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National Retirement Security Week serves as a timely reminder of our duties as financial professionals. This year’s observance gives us the opportunity to focus on two critical aspects of retirement planning that require our immediate attention and action.
The Sequence of Inflation Risk, and Multi-Generation Retirement™, are emerging concepts that can profoundly impact retirement outcomes. The landscape of retirement planning is evolving rapidly, driven by increased longevity and the persistent, detrimental effects of inflation. As an industry, we must adapt our approach to retirement planning to address these new challenges faced by retirees.
The traditional methods we have grown accustomed to may no longer suffice in this changing environment. If we continue to rely solely on conventional planning strategies, we risk leaving our clients financially vulnerable in their later years.
As you read this blog post, I urge you to consider how these factors might reshape your own approach to retirement planning. Your decisions will have far-reaching implications for your clients’—and their families’—long-term financial security.
Multi-Generation Retirement™
I have a friend whose mom is now almost 102 years old and in decent health. My friend is 67 years old, and she and her husband are considering retirement. Other than a small survivor's Social Security benefit, she does not have much in the form of income or assets. When my friend retires, she will support two generations of retirees - herself and her husband as one generation, and her mother as the other.
In his book Lifespan, Dr. David A. Sinclair, a professor of genetics at Harvard Medical School, says that aging alongside a decline in quality of life is not a biological inevitability.
Dr. Sinclair says that most of us have learned to equate a long lifespan with decades of poor health—“broken hips, diapers, chemotherapy and radiation, surgery after surgery.” Dr. Sinclair says this should not be, and does not have to be, the reality.
In fact, he believes that in 50 years, most humans will live to 120 or 130 years old without losing their quality of life.
So, consider this.
A couple has a child at age 30. When that child turns 70, he wants to retire, but because his parents did not plan to live as long as they did, they are now 100 and broke. He now has two generations to support in retirement.
That child, when he was 30 years old, had a child—a daughter. When she turns 70, she decides to retire. With poor planning, her parents are 100 and broke, and her grandparents are 130 and broke. She now has to support three generations of retirees!
And do you know what none of the above-mentioned children have that previous generations possessed? An inheritance.
This is the concept behind Multi-Generation Retirement™.
This is not science fiction. This is why we must change our thinking about retirement, account for much longer lifespans, and increase growth in our retiree portfolios in calculated ways.
The Sequence of Inflation Risk
We have previously explored the Sequence of Return Risk. However, there is an equally important concept we call the Sequence of Inflation Risk, which can have an equally devastating effect on retirement savings.
It is critical to remember that the Federal Reserve targets a 2% inflation rate, not zero inflation. In our previous discussion of the Retirement Investment Paradox™, we explored the compounding effect of 2% inflation over extended retirement periods.
However, we must also consider the potential consequences if inflation exceeds the target rate. How might this affect your client's ability to maintain financial stability throughout retirement?
Let us examine a hypothetical scenario:
Assume we each have portfolios worth $1 million, and that for the first 40 years of retirement, we both achieved a comfortable 6% average net rate of return. Said differently, the Sequence of Return Risk was not a factor.
Additionally, we both experience an average inflation rate of 2.5%, distributed as follows: 10 years at 4%, 10 years at 3%, 10 years at 2%, and 10 years at 1%.
Now, consider two different sequences of these inflation rates, for you and for me:
Scenario 1
You experience inflation in ascending order, meaning 1% for the first 10 years, 2% for the second decade, 3% for the third decade, and 4% for the last decade. In this case, you remain solvent, and your assets have nearly doubled over the 40-year period.
Scenario 2
I experienced inflation in descending order, meaning 4% for the first 10 years, 3%, 2%, and 1% for the last decade. Despite the same average inflation rate, I depleted my assets by the 37th year of retirement.
This comparison illustrates the significant impact of the sequence of inflation rates on long-term financial outcomes, even when the two scenarios’ average rates remain constant.
The importance of growth, as explored in the Retirement Investment Paradox™, becomes evident when we examine scenarios with lower returns, and how the Sequence of Inflation Risk becomes more pronounced as we experience lower average returns on our portfolios.
Consider a situation where we both achieve only a 4% net rate of return. Under these circumstances, the impact of the inflation sequence becomes magnified.
With an average net 4% rate of return, you would exhaust your retirement savings in the 36th year, while I would deplete my funds by the 26th year. This highlights how the sequence of inflation rates can significantly accelerate the depletion of retirement assets when combined with lower investment returns.
Early higher inflation followed by the Fed’s 2% inflation
In this way, the Sequence of Inflation Risk unveils an important aspect of retirement planning that demands our attention. This concept shows how the timing and magnitude of inflation can dramatically impact the longevity of retirement savings. Let us explore this phenomenon further through a different set of scenarios.
