Articles of Interest

 Guaranteed Income — for Life

 By Jocelyn Black Hodes | DailyWorth 

If you’d retired, or were planning to, around 2008 you probably found yourself in big trouble. When the stock market crashed, many people saw their hard-earned retirement nest eggs lose 35 to 40 percent of their value in what seemed like a blink of the eye. Ouch. For those nearing retirement age, that meant a serious revision of their retirement plan and serious doubts about the 4-percent withdrawal rule

This rule, which was believed to be fail-safe for years, claims that withdrawing 4 percent of your savings during the first year of retirement and increasing that dollar amount by 3 percent in each subsequent year to keep up with inflation would prevent you from running out of money for 30 years. Now, even the seemingly conservative 4-percent withdrawal rule is probably too risky. Is the dream of “guaranteed income for life” just a dream? Maybe not. 

One solution is to work longer, or you can significantly scale back your lifestyle in retirement and make due with less. Another solution? Consider supplementing your retirement savings portfolio with an annuity. Since 2008, more and more financial experts are praising annuities as possibly the best strategy to hedge longevity. (And since women live longer than men, that’s a particular concern for us.) 

An annuity is a contract between you and an insurance company that can provide you with a reliable income stream for a certain period of time in exchange for a lump-sum investment or series of investments.  

There are three main types of annuities: fixed, indexed, and variable. Depending on your timing and income needs, you may choose an immediate annuity, which begins paying income ASAP, or a deferred annuity, which gives you the ability to grow your investment account and income potential.  

In a fixed annuity, you get a guaranteed rate of return based on current interest rates and periodic payments in a fixed amount based on your account value at the time you decide to receive income. These payments can last a certain amount of time, like 20 years, or for life or the lives of you and your spouse. The longer the payments are set to last, the lesser the payment amount will be.  

An indexed annuity gives you the chance of earning a greater return than a fixed annuity typically based on the performance of the S&P 500 Index. However, that greater return is capped and is usually no more than 8%. Indexed annuities also guarantee a minimum contract value, regardless of index performance.  

A variable annuity gives you the option of investing your payments in the market (typically mutual funds) and earning an unlimited return. However, you can also lose money based on how your investments perform, and just as your rate of return varies, your income will as well.  

Annuities often include a death benefit and a variety of other optional features, for added fees. Variable annuities offer “living benefits” that can include protecting your account from losing value, guaranteeing your minimum payment, and allowing large withdrawals without penalty (many annuities come with a “surrender period” during which you would have to pay a penalty fee to withdraw your money). The more features you get in a contract, the more you will pay in fees that will reduce your account performance.  

For someone in retirement or close to it, an immediate annuity could be a smart way to protect yourself from outliving your money and from market risk. Just keep in mind that choosing an immediate annuity means giving up control of your investment, so you need to be prepared to make that sacrifice.  

If you’re at least 10 years away from retirement, a variable annuity could make sense, but only if you are in the small minority of people maxing out all other tax-deferred retirement plans. While annuities in general are complex products and require thorough research and education, variable annuities tend to be the most confusing and fee-heavy.  

Unfortunately, annuities have a history of being sold by agents who are eager to make big commissions and do not explain them as well as they should and disclose all of the restrictions and costs upfront. So make sure you do your homework, shop around, and ask lots of questions!  

Bottom line: In today’s world of disappearing company pensions, questionable Social Security and market volatility, annuities are powerful tools that should be seriously considered as part of anyone’s retirement plan. With the proper due diligence, an annuity can make the dream of guaranteed income for life a reality.  

White Oak Financial Management, Inc. can help find the right annuity for you if you would like to have some guaranteed income in retirement that acts like a pension, or if you want help in forming a complete retirement income plan designed to last your lifetime.  Please call us at 828-274-7844 or contact us at [email protected] to find out how we can help. 


Escaping Failed Asset Allocation

September 3, 2011

Dan Ariely recently went off on the standard practice of constructing an asset allocation based on the expressed risk tolerance of an investor:

We also asked people to tell us how much risk they were willing to take with their money, on a ten-point scale.  For some people we gave a scale that ranges from 100% in cash on the low end of the risk scale and 85% in stocks and 15% in bonds on the high end of the risk scale. For other people we gave a scale that ranges from 100% in bonds on the low end of the risk scale and buying only derivatives on the high end of the risk scale.  And what did we find?  People basically looked at the scale and said to themselves “I am a slightly above the mean risk-taker, so let me mark the scale at 6 or 7.” Or they said to themselves “I am a slightly below the mean risk-taker, so let me mark the scale at 4 or 5.” In essence, people have no idea what their risk attitude is, and if they are given different types of scales they end up reporting their risk attitude to be very different. (my emphasis added)


Source: Stephen Cohen

Anyone involved in this business can attest to the fact that the expressed risk tolerance of the same individual can vary, even dramatically, over time.

 Emotional Investment Cycle

 What can be done to minimize the problems associated with being too bullish at the top and too bearish at the lows?  For starters, it makes zero sense to rely on an investor’s expressed risk tolerance when constructing an asset allocation–as pointed out above by Dan Ariely.  Furthermore, reliance on an investor’s age also presents another set of problems (bonds can also have horrific drawdowns.)  Also popular is the practice of reliance on long-term historical inputs, such as variance, expected return, and correlation, in order to construct the “optimal” portfolio.  We’ve frequently dealt with the fallacies of modern portfolio theory.

What does that leave us with?  Our preferred method of helping clients avoid the problems associated with emotional asset allocation is “the bucket approach” as we discuss in The Upside of Mental Accounting.  Furthermore, I would submit that a core piece of that allocation should be invested in a global tactical asset allocation strategy, driven by relative strength.  Unlike portfolio construction based on expressed risk tolerance, age, or historical modern portfolio theory inputs (all of which are based on things that the market doesn’t necessarily care one bit about), relative strength-driven asset allocation has the benefit of an increased likelihood of performing well in a variety of market environments.  Importantly, relative strength-driven asset allocation will result in market leadership being represented in the portfolio.  This means that the portfolio may have heavy exposure to currencies, precious metals, and fixed income at some parts of the market cycle and heavy exposure to domestic and international equities and real estate at another part of the market cycle (or many other portfolio combinations).  The essential point is that allocation changes will be driven by relative strength, not some other factor.

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