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Plan like an Institution.

The one thing that unites both Institutional and Individual investors is the quest for returns. Returns are how all investors measure our portfolios (and ourselves). Few would believe, however, that returns aren’t that relevant. But our liabilities are.

Institutional investors create a portfolio as a means to an end – that is, to fund some liability. (Like a stream of retirement income payments to pension beneficiaries, say).

For the Individual, the same question – “What are you saving for?” – reveals the objective for that Individual; to fund a future liability called retirement. In this light, liabilities are the true benchmark and this liability awareness is needed for retirement planning. A major difference between Institutional versus Individual investors however is their approach to planning.

A pension plan, say, will follow a structured process to determine how much is promised in current and future pension payments, to how many and over what time period. This is the liability that must be paid.

The plan to ensure that sufficient funds are available to pay intended pension income(s) is called funding the liability. Simply put, to have a targeted dollar income in retirement, how much needs to be saved each year until then, how much do these saving have to earn and how long do the payments have to last?

The math incorporates a range of assumptions for average ages, mortality and expected rates of return and also for current and future contributions. The result is either there will be sufficient dollars to fund the targeted retirement payments or there won’t. Either the future liability is or isn’t affordable.

If not, assumptions and targets get adjusted and the process restarts. The institution might increase/decrease contributions or future payments or both. It’s unemotional and sometimes grim stuff. And for the most part it’s mandated by a pension regulator. (Except the unemotional part. That’s a choice).

This should sound familiar. It’s not that different than what an Individual ought to do.

An Individual can approximate the Institutional process for personal retirement planning, by using some of the on-line retirement income calculators. (See June 12, 2010 Blog post). All banks have one on their web site. Most calculators incorporate CPP, OAS, a company pension, RRSPs and other savings. The Individual can change assumptions, rates of return and do ‘what if’ analysis. What if more or less is saved? What if retirement is earlier or later? In the end, Individuals face the same questions that a pension plan might -– how much money must be saved and what rate of return must be earned to pay a target retirement income amount to a certain age?

Importantly, these calculators can help the investor focus on long-term planning and away from the day-to-day market bumps. They match the plan’s time horizon to the investor. Note also that this process provides input for (indeed dictates) asset allocation (the first step in portfolio construction). And an added bonus is the math is done for you.

Next time?

How important is Asset Allocation?

Doug Cronk, CFA is Manager, Investments for a Canadian Pension fund.

2 Comments Post a comment
  1. Bruce Tollefson #

    I’ve reached retirement and now have different portfolio goals from the accumulation phase.

    Do you have any guidance as to withdrawal strategies in retirement? I must admit I am new to your blog and have not searched it.

    Thank you.


    April 30, 2011
    • Bruce,
      There is plenty written on withdrawal strategies … search Rob Carrick of the Globe and Jonathan Chevreau of the Financial Post.
      And find a fee-only financial planner to advise you. (ie. some one compensated by fees … not product, transactions or commissions).
      BTW … this is exactly what pension funds do … provide for accumulation and then de-cumulation.
      good luck.


      April 30, 2011

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