“The US retirement planning market is well developed and home to a lot of new academic theory, which focuses on probability-based and safety-first approaches,” explains Mike Morrison, Head of Platform Marketing, AJ Bell. “The former will be familiar to British savers as it forms the basis of the accumulation phase of a pension, where the individual owns a portfolio of investments across a range of assets, based on their risk tolerance, with the intention of building as large a pot as possible. The latter is quite different and suggests this traditional approach may not be the best way to do it.”
Morrison continues: “Under the safety-first approach, now refined as 'Modern Retirement Theory', the saver looks to match specific spending requirements with particular assets. This means the portfolio provides cash as and when it is needed and puts the investment focus on targeting predictable income rather than pursuing capital gains in what can be volatile markets.”
Notes for Editors
- Modern Retirement Theory can be described as a pyramid of funding hierarchy and risk-matching. The saver first structures a portfolio to make sure their basic needs can be funded and then adds a contingency level to this. A third pot is then set up to cover discretionary spending and a fourth and final layer is a long-term legacy fund.
- According to this school of thought, the focus on income rather than capital gains helps to negate the danger posed by market volatility and an unfavourable sequence of investment returns at the worst possible time. This risk is analysed in depth by Moshe Milevsky in his 2006 research paper Retirement Ruin and the Sequencing of Returns and 2013's Life Annuities: An Optimal Product for Retirement Income.