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The Longevity Trifecta

Hunter Brackett, CFA
Senior Manager | CAPTRUST Consulting Research Group

Mike Gray
Senior Vice President | CAPTRUST Financial Advisor

Mark Paccione, CFA, CFP® 
Director | CAPTRUST Wealth Practice Leader

As John Curry discussed in this quarter's Strategic Research Report’s feature article, longevity has significant implications for the broader economy, but at a more personal level, it also influences individual financial planning decisions. In financial planning circles, we have noticed increasing conversation around the idea of shortfall risk — the risk of running out of money in retirement — and an increased focus on planning strategies to address this important longevity-related risk.

Investors on the cusp of retirement should address three main areas as they develop a retirement distribution strategy — call it a “retirement paycheck” — intended to last as long as they do. The three areas include:

Investment management: finding an appropriate mix of assets to fund cumulative financial needs given longer life expectancies. 

Liquidity management: planning for and managing withdrawals so that sufficient funds are available for both expected and unexpected expenses. 

Risk management: planning for risks and pitfalls such as underestimating retirement expenses or retiring too early. Other risks, such as the risk of unexpected or uncovered healthcare or long-term care costs, should also be considered and managed, as appropriate. We discuss these in a separate article.

By developing a comprehensive plan to address the three aspects of this “longevity trifecta,” clients will have a better chance of meeting their retirement goals.  

Investment Management

The first step in creating a reliable retirement paycheck is a well-diversified asset allocation strategy — one that is globally diversified and incorporates the right mix of stocks and bonds. The optimal asset allocation is one that balances the need for growth — given the potential for a 25- or 30-year period in retirement — with the need to limit volatility. Conventional wisdom states that as individuals approach retirement and their investment time horizon shortens, portfolio allocations should shift away from traditionally riskier asset classes such as equities and toward less volatile areas such as fixed income. We continue to believe that fixed income plays an important role in client portfolios as it provides a cushion during times of economic stress. However, the lower volatility of fixed income normally leads to a trade-off of lower expected returns compared to other asset classes.

Contrary to the inclination of some investors as they near retirement, retirees cannot depend on fixed income investments to generate sufficient income. Given longer life expectancies, portfolios that are heavily weighted to fixed income may not generate enough return to meet an investor’s financial needs, especially in light of historically low interest rates. Retirement investors may need to maintain a higher allocation to equities and other traditionally riskier asset classes in order to achieve their financial goals. They will likely need the higher returns provided by these riskier assets to continue to grow their assets. However, volatility, especially when it generates losses early in retirement, can be particularly damaging to a retirement portfolio.

Figure One shows CAPTRUST’s capital market assumptions, which cover a full market cycle, typically a period of five to seven years. We expect subdued fixed income returns as rising interest rates present a headwind for this asset class. In contrast, we maintain a constructive view on equities as global growth prospects gradually improve and inflation remains well contained.

Our risk assumptions (as measured by standard deviation, or the possible divergence of the actual asset class return from its expected return) for equities are considerably higher than fixed income, so this factor should be incorporated into asset allocation decisions. However, Figure One also shows that equities have higher risk-adjusted returns (expected return divided by expected risk) than core fixed income. It is important to state that standard deviation is but one measure of risk, and we view risk through several other lenses, most importantly the concept of permanent capital impairment or loss.

Regardless, the investment strategy behind a 25- or 30-year retirement should not be treated as a set-it-and-forget-it solution. An investment strategy should be reassessed periodically — every two or three years or even more frequently in the event of significant capital market changes.

Liquidity Management

Proper planning for and management of portfolio withdrawals during retirement is critical to managing longevity risk. Retirees must ensure sufficient funds are available for expected and unexpected expenses that will naturally occur during the golden years.

One helpful place to start is the “4 percent rule.” Conventional wisdom suggests that a 4 percent annual portfolio withdrawal rate is sustainable for a 30-year period of retirement, meaning the principal will not be touched and all withdrawals will be funded with investment earnings. While historically low interest rates and elevated market volatility in recent years have caused some to question that assumption, the 4 percent rule is a good rule of thumb. If an annual 4 percent withdrawal from your portfolio covers expected retirement expenses, which include basic living, leisure, taxes, and healthcare expenses, then you should be in good financial shape and be able to meet your retirement needs. Of course, a deeper analysis is recommended to validate that conclusion.

