On The Road to Retirement, Chart Your Path with a Flashlight – Not A Streetlight

Ashok Ramji Finance 101, Income Planning, Insight Investing Articles, Retirement

There's an old story about the streetlight effect.  The story goes that a person is looking for their keys or their wallet under a streetlight.  A cop walking by asks the party conducting the search what is going on and then offers to help find the missing item.  After some time elapses and with the desired object still missing, the officer checks assumptions. Are you sure it was lost in this vicinity?  The reply that comes back: no, it was probably lost across the street or in the alley, but the light is better out here.

The Streetlight Effect

In some ways, modern investment planning exhibits this streetlight effect.  Most instructional material I have come across focuses on identifying principal risk.  There is systematic risk which cannot be diversified away, and unsystematic risk which can be reduced through a combination of different holdings in a portfolio.  We learn about how to measure risk using betas or standard deviations, and then learn how to vary the investment holdings with attention to things like covariances and correlation coefficients.  If all this sounds Greek, it's for good reason. Most of the formulae have Greek letters like alpha (α) and beta (β).

This then is the streetlight that comes shines down on the road to retirement.  The focus is on the risk-return tradeoff to principal. How can the account value be increased most efficiently with the least amount of risk.  Ask someone at or near retirement what s/he is looking for, and the surveys overwhelmingly come back in favor of income. Humans are wired for survival, and the fear of poverty or running out of money has been and will continue to be of high importance in retirement planning.  Our pre-retiree or retiree is looking for the keys to survival (income), and the surrounding area where the light shines brightest is focused on the risk-adjusted rate of return.

Thankfully, our hero doesn't need to be kept in the dark.  S/he can find the missing keys using a flashlight. This blog at Insight Folios illuminates such concepts like having a laser-like focus on income generation first, and the rest will follow.  Want an example? Check out Insight Folios' Paul Durso as he explains Growth vs Income