Anyone thinking about retirement income should pick-up a copy of Retirement Portfolios by Michael Zwecher. This recommendation applies to both financial services professionals and consumers who are approaching or at retirement.
Zwecher’s book is the definitive guide to constructing and maintaining portfolios that generate sustainable retirement income.
We recently had the opportunity to speak to Michael Zwecher about the book and the business of building retirement portfolios.
Annuity Digest: Why did you decide to write Retirement Portfolios?
Michael Zwecher: I had done a great bit of retirement-income-related work on this at Merrill.
During 2008 I found myself sitting at a myriad of retirement income conferences. A common theme at these conferences was the desire to know how to allocate and how the product space and wealth spectrum fit into retirement income.
I felt that each of these pieces was relatively easy to flesh-out.
I kept hearing questions for which there were answers—they just were not widely disseminated.
Also, when I switched from risk management to structured products, I was charged with coming-up with something that was of value to clients.
People work hard for their money and they deserve answers and solutions that help them preserve and derive income from that wealth.
People who work 30-40 years work very hard for all that they save. They deserve to have the best solution possible for that hard-earned money, and that best solution does not necessarily conflict with the business models of financial advisors.
999 out of 1,000 advisors would prefer to give the best advice possible, and they might even prefer to give better advice versus less optimal advice even if it affects their compensation.
The short answer is that I thought it was important, feasible and more straightforward than often thought.
Annuity Digest: Retirement Portfolios provides a road map for the retirement income industry, and the guidance is particularly relevant to financial advisors. Does this conceptual framework or model that you provide actually exist in practice?
Michael Zwecher: Parts of the framework do exist at various firms.
A lot of the work that went into Retirement Portfolios came out of work done at Merrill, and they have adopted parts of it in their retail advisor operations.
There are some firms that are closer to a more comprehensive approach. This handful of leading firms is ahead of the pack, and they are actively trying to figure-out how retirement income fits with their business models.
Annuity Digest: Is the industry--particularly the advisor side--doing a good job of: a) communicating the value proposition of retirement income solutions to clients, and; b) enabling good retirement income outcomes for their clients?
Michael Zwecher: So far it has been mixed.
In most cases, firms have avoided addressing retirement income in a wide-ranging, holistic manner. For many firms, the idea has been “trust us for everything,” and this everything is largely based on their existing core competencies. The notion of a one-stop shop for all solutions has existed on both the insurance and the capital market sides.
Neither of these approaches met with deep penetration. There may have been some profitability attached, but the swinging for the fences approach does not work very often.
Slowly firms have been sort of refining their retirement income approaches to something more nuanced—a spectrum of approaches rather than a comprehensive approach.
If the industry was there, we would not be having this conversation.
Clearly the anxiety vis-à-vis retirement income is manifest in the higher savings rate in this country. People are not sure what will happen to their wealth after they retire or whether they will have enough.
This is as much a matter of uncertainty about the future state of wealth as it is about current employment worries.
People are now focused on things they would not have thought about previously. For example, the credit risk associated with GM bonds is something people are attuned to. The risks—market or credit—associated with financial assets is something on people’s minds.
Annuity Digest: Can you share any retirement income success stories that you may have observed? Do you have examples of successful independent practices or advisors taking a team approach inside of broker-dealers?
Michael Zwecher: There are some success stories that have come out of the RMA program sponsored by the Retirement Income Industry Association (RIIA). For example, there is an advisor in Pittsburgh who has had a lot of success as a result of having tough conversations with clients. The honest approach—even though a tough message—was welcome.
This advisor’s tangible, well defined, outcome-oriented goals inspired clients to try to meet the objectives. The result is more assets under management per client and more overall clients.
There are other similar stories that have come out of RIIA and the RMA curriculum.
