In Profile

A Conversation with Lee Freitag

The New Challenges Of Accumulation

by P.E. Kelley

Mr. Kelley is managing editor of this magazine. Connect with him at

Longevity has thrown a monkey-wrench into many of our assumptions about building adequate and sustainable income for clients. The prospect of outliving one’s assets, running out of money before running out of breath, has become a frightening possibility for many. Moreover, the plans we utilize to help build sustainable portfolios, starting with a once reliable 60/40 strategy, have begun to strain under a nagging low interest environment that is kicking out diminishing yields. When viewed through this prism, the outlook for equities in the long term can be disconcerting, as investors begin to reset the dials on risk, volatility and income expectation.

Lee Freitag is the Practice Lead for Retirement Solutions with Northern Trust Asset Management. He spoke with us about some of the new challenges to developing adequate income over a suddenly riskier accumulation timeline, introducing a compelling idea of ‘asset class correlations’ which may provide advisors a framework to monitor and adjust to the conditions of today’s financial realities — taking into account market, inflation and interest rate risks while introducing wholly new alternatives into the equation.

PEK: What concerns retirees the most about generating income in retirement?
LF: Retirees are faced with challenging decisions on how to generate income from assets earmarked to meet spending needs in retirement. Persistently low current yields from what had historically been higher yielding core fixed income asset classes, together with expectations for lower returns from equities than over the past decade or so, suggests that retirees may have to reassess portfolios of the past to protect against running out of money. It’s widely believed within the investment industry that traditional portfolios containing only core fixed income and equities won’t sufficiently support today’s income needs.

In a recent survey of advisors, Northern Trust Asset Management asked what they considered their biggest investment challenge. Many replied that their main concern is generating income for their clients in a low yield environment. They also expect lower overall market returns that will negatively impact asset growth. We also know from a recent survey of 200 people who retired within the past 5 years that retirees are looking for advice on how to draw down assets, preferring flexibility and control of their assets to address the uncertainty of current market environments. Additionally, retirees want the opportunity to grow their assets with the expectation that they might need to be able to withdraw larger amounts later to meet higher costs. In other words, they fear outliving their savings.

These are all important topics that advisors should discuss with their clients in order to optimize retirement income and get them comfortable with their income drawdown decision. We believe this provides a significant opportunity for advisors to engage and educate investors, particularly as most new IRA assets are rolling over from employer-sponsored plans. According to the Investment Company Institute (ICI), mid-2020 saw about six in 10 traditional IRA–owning households indicate that their IRAs contained rollovers from employer-sponsored retirement plans.

PEK: Many investors have relied on a traditional 60/40 portfolio for retirement income.  How does it meet or fall short of investor goals today?
Historically, a traditional 60/40 portfolio, as represented by the MSCI World Equity Index and the Bloomberg US Aggregate Bond Index, provided both strong returns and consistent, reliable income. However, going forward, there is a strong likelihood that the 60/40 portfolio will not provide the returns – and certainly not the income – of days gone by. The 60% comprised of U.S. equities may be especially vulnerable from a return perspective given their decade-long extremely strong run. For instance, Northern Trust’s most recent 5-year return outlook for U.S. equities is 4.3%, which is our lowest forecast in the last six years.

Meanwhile, the “40” fixed-income part of the 60/40 portfolio is at some risk of shorter-term elevated inflation, which would create pressure on returns of an already-low yielding asset class. The current yield on the Bloomberg US Aggregate Bond Index was 2.4% as of 8/31/2021. And Northern Trust’s five-year forecast for the Index is this same low 2.4%, which is among our lowest forecasts for that asset class over the past six years.

Given these returns and forecasts, we expect that a traditional 60/40 portfolio is more than likely to fall short of helping investors reach their retirement income goals.

PEK: Fixed income has long been appealing to investors because of its lower relative risk compared to equities and the diversification that it brings to a portfolio. By moving away from bonds, would the risk level still be appropriate for retirement income strategies?
LF: One of the reasons portfolios have paired traditional bonds and equity over time, aside from the income generation, is to capture the volatility dampening effects of fixed income in the total portfolio. However, with expected low yields and returns from traditional fixed income, investors may need to take more risk in their portfolios to merely keep up with historical 60/40 returns, let alone get ahead. Advisors will have to reengage clients on what they should expect from certain portfolio risk and return levels so that they take the proper steps needed to meet their retirement income goals. This may require an increase in the equity allocation or a reconstruction of the traditional 60/40 altogether, where a more globally diversified approach may help enhance income and improve overall return.

it is important to note that asset classes perform differently in different economic cycles, supporting the case for portfolio diversification, as it can be difficult to predict asset class relationships in future economic cycles based purely on historical behaviors...

