1. Asset liability management
A conservative way to ensure that a retiree’s expenses will be covered is asset-liability management, by which an individual invests money today to meet a future liability (their retirement expenses in future years) with a high degree of certainty. Under this method, a retiree could decide how much income they want in the future, and invest an amount of money that will achieve that goal using conservative investments (e.g., Treasury Inflation-protected securities, or TIPS).
However, given the conservative investments (and low current yields), this method can require a significant initial outlay of funds, and, because individuals do not know their exact longevity, it would be impossible to know how many years of income would be required.
2. Static inflation adjusted withdrawal
The second method is to take static inflation-adjusted withdrawals from a portfolio each year. For example, the 4% rule developed by Bill Bengen suggests that, based on historic market returns and certain assumptions, retirees can afford to take out 4% of their portfolio in the first year, and adjust that amount for inflation in subsequent years (and while the 4% rule was developed in the 1990s, it remains an effective strategy today).
This method allows for a steady, inflation-adjusted stream of income for the retiree (although its inflexibility could leave a retiree with significant unspent assets at their death if investment returns are strong).
In next blogpost, we will discuss the next 2 strategies for retirement income planning.