The importance of effective distribution strategies is rapidly increasing as 78 million baby boomers approach retirement over the next decade.1
The diminished role of defined benefit plans, longer life expectancy, escalating health care costs, and poor equity returns over the last decade are just a few of the issues confronting retirees that create a challenging retirement landscape.
Advisers use a mix of distribution strategies and financial products to manage these risks. Costly products, market volatility, and the opportunity cost associated with cash holdings represent a few obstacles with these strategies.
Fortunately, an affordable reverse mortgage, the Home Equity Conversion Mortgage (HECM) Saver, was made available in October 2010. This non-cancellable line of credit that borrowers control (hence the reference to “standby”) and that can be paid back at any time without a penalty, may provide a significant risk management solution to practitioners and retirees.
- This study considers using an HECM Saver reverse mortgage as a risk management tool in conjunction with a two-bucket investment strategy, coined the standby reverse mortgage strategy (or SRM), in order to increase the probability a client will be able to meet predetermined retirement goals.
- The HECM Saver has unique and attractive features including lower cost; a non-cancellable line of credit; the borrower’s control over when, and if, he or she uses the line of credit; and a line that can be paid back at any time without a penalty.
- The SRM represents an additional source of readily available cash in a bucket strategy to draw upon when clients’ portfolio values deviate substantially from their expected glidepath (where their portfolio should be relative to their capital needs analysis).
- Monte Carlo simulations were performed using real withdrawal rates of 4 percent, 5 percent, and 6 percent; a home value of $250,000; and a portfolio value of $500,000. The SRM strategy was successful through all scenarios.
- We find this risk management strategy improves portfolio survival rates by a significant amount. The improvement in survival rates is attributable to the mitigation of the volatility drain—the risk of having to sell investments when depreciated.
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- U.S. Census Bureau. 2010. Age and Sex Composition: 2001. Retrieved September 2, 2011, from www.census.gov/prod/cen2010/briefs/c2010br-03.pdf.