PEK: What asset classes in place of bonds should be considered in order to satisfy today’s income needs?
In the current environment of diminishing yield, conventional approaches to portfolio construction will require some retooling. The first step is to revisit the importance of portfolio diversification beyond the traditional components of a 60/40 portfolio. Portfolio allocations should include asset classes that not only seek to provide strong returns over time, but also address market risk, inflation risk and interest rate risk, among other risks.

Furthermore, it is important to note that asset classes perform differently in different economic cycles, supporting the case for portfolio diversification, as it can be difficult to predict asset class relationships in future economic cycles based purely on historical behaviors. In building portfolios to weather various economic cycles, we can begin with asset class correlations, noting that while some evidence of high correlation exists among many risk asset classes, there are asset classes in the risk asset space, like natural resources, global real estate and high yield that exhibit somewhat lower correlation to other risk assets and aid in building a diversified portfolio.

Combined, these asset classes provide capital growth, downside protection, inflation sensitivity and opportunities to produce robust income. It is also worth noting that a globally diversified portfolio includes global equities but only U.S. bonds. The reason for this is that global equity diversification has been shown to reduce volatility vs. just a U.S. equity mandate, while U.S. retirement investors’ cash outlays are denominated in U.S. dollars, so paying for them via yield from U.S. bonds has traditionally been the simplest, most cost-efficient way to effect those transactions. Moreover, international developed market fixed income assets bear a higher duration risk given the lower current real rates in many markets. Additionally, in globally diversified portfolios, we can capture additional fixed income U.S. yield by including high yield, long credit and MBS allocations.

Also, to some extent, after currency conversion, global real asset categories, such as natural resources, global real estate, and global infrastructure offer opportunity for higher yields that are particularly valuable given the current low yield environment of bonds in the Bloomberg US Aggregate Bond Index.

We believe a portfolio that considers the opportunities created by all of these asset classes – high yield, long credit, MBS, real assets — offer “enhanced” income and the chance for future portfolio growth.

PEK: How important is it to consider the impact of inflation on a client’s portfolio?
LF: Based on our most recent Capital Markets Assumptions, which is our 5-year forecast, we believe inflation will persist at low levels over the next 5-year horizon. Despite our “Stuckflation” investment theme, we recognized shorter term inflation spikes during 2021 which can be unnerving for consumers and investors. Higher rent and items like gas and food can quickly be felt in consumers’ pockets and indeed have for the better part of this year. While we believe these short term spikes are temporary and expect inflation to settle back to more normal levels over the long term, we recognize inflation as a risk that portfolios should prepare for over various market cycles.

A more broadly diversified portfolio can help counter short-term inflation spikes while over the long term, a diversified portfolio can help dampen the effects of losing purchasing power, even with low levels of inflation. In order to combat purchasing power erosion caused by inflation, we believe portfolios should incorporate broad exposure to equity based natural resources and Treasury Inflation Protected securities, both of which respond well to inflationary pressures and add diversification to portfolios.

PEK: How can advisors enhance client conversations around retirement income planning?
LF: In our recent survey of worker and retiree attitudes towards retirement, we identified the three most important benefits clients derive from working with an advisor: (1) Confidence in their investments and financial plans (2) protection against too much investment loss and (3) the opportunity to achieve higher returns. The survey also revealed that workers would find it valuable for their advisors to use financial tools in their conversations since they would help in achieving benefits sought. A tool, or vended software, that allows for robust financial planning in a dynamic setting would allow an advisor to work with their clients in real time to adjust portfolios, level set on risk and examine or re-examine retirement expectations.

The survey also revealed workers and retirees to have a high preference for financial advisors to incorporate social security and healthcare cost tools into the conversation. By marrying the output generated by these tools to an appropriate retirement income portfolio, we would expect clients to stay more committed to their retirement income goals.

PEK: Are there ways for advisors to build deeper relationships with their clients and better understand their income goals?
LF: Practice management is always top of mind for advisors and improving relationships with their clients helps build and grow practices. Advisors can build on these relationships by better understanding client pain points and their investment acumen so they can have more appropriate, customized conversations. Foundational conversations around budgeting and spending, diversification, inflation and withdrawal strategies will enhance client engagement. Further trust can be built through additional conversations around the impact of regulations and taxes on their income goals, which then fosters thoughtful conversations around appropriate investment solutions.