Physicians monitor the health of their patients by measuring a range of vital signs—e.g., body temperature, pulse rate, respiration and blood pressure—to help detect signs of potentially deteriorating medical conditions in individuals. Similarly, financial professionals must also monitor the vital signs of a retiree’s retirement income plan due to the special challenges of sustaining retirement income over 25 or more years.

Unlike wealth accumulation, which is a linear process, decumulation is nonlinear, subject to turbulence, or disorderly, unpredictable flow, so argues the author of a recent paper, “The Vital Signs of Retirement Income.”

Since there are no mathematical solutions for turbulence, it is crucial that financial professionals monitor retirement income plans for early-warning signs that may produce adverse future outcomes.

Four Key Vital Signs

“The Vital Signs of Retirement Income” offers four key vital signs for financial professionals to monitor, as well as a warning-sign checklist that can be a useful tool in helping to avoid the death-spiral risk to which retirement income plans are subject.

Vital Sign No. 1—Negative Returns

Negative returns are the first vital sign of portfolio longevity as every financial professional knows. Negative returns must be viewed in three ways: worst-case losses, multiple years of negative returns (including multiple years of small losses) and the portfolio’s downside risk.

Vital Sign No. 2—Annualized Erosion Rate

Though retirees may understandably expect that portfolios will decrease in value as they draw on income, many retirement portfolios can rise in value over the retirement income period. Depending upon the portfolio’s allocation and the annualized erosion rate, retirement portfolios may find themselves in later years unable to meet desired future income needs.

It’s important for financial professionals to determine an acceptable annualized erosion rate for each five-year block of time. Approaching these thresholds is a warning, and exceeding them requires a response.

Vital Sign No. 3—Changes in Account Value

Falling account values, especially in the early years and during years of overall positive markets, are a significant caution flag. Declines of 10% or more are likely to require immediate action to adjust plan distributions.

Vital Sign No. 4—Distribution Rates

Distribution rates tending toward 10% should be a warning sign since the paper’s analysis points to a 100% failure rate when there were at least two years in the first 20 years that had a distribution rate of 10% or more.

This important paper offers a way to collectively look at these four vital signs and provides a warning-sign checklist that financial professionals can use to help guide their clients through their challenging retirement income years.

Please reference disclosures at: https://blog.americanportfolios.com/disclosures/