I think one of the biggest problems that baby boomers are going to encounter is transitioning from accumulation to decumulation.   At 30 I am still young, but it has to be an odd feeling moving from the gathering of assets to partitioning which assets to spend and when.  I recently read an article in Investment Advisor written by Dr. Stephen J. Huxley and Brent Burns, MBA titled “Building a Personal Pension Portfolio” that provided a really straight forward approach to the problem.  It should be noted that I have seen information on this type strategy before and the article written by Dr. Huxley and Mr. Burns while very inspiring is just the tip of the iceberg.

To generate both predictable income and long-term returns, we advocate splitting a portfolio into two sub-portfolios—income and growth. Each sub-portfolio uses asset classes that best suit its purpose. Individual bonds are used to generate the predictable pension-like cash flows in the income portfolio, while stocks and other long-term-growth-oriented assets make up the growth portfolio.

The income portfolio delivers predictable cash flows in the near term, usually eight to 10 years, regardless of what is happening in the stock or bond markets. It also provides a time buffer for the growth portfolio to ride through down markets. The growth portfolio is tasked with driving long-term total return to replenish the income portfolio as it is spent down.

The professional part? The two advisors depend on the concept of Liability-Driven Investing to provide for the income part.

What is Liability Driven Investing?

According to investopedia,

A form of investing in which the main goal is to gain sufficient assets to meet all liabilities, both current and future. This form of investing is most prominent with defined-benefit pension plans, whose liabilities can often reach into the billions of dollars for the largest of plans.

And Wikipedia adds fantastic information about applying LDI to Individuals

A retiree following an LDI strategy begins by estimating the income needed each year in the future. Social security payments and any other income is subtracted from the income needed to determine how much will have to be withdrawn each year from the money in the retirement portfolio to meet the income need. These withdrawals become the liabilities that the investment strategy targets. The portfolio must be invested so as to provide the cash flows that match the withdrawals each year, after factoring in adjustments for inflation, irregular spending (such as an ocean cruise every other year), etc. Individual bonds provide the ability to match the cash flows needed, which is why the term “cash flow matching” is sometimes used to describe this strategy. Because the bonds are dedicated to providing the cash flows, the term “dedicated portfolio” or “asset dedication” is sometimes used to describe the strategy.

The Authors discuss using a very similar structure as Wikipedia describes above.  The authors seem to solely depend on specific bond purchases, but I believe this is a bit shortsighted.

Using Multiple Income Streams During Retirement

The Authors are quick to dismiss REITs and Dividend Producing Stocks as they believe those assets classes are a “lousy source of predictable retirement income in periods of market turmoil.” The authors use the fact that the S&P 500 dividend payments dropped 23.5% from January 2008 to January 2009, but why use that specific index?

I have expressed my obsession with the topic before, but I am not sure why they would ignore the Dividend Aristocrat list?  These stocks have paid increasing dividends for the past quarter century (My first Post on investing with the Dividend Aristocrats and my latest Dividend Investment Portfolio Update).

Notwithstanding that very slight disagreement regarding dividend paying stocks I think they completely miss the boat on the topic of insurance products in retirement planning.  If I had to guess the reason they do this is because it is an investment magazine rather than an insurance based periodical.  At their very core annuities an annuity is an equal stream of payments from an insurance company…what is more guaranteed than that? Of course insurance companies can go out of business but bonds can default.  There are even advance annuities that while they have high fees may guarantee a larger stream of income later on in life (all dependent on specific terms found in various riders such as Guaranteed Minimum Income Benefits or Withdrawal Benefits).

While I may disagree in the application the strategy is phenomenal in my humble opinion. Imagine if it was a bit supercharged with multiple streams of income?