Securing Replacement Income with Goal-Based Retirement Investing Strategies

Abstract

To supplement retirement benefits received from public and private pension systems, individuals need to make voluntary contributions and decide how to efficiently invest these contributions. In this article, the authors analyze the problem of how to secure minimum levels of replacement income in retirement while offering attractive probabilities of reaching higher levels. Such strategies can offer an interesting alternative to target date funds, which have no focus on the generation of replacement income, or annuities, which can be used to secure replacement income but at the cost of substantial rigidity.

TOPICS: Retirement, pension funds, wealth management

Key Findings

• • Goal-based investing principles can be used to create retirement solutions that secure a minimum level of replacement income while delivering a high probability of reaching higher levels defined as aspirational goals.

• • These “flexicure” retirement solutions use a dedicated safe portfolio, known as a retirement goal-hedging bond portfolio (or retirement bond in short), which is a fixed-income portfolio whose cash flows (or factor exposures) match those of the stream of replacement income for a fixed period of time, say 20 years, in retirement.

• • Such strategies use liquid building blocks, they reliably secure a clearly identified replacement income goal without requiring ad-hoc parametric assumptions, and they offer upside potential; as such they represent an attractive alternative to existing retirement products such as annuities or target date funds.