Most of you will understand the term selling into a loss. Decumulation? Maybe not.
It is, however, a much more descriptive term than “the income phase” as it is literally the opposite of accumulation. As such, certain things that work in a client’s favor during the accumulation phase – like dollar cost averaging – work against them during decumulation.
During decumulation, dollar cost averaging becomes selling into a loss, and it can spell big trouble for an investment portfolio.
quantifying the risk
Just how significant can this decumulation risk be?
In one study compiled by AXA, it can spell the difference between a portfolio that lasts a lifetime and one that expires before the client. Consider the following:
A male, age 65, with a $2.5MM investment portfolio decides to pull the trigger and retire. He takes an income of $175K the first year of retirement and inflates that number by 1% each year to take some of the edge of inflation.
The client’s timing is horrible in some ways, as his market experience mirrors that of the time period from 1973 to 2000, starting with two big down years. Over the long haul, however, his investment portfolio returns exactly what the S&P does over this period of time, 13.73%, and experiences only six down years.
Seems like a successful ride into retirement, right?
By the time this client reaches age 85, his once robust $2.5MM is now worth a mere $1.2MM. His annual income needs have grown to approximately $215K per year, and he better get busy dying because he is going to run out of money in the very near future – five to seven years depending on market performance.
If, however, he were able to pull income from another source that was not subject to market losses in years following those six down years, his portfolio would have grown to nearly $9MM, and he could happily look forward to many more years of retirement income.
The question, then, is where to find the income, and for that we need to travel back in time to when the client was age 45.
Back then, he decided to fund a life insurance contract to create some additional retirement income. He was conservative in his approach because he viewed it as a hedge against market losses. With that goal in mind, he considered the following product attributes essential:
- Insulation from market losses. Whether by a guaranteed floor or a guaranteed minimum rate of return each year, he wanted to know that his insurance would not suffer the same losses as the balance of his investment portfolio.
- Access to cash values that would also be insulated from market losses. This means using withdrawals to basis followed by “wash” loans to eliminate the possibility of taking a big interest hit if the product performance did not exceed the loan interest.
- A conservative rate of return assumption. Sure, he wants his assets to grow over time, but the place to be aggressive is in his investment portfolio managed by his planner, not in his life insurance contract. In fact, the insurance contract being designed this way gives him the confidence to be a bit more aggressive in his other positions.
The life insurance contract needed to be funded at about $17,500 per year to have enough cash value at age 65 to provide a real income hedge. Coming up with that additional funding on top of what he was contributing to his other investments was tough, so he and his agent looked at two different funding scenarios to compare to the unhedged portfolio:
- Scenario I: The unhedged portfolio.
- Scenario II: Funding the life insurance with additional investable assets each year.
- Scenario III: Funding the life insurance by re-allocating a portion of his existing investable assets on an annual basis.