Annuity Digest: Retirement income requires quite a bit of “heavy lifting” compared to wealth accumulation. For example, retirement income involves: a comprehensive financial planning exercise; complex product analysis and selection; meaningful regulatory hurdles, and; proficiency and execution capabilities across several broad product verticals such as equities, fixed income products, derivatives and insurance. How does this process scale--particularly when advisors must deliver such a complex solution set to a mass market?
Michael Zwecher: The question really boils-down to how comprehensive the financial planning process is.
For example, we could come up with a financial plan just based on spending and this is relatively straightforward.
A plan based on expenditures, however, is complex and would take several hours.
Simply looking at assets and thinking about annuitization—whether bond based or insurance based, could result in an answer in about 30 seconds.
The computational power and knowledge to find the present value of expected expenditures is much more involved than finding the spending power of your current assets; then adding in any expected stream of savings (but remembering that there is a big distinction between existing assets and planned-for savings)
The expenditure approach—because of the sheer complexity and the limited usefulness of far-off projections—has met resistance.
Look at any industry questionnaire. It is very time consuming and ultimately almost always leads to the conclusion that you do not have enough money.
Further, suppose you are 45 today. You simply do not know what your expenditures are going to be in 20 or 40 years. The presumed precision in the forecasted expenditure number is not something that people really buy into. Secondly, any projection of assets is based on a presumed rate of return that folks intuitively understand isn’t a sure thing and yield an expenditure-planning amount that is typically sensitive to realized returns.
The heavy lifting approach is cumbersome for both the advisor and the individual. Then at the end of it all, you have a plan that is subject to enormous uncertainty given the quality of inputs and very long time horizon over which needs are projected.
Why go through the exercise if you are not going to believe the result?
Data aggregation would be most valuable and relevant to the “lighter” approach—the approach that is purely based on the level of spending that your current assets could sustain. If you can aggregate all your sources of financial wealth with one click, then it is easy to ask a person’s age and do some annuity-equivalent or treasury-equivalent calculations to arrive a sustainable spending results over a given time horizon. Then providing a bump for planned-for savings is a straightforward extension.
Some very quick calculations can give you a nice ballpark estimate without a lot of work. The heavy lifting should really only be used if it helps develop the client-advisor relationship. In other words, the heavy lifting should not be the predicate but rather the cement or glue that holds that relationship together.
Annuity Digest: Do frictions that may exist on the advisor side ultimately boil-down to control of assets and compensation issues, or is scalability more of a challenge?
Michael Zwecher: The advisor has a preferred compensation model—“lots of it and keep it coming.” This is natural—anyone wants the highest revenue stream for the longest time possible.
There are natural frictions—and this is one of the cores of the problem–between and particular solution and the preferred compensation of any advisor.
For example, a fee-based advisor has relatively little interest in transaction-based solutions and vice versa.
The issue is really the narrow thinking of the silo approach (the “right” solution is the one that fits my business model).
What the firms need to do is not be wedded to a single approach.
Some people use hammers and some people use screwdrivers on the producer side. What the firms need to be thinking about is fitting a multiplicity of compensation structures that advisors utilize in the retirement income space.
This is more realistic and easily accomplished than it appears. Each different approach has a compensation structure that naturally fits.
If you really want to dominate in the space and not just have a small niche, you need to feed into all of the channels rather than just one. It is easy for an insurance company to feed more product into the various annuity categories, but this does not make one a retirement income advisor as it is one product in one space.
If you are an independent insurance advisor, you will be looking for some capital markets solutions to complement your core solutions. Conversely, the capital markets-oriented advisors will be looking for guaranteed products to complement their core offerings.
If I am the producing firm, I want to create a platform of products and solutions that will be useful to all of the compensation types that I am dealing with.
Annuity Digest: Would the retirement income industry benefit from the development of a fresh, non-conflicted distribution model? In other words, does reaching full potential in the retirement income industry require tweaking and leveraging existing distribution models, or does it require something entirely new and different?
Michael Zwecher: I think it is a matter of separate, different business models.
One of the heartaches of version 1.0 of retirement income was watching firms attach retirement labels to existing products that are fine for accumulation but not really suitable for retirement portfolios..
