What is your Product Allocation in Retirement?
We know asset allocation. What is Product Allocation in retirement?
The term itself is popularized by a book with major shortcomings (anyone hear insurance sales pitch?), but I don’t think we should give up on the term. It recognizes concepts and models a framework that is vital in retirement planning and risk mitigation.
In retirement, product allocation is the mix of your portfolio devoted to specific investments or products that generate income or mitigate risks. Another way to think about it: what mix of products and investments should you have to reach your retirement goals?
In the (much easier) accumulation phase, product allocation is the yin to your human capital to the yang of your investments. In de-accumulation, everything becomes more complicated.
What is the best mix for you in retirement?
Product Allocation in Retirement
Using a broad definition of products, everybody has at least one in their retirement. Social Security is a product. It offers a life-long, guaranteed, COLA-adjusted income stream that is useful for both income and longevity insurance. Social Security is an annuity, and there is no better product for longevity insurance in retirement!
So, at the bare minimum you have your investment portfolio and a social security annuity that can be useful for longevity protection. The goal of a good retirement plan is to have a nice mix of income and to mitigate the risks we all face in retirement.
This is why we need to think about product allocation in retirement. You need money now and later!
What is the Philosophy Behind Product Allocation?
Retirement, more than anytime in your life, is a time when you face a series of known (and unknown) risks.
Products mitigate risk. A Retirement Plan is a plan to turn assets into income while addressing risks. So, there are two aspect to retirement planning, the income and the risks.
What proportion of your overall assets do you deploy towards income vs risk mitigation? This is your product allocation in retirement.
As I mentioned above, almost everyone has at least one product in retirement: social security. This is, by far and away, the most important product for most retirees.
When you have over saved for retirement, you might plan to live significantly above the limited resources provided through social security. Most DIY investors are very familiar with stocks and bonds and have their asset allocation fine-tuned. Products, on the other hand, are in the realm of salesfolks and often neglected by DIY.
That is unfortunate, as we all have risks to mitigate!
How can you think about mitigation of these risks? What product allocation do you need and where can you get said products?
First, let’s visualize product allocation.
The Pie Graph of Product Allocation
As an example, see above for a pie graph of product allocation in retirement. Here, we have social security and a pension (both products). Many folks no longer have pensions, but they can be an important source of income for some.
Next, are commercial annuities. These annuities, SPIAs and DIAs, are low-fee, easily comparable, and can be shopped and purchased on-line. You don’t need (or want!) a salesman or a sales pitch for these simple, cost effective, and effective annuities that serve a purpose and massively mitigate risk.
A SPIA is for income. These Single Premium Immediate Annuities pay out a series of cash flows after a lump sum is given to an insurance company.
Deferred Income Annuities, on the other hand, pay out sometime in the future. DIAs are for longevity insurance. A special type of DIA, a QLAC, is a DIA in your qualified retirement accounts.
I have covered annuities in detail previously. You need to understand them, embrace them, and USE them in your retirement. Again, they don’t pay high fees to anyone so they won’t be pitched to you. Understand the positive and negative aspects of annuities.
Let’s move on.
Part of our portfolio is invested in stocks and bonds for income, inflation risk, and also, importantly, legacy goals. Life insurance is also a product available for legacy goals when used appropriately.
Human Capital in Product Allocation
In addition, most still have human capital in retirement as well. This could be a part time job, or anything else where you generate some side income (such as rentals). Human capital is not necessary in retirement (as many don’t want to work in exchange for income!) but let’s not rule out a side gig for those otherwise “retired.”
I also want to think about human capital in a slightly different way. Humans are adaptable!
You have the social capital, your ability to reach out to relatives, neighbors, and community for assistance.
You have the ability to cut expenses or make different decisions depending on your personal economy.
Too often in retirement income planning we focus on a static model for the future. The safe withdrawal rate is such an example. I will robotically take an inflation adjusted 4% for the rest of my life. Who lives that way? Human capital is both sides of the equation: income and spending. Both are mailable.
Human capital is important. It is a small part of your product allocation, but perhaps most important because it is entirely in your realm of influence. You can control it. You control your behavior, and for the most part DIY folks have intelligence and flexibility on their side. Use planning to your advantage.
Product Allocation Pie Graph Summary
So, we have a product allocation of 10% human capital, 30% investments, and 60% products.
This product allocation can vary widely depending on your goals and risk tolerance. Product allocation, just like asset allocation, is very personal. No one should impose their will and tell you exactly what you need. No one is you.
What is the idea Ratio of Products to Investments?
What is the ideal ratio of products to investments?
Like asset allocation, product allocation is an individualized decision. Much of it stems from the desire to floor your income vs the desire to leave a legacy.
DIY will have a significant proportion of their assets in investments, because they are still in an accumulation mind-set. This is actually perilous, as investments address a certain subset of risks more adequately than others.
When thinking about the ideal ratio of products to investments, if we are lumpers, we have safety-first vs investment minded folks.
Safety-First Retirement vs. Investments
For safety-first people, it is reassuring to have 100% of your known fixed costs paid for in advance. You can get guaranteed payment from social security, pensions and commercial annuities. Of course, “guaranteed” can be debated in this context, but this is not the time to do so. Whatever is left over, can go to discretionary or legacy goals.
The flip side is the risk-based or investment folks who use withdrawals from their portfolio instead of a guaranteed floor. Their product allocation may just involve social security. This provides ultimate freedom and flexibility, but as a cost. Risks. As we know the process of aging involves progressive mental incapacity. We all regress in our prowess, physical and mental, and investing may not be top of mind to the average octogenarian.
Who are you? Are you risk averse and want to guarantee a floor of income that will last your lifetime? Or, are you ok with risk and the uncertainty of continued market, political, and even environmental threats on the certainty of your retirement nest egg?
If you have the assets, why not take care of both!
The Philosophy of Product Allocation in Retirement
So, who are you? Safety first and risk adverse, or investment minded and willing to let market risk persist in the golden years? As a DIY with adequate retirement reserves, it pays to be both.
What the philosophy of product allocation informs is that it is never all one or the other.
Just like with your asset allocation, you can be 100% stocks or 100% bonds. Such an extreme, however, is not right for most folks. And, in fact, product allocation—just like asset allocation—changes over time depending on your life circumstances and goals.
Retirement planning involves income planning and product planning. Retirement planning is not an either-or scenario. Remember, the goal is to spend your money and mitigate your risks.