Eventually, many clients will rely on the nest egg they have accumulated and preserved to address their financial needs during what may be a lengthy retirement. While some may think that retirement will be worry-free living on the beach, for others, it can present investment-related behavioral and psychological challenges. Specifically, they may not be accustomed to seeing account balances go down while simultaneously withdrawing from their portfolio, especially after decades of systematic contributions and long-term market growth. They may worry about how long their nest egg can last, given their standard of living, how inflation may affect their future purchasing power, and what happens if markets are stagnant.
When it comes to addressing these concerns, we believe that traditional retirement income strategies often over-emphasize allocations to fixed income securities. Our dynamic approach to retirement income and spending, when compared to many traditional retirement strategies, has a greater allocation to equities and less to fixed income investments. We’ve designed our approach this way with the aim of striking the ideal balance between the present need to pay for current expenses and retirement goals and the need for wealth to last throughout retirement. But asset allocation is only one part of the solution. We believe our rebalancing process ties everything together by helping to minimize both behavioral risks and the sequence of return risk (the risk of having to sell investments when they are down) for retired clients.
Horizon Distribution Models consist of two main components, the Spending Reserve and the Investment Portion.
The two components are designed to interact as follows:
- Clients withdraw from the Spending Reserve to fund their lifestyle.
- Gains in the Investment Portion are used to replenish the Spending Reserve as the portfolio is rebalanced back to target allocations on a quarterly basis.
- Repeat steps one and two every quarter.
This sounds nice in theory, but what happens if the Investment Portion isn’t growing?
Within Horizon Distribution Models, we recommend a target allocation to the Spending Reserve of three years (12 quarters) of spend. For example, a client taking 5% per year, the Spending Reserve would represent 15% of the total portfolio. The key part of our rebalancing methodology is the Spending Reserve, which is only replenished due to portfolio rebalancing following quarters when there were gains in the Investment Portion.
If, over the prior quarter, the Investment Portion experienced a negative return, we would not recommend replenishing the Spending Reserve despite the client continuing to withdraw from it. We believe this methodology helps minimize sequence of return risk and simultaneously allocates more to investments in down markets. Below is an illustration for a 5% Distribution model, which shows allocations over time during negative and positive quarters.
For illustrative purposes only. This chart is not representative of any specific account, but is intended only to illustrate the investment process. All investing involves risk and clients may lose money. Please see attached disclosures.
Conclusion
After three negative quarters in a row for their portfolio, retirees may start to worry if they need to reduce their spending. However, distribution models will still have more than two years (9 quarters) left in a spending reserve allocation. It may be a powerful conversation when you tell your clients they can keep their standard of living when their portfolio is down.
The allocation to the Investment Portion is designed to increase over time during quarters with negative returns. This is due to our rebalancing methodology we implement that increases the target allocation to the investment portion.
As the target allocation to the Investment Portion increases, we believe the portfolio is better positioned to capture gains during market recoveries in order to replenish the now underweight spending reserve back to target levels.
Before investing, consider the investment objectives, risks, charges, and expenses of the strategy. All investing involves risk. This strategy is not an insurance product with payments guaranteed. It is a strategy that invests in marketable securities, any of which may fluctuate in value. There is a possibility of outliving the assets if market performance is lower than forecasts used in planning, or if longevity is longer than anticipated. Calculations used with investors are estimates based on historical market behaviors, and there is no assurance that these behaviors will be repeated in the future. Investors should note that historical data suggests that higher Spend Rates will have a lower likelihood of success for the entirety of the retirement period than a lower Spend Rate would. Past performance and market data are no guarantee of future results and investor experiences will vary.
Past performance is not indicative of future results. This information is for educational use only and should not be a recommendation to buy or sell a security or to adopt a particular investment strategy. The opinions expressed here are not investment recommendations, but rather opinions that reflect the judgment of Horizon as of the date of the report and are subject to change without notice. Opinions expressed do not consider specific client investment objectives. The investment strategy or strategies discussed may not be suitable for all investors. Investors must make their own decisions based on their specific investment objectives and financial circumstances.
The Real Spend® retirement income strategy is NOT A GUARANTEE against market loss and there is no guarantee that the Real Spend® strategy chosen by an investor will lead to successful investment outcomes for part of, or for the entirety of an investor’s retirement. This strategy is not an insurance product with payments guaranteed. It is a strategy that invests in marketable securities, any of which will fluctuate in value. Before investing, consider the investment objectives, risks, charges, and expenses of the strategy. Keep in mind investing involves risk. There is a possibility of outliving the assets if market performance is lower than forecasts used in planning, or if longevity is longer than anticipated. Past performance and market data are no guarantee of future results and investor experiences will vary.
The investments recommended by Horizon are not guaranteed. Asset allocation cannot eliminate the risk of fluctuating prices and uncertain returns. Strategies are subject to risks including general market risk and risks related to economic conditions. Underlying investments fluctuate in price and may be sold at a price lower than the purchase price resulting in a loss of principal. The underlying investments are neither FDIC insured nor guaranteed by the U.S. Government. There may be economic times when all investments are unfavorable and depreciate in value. Clients may lose money.
Horizon Investments is an investment advisor registered with the U.S. Securities and Exchange Commission. Registration does not imply a certain level of skill or training. More information about Horizon’s investment advisory services can be found in our Form ADV Part 2, which is available upon request.
