment Officer for Merrill Lynch Global Wealth Management. "As you are spending these assets, you don’t have to worry about what the market is doing."
The second, intermediate-term portfolio is designed for longevity and comes into play when you need to replenish the assets in your consumption portfolio — or during an opportune moment in the market. This portfolio has a longer time horizon, so it is invested in a diversified mix of asset classes and seeks to generate growth.
"These asset classes were also used in traditional retirement planning, but often they were tapped too early and lacked sufficient investing horizons to have stable returns," says Tom Latta, head of due diligence for Global Wealth Management Investment Management & Guidance at Merrill Lynch. "This portfolio is designed to roll across investment cycles and gives investors the opportunity to take more risk with their investments for greater returns."
Retirees whose objectives include making bequests, funding the educational expenses of grandchildren or transferring wealth to heirs will have a third portfolio intended for long-term wealth structuring. You may decide to invest in multiple asset classes in your portfolio, perhaps more aggressively than the longevity portfolio if your risk tolerance and time horizon fits that scenario.
Because retirement is a dynamic time and your needs inevitably will change, the third step in the framework involves regular check-ins with your financial advisor to review your portfolio. As the years pass, you may find you’re spending more than you projected or that philanthropy has replaced travel as a primary interest — changes that will require you to adjust your plan. As you withdraw assets from your long-term portfolio to replenish your consumption portfolio, and also as market conditions warrant, you’ll want to consider rebalancing your asset allocation.
In sum, the Retirement Income Framework can help you conceptualize a strategy for your retirement assets. As O’Keeffe notes, "The greatest value to clients is working with them to use their framework as a template for prioritizing their retirement objectives, assessing the risks that can derail investments in retirement and then developing a solution that fits their unique life circumstances."
(A Merrill Lynch Senior Financial Advisor. She can be reached at 410-213-8520.)