Another withdrawal planning method is to calculate the required portfolio return rate based on a more detailed income and expense analysis. To determine the required portfolio return rate, use the following formula:

The required portfolio rate of return indicates the annualized investment return required to meet retirement expenses without touching principal. A required portfolio return rate below 7 percent, for example, is potentially achievable. Return rates above 7 percent may be unrealistic or expose the retiree to too much risk. 

Another more detailed and thoughtful approach is age banding. In a 2005 Financial Counseling and Planning article, Somnath Basu discusses problems with traditional liquidity management approaches, and proposes a model designed to more accurately model retirement spending reality and retirement savings needs.1

With age banding, retirement is separated into three distinct phases. In the first phase, approximately ages 65–75, leisure expenses typically increase as new retirees travel more as a result of newfound freedom. The second phase, typically ages 75–85, is a transition period where leisure expenses decrease and medical expenses increase. In the third phase, ages 85–95, medical expenses significantly increase. By estimating these three phases’ cost and discounting them back to present value, according to Basu’s research, one can more accurately determine the savings needed to fund retirement.

Assets set aside to fund the three phases can be managed with different investment objectives or buckets using the behavioral finance concept of mental accounting. The first bucket is invested in less volatile, more liquid, and more conservative asset allocations as it funds immediate and near-term expenses. The second bucket can be more aggressively invested, and the third bucket for the final phase can be the most aggressive due to its long time horizon, potentially 20 or more years. An additional benefit to this approach is that the more aggressive third bucket can be invested to grow apace with the healthcare inflation rate, which is significantly higher than the overall inflation rate.

As with the investment strategy, liquidity management should be reassessed periodically. To the extent that the capital markets outperformed expectations, it may be possible to increase retirement withdrawals. Conversely, in the event of market declines, it may be necessary to reduce withdrawals to get the strategy back on track.

Risk Management

In addition to investment and liquidity management, individuals must protect against uncertainties exacerbated by longevity. Underestimating years in retirement is one danger; failing to plan, underestimating expenses, retiring too early, and failing to save enough are additional risks. While planning risks cannot be entirely eliminated, they can be minimized by scrutinizing the most important variables affecting the plan. 

Although this may be the most important step, 30 percent of households close to retirement have done little to no planning for retirement. The variables can be influenced by others’ retirement experiences, such as parents and older siblings, or unpleasant financial events.2 While the questions are simple, such as target retirement age and desired income, the information’s accuracy is very important. 

As identified above, understanding your expenses is an essential first step. One potential problem is underestimating retirement expenses. Unfortunately, predicting expenses as we age can be challenging. Inflation is a central consideration as rising inflation may decrease purchasing power if investment earnings do not keep pace with the cost of living.3 Household expenses are normally the largest outlay and tend to decline with age. Healthcare costs are a large component as well and tend to increase with age. Deciding when to retire should be well thought out as high switching costs exist; going back into the workforce can be difficult. The timing decision touches other retirement math; a good example is taking Social Security as soon as possible (age 62 for now) or delaying payments until a later age in order to receive the full Social Security benefit. Meanwhile, many people have realized their situation will require working longer, but face the question of whether work will continue to be available.

Failing to save enough is linked to many other retirement decisions and outcomes. Prior saving habits will influence when one retires as well as what type of lifestyle can be sustained while in retirement. It might be necessary to adjust current spending habits to allow for increased savings and to play catch up in the years leading up to retirement.

Longevity presents unique risks for individual financial planning, so a comprehensive strategy is the key to successfully navigating this issue. Conservatively positioned portfolios may protect investors from market volatility, but could expose them to the risk of depleting their retirement savings or failing to keep pace with inflation. Depending on an individual’s risk tolerance, a higher allocation to equities and other historically risky asset classes may help clients meet their financial goals given longer life expectancies. Planning for and managing fund withdrawal during retirement is necessary to ensure sufficient funds are available for expected and unexpected retirement expenses. Risk management is critical to avoid common pitfalls such as retiring too early or underestimating years in retirement. We encourage clients to discuss these issues with their CAPTRUST advisor, so that longevity is incorporated into their current financial plan.


1 Basu, Somnath, (2005), “Age Banding: A Model for Planning Retirement Needs.” Financial Counseling and Planning. 16: 29-36
2 Lusardi, (2003), Planning and Saving for Retirement. Dartmouth working paper series
3 Willet, M., (2008), A new model for retirement education and counseling. Financial Services Review, 17, 105-130



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