First, a Dedicated Bond Portfolio
Under this framework, a retiree will prefund the desired level of income replacement in retirement for a certain number of years. This could be accomplished with a dedicated bond portfolio whose cash flows (coupons and principal payments) are expected to match the retiree’s income needs. For example, target-maturity bonds (also known as defined-maturity bonds) are designed to mature and pay out principal (minus defaults) after a specific number of years.
Bond allocations of this sort also are flexible, and therefore allow for adjustments over time as retirees’ conditions and circumstances change – unlike contractual insurance-type products such as immediate or deferred income annuities. Investors remain in control and can make adjustments at their discretion.
Second, the Growth-oriented Equity Portfolio
At the same time, assets not allocated to the bond portfolio can be allocated to equities and other growth-oriented investments to help retirees maintain and grow their wealth in retirement. Crucially, a predictable stream of income from a dedicated bond portfolio means retirees may be less likely to need to tap their growth-oriented investments to fund expenses. This should help investors ride out the up and downs typical of higher-risk, higher-return assets – and, in the process, help to mitigate the effects of sequence risk.
Summary
The two portfolios – one designed for income, the other for longer-term growth – represent a fine balance that the framework seeks to solve: predictable income and growth on one hand; flexibility and control on the other.