Consider a retiree with a net 6% average rate of return on their portfolio who faces varying high inflation levels early in retirement, followed by a more moderate 2% inflation rate (the Fed’s inflation target).
Source: Dunham & Associates Investment Counsel, Inc. October 2024
In the first scenario, a retiree experiences 4% inflation for the initial 11 years of retirement, followed by 2% inflation thereafter. This individual's retirement savings last for 40 years before depletion.
In the second scenario, the retiree starts with a 5% inflation rate for the first seven years of retirement, again followed by 2% inflation. Despite the shorter duration of high inflation, this retiree's funds are exhausted in year 39 of retirement.
The third scenario shows that with 6% inflation during just the first five years of retirement, followed by 2% inflation, the retiree still faces fund depletion in year 39.
These scenarios underscore two crucial insights. First, even relatively brief periods of high inflation early in retirement can have long-lasting and detrimental effects on financial stability.
Second, growth in a retiree’s portfolio is necessary—as much as a 6% net rate of return. Less return accelerates the depletion of assets, as we see in the above examples.
This phenomenon occurs because high inflation in the early retirement years erodes purchasing power more rapidly, forcing larger withdrawals from the retirement portfolio. These increased withdrawals, in turn, leave less capital to grow and compound over the remaining retirement years, even when inflation moderates later.
Final Thoughts
National Retirement Security Week allows us to pause for thought that failing to plan for the Sequence of Inflation Risk, longevity, and adequate portfolio growth can lead to an unintended Multi-Generation Retirement™. This scenario is not merely about relying on younger generations for support. Rather, it is one where multiple generations find themselves simultaneously in retirement, potentially straining family resources and compromising financial independence for all involved.
The Dunham Retirement Income Program and DunhamDC are designed to potentially address these complex challenges. Our innovative approach, recognized by a 2024 Luminary Award nomination for Innovation, aims to mitigate the risks of inflation sequencing and extended lifespans while seeking to promote growth. Please be aware that all investments involve risks, and results may vary. Past performance is not indicative of future results, and there is no assurance that any investment strategy will achieve its objectives.
National Retirement Security Week emphasizes the importance of implementing retirement plans that account for these additional risks. By considering the Sequence of Inflation Risk and long-term growth, we strive to ensure each generation can maintain financial independence throughout their retirement years.
Our goal is to help clients avoid the complications of Multi-Generation Retirement™ and instead foster a future of financial security and autonomy for all.
For more information on this topic, the Dunham Retirement Income Program, or DunhamDC, please call the Dunham Business Development Team at (858) 880 – 5778.
Disclosures:
This communication is general in nature and provided for educational and informational purposes only. It should not be considered or relied upon as legal, tax or investment advice or an investment recommendation, or as a substitute for legal or tax counsel. Any investment products or services named herein are for illustrative purposes only and should not be considered an offer to buy or sell, or an investment recommendation for, any specific security, strategy or investment product or service. Always consult a qualified professional or your own independent financial professional for personalized advice or investment recommendations tailored to your specific goals, individual situation, and risk tolerance. All examples are hypothetical and are for illustrative purposes only.
For more information on Dunham DC and the Dunham Retirement Income Program, please visit
https://www.dunham.com/FA/Pages/DunhamInsights
About the ThinkAdvisor Luminaries Award
Dunham & Associates Investment Counsel, Inc. was nominated as a finalist for the Think Advisor Luminaries Awards 2024 in the asset management innovation category for the period January 8, 2024, to present. The ThinkAdvisor Luminaries award honors firms that excel at financial and investment innovation by creating new financial products, services, or processes which meet advisor and investor client needs, while delivering efficiency and competitive advantages to industry players via new platforms or other tools. In evaluating entries, multiple factors were taken into consideration, including the nominee’s impact on the firm’, it’s advisors and the broader professional community and industry, as well as on the landscape of clients, prospective clients, investors and would be investors nationwide. Compensation was not received from anyone in exchange for rankings for the study. A fee was paid solely to promote the award nomination.
For more information on the Luminaries Award, please visit: https://event.thinkadvisor.com/luminaries-awards/criteria
All examples are hypothetical and are for illustrative purposes only. We encourage you to seek personalized advice from qualified professionals regarding all personal finance issues. The solution for an investor depends on their and their family’s unique circumstances and objectives. Past performance is no guarantee of future performance and there is no guarantee that any investment strategy will meet its stated objectives.
Dunham & Associates Investment Counsel, Inc. is a Registered Investment Adviser and Broker/Dealer. Member FINRA/SIPC. Advisory services and securities offered through Dunham & Associates Investment Counsel, Inc.