As life expectancy increases around the world, investors may soon realize that with longer life also comes a longer liability. Retirement occurs well beyond the “age of 65” as countries around the world increase the retirement ages and eligibility for governmental retirement assistance programs. 2017 Nobel Prizer winner and University of Chicago Booth School of Business Professor Richard Thaler puts it succinctly, “You have to worry about getting unlucky and living to 100.”
For investors, increasing lifespans also means that standard rules of thumb for consumption and investments like the “5% withdrawal rule” or the 60-40 portfolio may not apply as equity risk premia around the world adjust to a global changing demographic. Research conducted at Northwestern finds that 75% of those with 401(k) plans may not be enough to sustain an investor’s current living standard, with a 2017 survey finding that 63% of baby boomers fear running out of money in retirement more than death itself.
In a paperwith Thomas Totten, our advisory boad member Laurence Siegel considers expanding the traditional portfolio with a lifetime income guarantee. They write, “
“Why is it so difficult to save for retirement in such a way that the retiree feels financially secure for the rest of his life? Why is so much effort spent on investment optimization, withdrawal rates, and other strategies designed to increase the likelihood of having enough money in retirement without actually guaranteeing it? The reason is that longevity risk, the risk of outliving one’s money, is the chief risk faced by retirees and it cannot be hedged through conventional investing. Life can be very long (we don’t know in advance how long), the amount of money needed in a long retirement can be huge, and most people don’t have it.
The only way to hedge longevity risk is with some kind of guarantee of lifetime income. Such a guarantee can come from a defined benefit (DB) pension plan, a commercial annuity, or some other source. Guaranteed lifetime income products take advantage of the insurance principle, the idea that (in the present case) those who die young help to pay for those who live a long time. But DB plans are on the ropes, and annuities have never caught on.”
Combining a retirement portfolio with a mix of annuities and equity exposure from the beginning portion of the life cycle before retirement reduces the risk of running out of resources while guaranteeing a minimum sustainable living standard after retirement.
As a secondary consideration, for legacy planning, investing in long term securities that grow with the economy help future generations hedge against rising prices, productivity, and changing economic landscapes.