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Effective retirement distribution strategies require significantly more than just periodically withdrawing funds. Investors need a more comprehensive approach to portfolio manage-ment, with more time and resources dedicated to retirement planning and cash flow management.

Investors need to understand the unique risks and chal-lenges facing retirees today, and why the traditional income approaches used with past generations may not work for the next generation. Simply generating retirement income may be an incomplete, even counterproductive, strategy. Instead, investors may need to focus on generating total return vs. income to build long-term wealth and financial security.

Investing in retirement has always been an intricate process involving complex risk considerations such as longevity risk, inflation risk and uncertainty of investment returns. But indi-viduals approaching retirement today face some additional challenges.

With today’s advances in medicine, diet, and technology, retir-ees are not only living longer but are staying healthier than previous generations. Those who remain healthy may main-tain more active lifestyles, which in turn may lead to higher income replacement needs during their retirement years.1

Retirement planning for previous generations assumed that the need for money declined with age. The previous rule of

thumb was to plan for about 70% of pre-retirement expenses. It was generally assumed that retirees would plan for more sedentary lifestyles, staying home and gardening or playing bridge. Today’s retirees are much more likely to travel, take up expensive hobbies or look to materially affect those around them. All of this may require growth from a portfolio over the long term.

Adequately funding retirement may also be a greater chal-lenge for the next generation of retirees because personal sav-ings and retirement portfolios are expected to play a much larger role than for previous generations.

These unique risks and challenges point to one key distinc-tion in the requirement for retirement portfolios for the next generation of retirees: Portfolio growth may be essential to meet these challenges and increase the probability of sustain-ing income needs over a 30+ year retirement period.

Traditionally, retirement portfolios were designed to provide income through a laddered bond portfolio or some other type of fixed income, stable value or other guaranteed income vehicle. With the current low interest rate environment, and the potential for increased inflation in the years ahead, it may be very difficult for average retirees to sustain their income needs over their lifetime without a significant allocation to equities to support long-term growth.

Retirement Portfolios For the Next Generation of Retirees By Joni Clark, CFA, CFP®, Chief Investment Officer, Loring Ward

February 2012

Structured Investing

Portfolio Perspectives

The primary concern with the traditional approach is that fixed income, especially long-term fixed income, is gener-ally not a good hedge against inflation. We all feel the effects of inflation on our day-to-day expenses through increasing prices, but inflation also takes a significant bite out of invest-ment returns.

The first bars for each asset class on the graph above represent the nominal, or unadjusted, returns of each asset class. The second bars illustrate the real, or inflation-adjusted, returns of each asset class which reflect the real purchasing power that the investor is left with after inflation. Notice that with cash and bonds, after adjusting for inflation, you are left with very meager returns to support long-term growth. Cash real returns were 0.6% and bond real returns were 2.4%, both less than half of equities.

While bonds pay steady income, using them expressly for income can create unintended inflation and longevity risks for retirees.

And for what?

In the end, financial security is about total wealth — the present value of net worth, not marginal income generated from the portfolio.

We believe a better approach to meeting retirement income objectives is an efficiently diversified portfolio constructed to

provide maximum total return for any given level of acceptable risk. The portfolio should be designed to meet a retiree’s current income needs while also targeting long-term growth objectives. This may be accomplished by bal-ancing the account with 50% or more in equi-ties in an effort to improve the probability of sustaining retirement income through the retiree’s life expectancy.

“Regardless of age or desired consumption a balanced portfolio provides the best odds of success… For most reasonable spending patterns, an overly conservative asset allocation, as well as an overly aggressive asset allocation, will only serve to increase the risk of running out of money too soon.”

— Moshe A. Milevsky, Applied Risk Management During Retirement

(June 2005)

Using this approach, the primary role of fixed income is to dampen overall portfolio volatility associated with equities — not to provide income. Instead, income is pro-vided through a synthetic dividend2, which is simply a combination of dividend and interest income and the harvesting of capital growth.

From a pure investment theory perspective, we should not care whether we draw income from dividends or capital growth. Money is money, whether it comes from a stock divi-dend, bond income payment or from capital growth. There’s no reason to prefer one above the other for spending needs.

In fact, drawing from capital growth may be more tax efficient

Structured Investing

Portfolio Perspectives

Inflation Risk: Will Returns Keep Pace with Inflation?

9.9%

6.6%5.5%

2.4%3.6%

0.6%

12%

10%

8%

6%

4%

2%

0STOCKS

Before Inflation After InflationBONDS

Before Inflation After InflationCASH

Before Inflation After Inflation

Annualized Returns1926 to 2010

Past performance is no guarantee of future results. Assumes reinvestment of income and no transaction costs or taxes. This is for illustrative purposes only and not indicative of any investment. Stocks are represented by the Standard & Poor’s (S&P) 500 Index; Bonds are represented by the Ibbotson/SBBI Long-Term Government Bonds Index; Cash is represented by one-month Treasury Bills. An investment cannot be made directly in an index. ©2010 Morningstar, Inc. All rights reserved. 3/1/2011

Inflation Risk: Will Returns Keep Pace with Inflation?

than receiving a stock dividend or bond income. If you redeem any instrument you’ve held for longer than a year, the cash receipts are currently taxed at the capital gains rates of 15%, instead of at higher income tax rates. With this in mind, the best way to meet monthly cash needs might just be to redeem appreciated assets.

A total return retirement income portfolio should provide better management of inflation risk, reduced volatility risk through effective diversification and improved sustainability of withdrawals through a long-term growth strategy.

Structured Investing

Portfolio Perspectives

References: 1 Retirement Income Redesigned, Harold Evensky & Deena Katz2 “Synthetic Dividend” is a term coined by Eugene Fama Jr., Dimensional Fund Advisors “Factors in Practice” (2007)

© 2012 LWI Financial Inc. All rights reserved.LWI Financial Inc. (“Loring Ward”) is an investment adviser registered with the Securities and Exchange Commission. Securities transactions offered through Loring Ward Securities Inc., an affiliate, member FINRA/SIPC. R 12-051 (02/12)

Note: Past performance does not guarantee future results and the principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Diversification neither assures a profit nor guarantees against loss in a declining market. Implementing a total return income portfolio cannot guarantee a gain or protect against a loss.