Keeping investors afloat in retirement
The picture above shows a Plimsoll Line.1 This mark, which is on the hull of every commercial sailing vessel, can teach us important lessons about retirement investing.
But first, some background on the Plimsoll Line.
In England in the late 1800s, sailing was an especially dangerous profession. Its inherent danger was amplified by the fact that unscrupulous merchants would insure old or unseaworthy vessels for more than they were worth and load them to the rails with cargo.
If one of these coffin ships2 reached its destination, the owner made an enormous profit. If it sank along the way, they collected the insurance payout. This practice contributed to a thousand British sailors drowning each year. How’s that for a moral hazard?
This outraged Samuel Plimsoll, who ran for the British Parliament, published a book exposing the problem, and spent six years haranguing fellow members to eventually pass the Unseaworthy Ships Bill in 1876. This required ships to bear a mark noting the waterline for a maximum load.
This beautifully simple mark allowed anyone to see, at a glance, if a ship was overloaded or not. It came to be known as the Plimsoll Line.
A portfolio Plimsoll Line — the funded ratio
Pension plans use funded ratios to quickly communicate the status of a plan. We’ve applied that practice to individual investors.
As I discussed in an earlier post on the new Russell Adaptive Investing™ approach Russell has developed for retired investors, the basic funded ratio equation looks like this:
(In slightly more complex terms, the liabilities are the actuarial present value3 of a retiree’s future spending goals. We calculate it using best practices of actuarial math rather than the more typical rules of thumb used to answer retirement-oriented questions like “What’s your number?” How you calculate that number makes all the difference.)
This simple metric is like a Plimsoll Line for a retiree’s portfolio. An investor with assets worth less than the value of their liabilities (i.e. they have a funded ratio of less than 100%) is at great risk of sinking along the way. Your investor portfolio can only carry spending loads that remain safe.
Read the following excerpt from Samuel Plimsoll’s book in light of your role as a financial advisor keeping your clients afloat during retirement.
“A great number of ships are regularly sent to sea in such a rotten and otherwise ill-provided state that they can only reach their destination through fine weather, and a large number are so overloaded that it is nearly impossible for them also to reach their destination if the voyage is at all rough.”
“[T]he storms of winter may come, but with good tight ships under them…they reach their desired haven, weary and worn it may be, but still safe.”
Our Seamen, 1872
Despite modern technology that allows captains to receive real-time weather reports and auto-pilot using GPS systems, the single most important tool to keeping a ship afloat is still a painted mark on the hull that shows if a ship is overloaded.
1Plimsoll Line: Internationally agreed upon reference line marking the loading limit for cargo ships, www.britannica.com
2Coffin ship: A ship likely to founder, and thus become the coffin of the crew; a term in common colloquial and newspaper use in the United Kingdom, during the agitation in Parliament begun by Samuel Plimsoll for legislation on the subject, http://www.wordnik.com
3“The Actuarial Present Value Process“, by Donald W. Parkyn, justpensions.com