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Objective for Investing: Income Protection vs. Wealth Maximization & What it Means to you...

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Recall that the objective is not to win the battle, but to win the war. The two are not necessarily the same.


Imagine you are given two choices: (1) high degree of wealth at age 65 but run out of money at 75 or (2) maintain a comfortable lifestyle until you pass away at age 85. Which would you choose? If we win the battles of wealth maximization and high average returns, we can still lose the war of protecting our lifestyle or income through retirement. One example showed following the wrong objective lowered returns and increased risk. These decisions defied common sense as a moderate risk portfolio for wealth maximization invested 88% in assets that had no propensity to protect income from high inflation. An example that sought a high average return over the long run got exactly what they asked for. But even with high returns the lifestyle dropped 26% because no one gave any thought to whether the highest returns came in when savings were just starting or just finishing. A little whiff of inflation knocked them down to a 48% drop. Simple common sense also dictates that gazing at past returns does not tell us everything we need to know about the future. So if we have a natural hedge for our expenses we should consider it seriously even if analysis of the past indicates it is unnecessary. A number of these problems can seriously derail our progress so we never complete the journey from wealth maximization and high average returns to maintaining our lifestyle. So if we switch to an income protection objective directly and measure the impact on our actual yearly cash flows as institutional investors certainly do, we will correct many of these problems and look more confidently towards winning the war of maintaining our lifestyle in retirement. Such technology is becoming more available to individual investors as finance professors recognize the need after the effective demise of the defined benefit pension industry.


Our Real Objective

Optimizing for the Wrong Objective

Practical Reality Seeps in...Conclusion

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