Retirement income version 2.0 involved firms cobbling together existing products intended to do everything for retirees. This magic-bullet approach did not fit the bill either.
From a product development and platform perspective, firms need to focus on having a platform intended to develop solutions specifically for retirement planning and retirees without constraints linking them to pure accumulation or decumulation platforms.
Think of it as a new, separate platform rather than a bolt-on to an existing platform.
A middle ground—a group devoted to product development between the plan sponsor space and the more topically oriented structured product space—is what is needed.
This new platform could come from different institutions. For example, a dedicated retirement income group within an investment bank could lever many different areas of the bank.
On the insurance side, the platform would need to complement existing annuity offerings (i.e. attaching capital market offerings). This would require leveraging and creating capabilities on the capital market side which is not necessarily prohibitive from expense or business model perspective.
The platform requirements in either case entail the additional of a team devoted to the problem coupled with distribution capabilities which would likely come from a third party.
From that standpoint of distribution, most large advisors are dual licensed (securities and insurance), so many are already geared-up to distribute capital markets and insurance solutions. Many also have access to capital markets / insurance platforms.
Annuity Digest: What would an ideal retirement income compensation model look like (e.g. purely fee-based, pure commission, or a combination of the two)?
Michael Zwecher: It depends.
I guess I see it splitting up two ways. The passive market—where the products tend to be incremented in a simple fashion—is more of a transaction-based, commission type of operation.
More active management that is focused on obtaining upside while protecting downside is more naturally fee-based.
The mix of uptake of passive versus active seems to be driver of compensation scheme.
The passive approach is almost a different type of investor—someone who is slowly, steadily accumulating and moving over the long-term towards a relatively fixed portfolio.
On the other hand, there are those who are going to be somewhat dissatisfied with where they are now and want to take a bit of risk. These people are willing to pay someone to actively risk manage their portfolios (not just active asset management, but risk management).
Would advisors prefer fee-based with large clients—absolutely. Whether clients will “bite” on this is the larger question.
A good advisory model would be open to either type. The commission model is an easy one to operate without much overhead, while the advisory model is more lucrative but has more overhead.
Annuity Digest: Is there a practical economic case to be made for an advisory that is 100 percent focused on retirement income, or would the lack of a natural transition from accumulation to decumulation make it prohibitively difficult to create a retirement income client base from scratch?
Michael Zwecher: I guess I don’t see it as prohibitively difficult.
An advisor purely focused on retirement income would seem rare because retirement income is just one part of the overall need—one component of a larger tool set.
Think of it as adding a pitch to the rotation. Retirement income is just one more way to add value and ultimately attract and retain clients and client assets
Annuity Digest: Is traction and/or change in the retirement income space most likely to come from within industry or from external sources such as Silicon Valley? If from within industry, what is the most likely source?
Michael Zwecher: This is a great question.
My guess is that some of it will come from regulators and some will come from the demand side (consumers) rather than plan sponsors.
There are two main parts of the market—one is retail or consumer and the other is the plan sponsor or defined contribution / 401k market.
I don’t think it is likely to come from the plan sponsor space. The incentive for plan sponsors is to keep things inexpensive. That said, there may be a firm in the plan sponsor space that wants to differentiate, but it seems rare.
So this leaves the retail space or regulators as catalysts. For example, the Department of Labor has been looking at lifetime income and this might create some changes.
Overall, though, the impetus is more likely to come from the retail side and bleed into institutional side.
With regard to forces outside of the traditional space, you may see more technologically advanced producers finding ways to develop and deliver inexpensive packages that fit the bill—for example, a package of zero coupon bonds that are cheap and relevant.
You see some of this (cheap replication) in the ETF space now, but it is not entirely relevant to retirement income planning. You have to differentiate between ETFs designed for low-cost broad-index exposure and the niche-filling ETFs which generally enable access to particular markets without being portfolio cores.
Annuity Digest: Thanks very much Mike.
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