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Retirement Risk Strategy

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In retirement, most people rely on a combination of social security, retirement plans and personal savings income. There are many key concerns of retirees’ about the myriad financial risks related to retirement, at the top of mind for many is the risk of outliving their wealth.

In most cases, investing is not a sure thing — it is more or less like a game – you will never know the outcome of the game until it has been played and a winner has been declared. When you play almost any type of game, you should have a strategy. Investing isn’t any different – you need an investment strategy.

The strategy in investment is basically a plan for investing your money in various types of investments that will help you meet your financial goals in a certain amount of time. Each type of investment contains individual investments that you must choose from. A clothing store sells clothes – but those clothes consist of skirts, dresses, shirts, pants, undergarments, etc.

Stocks, bonds and annuities are all excellent retirement savings vehicles. Depending on an investors’ time horizon and risk tolerance, each has unique advantages. Stocks have the greatest growth potential, bonds provide a level of stability and income, and annuities offer guarantees that neither stocks nor bonds can provide. In the world of investing there are many different investment vehicles and strategies but they can be split into a couple of broad categories.

Retirees who invest their savings in other assets, such as stocks, bonds or funds, can potentially earn higher returns, but run the risk of outliving their wealth. This might occur due to a financial market downturn, poor investment choices or living longer than expected.

Stocks are high risk.  This is because such investments have the potential to return excellent profits but there is also a raised risk of losing your total investment. To do well in stock investing you need to have considerable knowledge of the investment vehicle or vehicles that you are using. You also need to understand the basic principles such as when to collect profits, when to cut losses and how to analyze the market. You also need the emotional strength to apply these strategies as required (this is often the most difficult aspect of active investing).

Bonds have limited earning potential because their long term value is known at the time of purchase. If you’re looking for big rewards on your investment, you’re not likely to hit the jackpot with Bonds. When you invest in Bonds, you do so knowing the maximum payout your investment can generate. With current bond yields low, interest rates lower, and the economic outlook cloudy at best, in this low-rate environment we feel that that the bond portfolio returns are likely to be fairly puny going forward, we’re inclined to expect significantly elevated levels of volatility in the bond market.

Mutual Funds – The sad fact is that the vast majority of mutual funds underperform the average return of the stock market. Some simply pick bad stocks. Others pick stocks fairly well, but not well enough to compensate for the costs of the fund. Remember, fund shareholders have to reduce their returns by whatever costs are imposed by their funds. In addition to fees, there are four other pitfalls mutual fund investors have to watch out for:

  • Dubious management. Given how many funds there are, not everyone can be above average. Many mutual fund managers have proven no better at picking stocks than the average nonprofessional, but charge fees as though they are.
  • No control. Unlike picking your own individual stocks, a mutual fund puts you in the passenger seat of somebody else’s car.
  • Dilution. When mutual funds own too many holdings, even insanely great performance by their best ideas gets watered down when you look at their overall performance.
  • Buried costs. Many mutual funds specialize in burying their costs and in hiring salespeople who do not make those costs clear to their clients.

A key threat to retirement security is longevity risk, the risk of living longer than planned and exhausting one’s assets.  Longevity risk, the risk of living longer than expected, heightens a retirees’ need for lifetime income. This risk is substantial: 23% of couples aged 65 will have at least one member live past 95. The retirees who live the longest face a heightened risk of outliving their wealth.

They can buy lifetime immediate annuities to hedge the risk of living so long that they exhaust their assets during their lifetime.  What makes annuities both unique and significant is that they are the only financial instruments available today that, like Social Security and pensions, can provide a lifetime income regardless of how long a person lives.

Annuities can offer retirees peace of mind as well as a means of boosting their current income. One way clients can accomplish this is to consider making immediate annuities part of a well diversified retirement portfolio. Annuities are the only financial instruments available today that, like social security and pensions, can provide an income for life. thus, annuities can offer clients added peace of mind.

Twenty five years ago, Social Security and defined benefit pensions supplied more than half of retirees’ income, but that number has been shrinking. Retirees are increasingly responsible for generating income from their own assets, and immediate annuities can be a very efficient way to generate a pension-like solution from retirement savings.”

While retirees shouldn’t annuitize all of their assets, income annuities offer unique qualities as an asset class when mixed into a broader portfolio of stocks and bonds.  Putting about 20 to 25 percent of retirement income portfolio into an immediate annuity can dramatically reduce a client’s risk of running out of money.

Annuities can generate more stable lifetime income and greater potential inheritance for heirs at a given risk level when compared with a portfolio comprised of traditional assets.

Investors who incorporate income annuities can realize:

  • Reduced income risk. You can’t run out of money, even if you live well beyond life expectancy.
  • Greater capacity to bear risk in the rest of a portfolio – Because income annuities are not correlated with market swings, they can smooth out overall performance.

A retiree might, for example, allocate 30% of his or her wealth to an annuity, while investing the remaining 70% in other assets. By so doing, he or she can gain the longevity protection and regular income that annuities provide while allocating capital for other purposes such as future liquidity needs or bequests. This possibility is one unappreciated by many individual investors, who too often view immediate annuities in isolation.

An income annuity offers an interesting way to insure that living expenses can be met in retirement. First, estimate total monthly expenses, and subtract expected Social Security and any other guaranteed income source, such as a defined benefit pension. The gap amount is what you could consider filling with an income annuity.

Income annuities will be one of the single most important investment products over the coming decade. Most products can only offer dividends, interest and capital gains, but an annuity has that fourth component, mortality return. The reason for this is simple: someone who purchases a lifetime immediate annuity is exchanging the use of his or her capital after he or she dies for a higher rate of return during his or her lifetime, earning what are known as “mortality credits.” There is no need for the retirees to hold bonds. SPIAS are like super bonds with no maturity dates and which boost retiree returns with mortality credits.     This trade-off may be worthwhile for retirees who need to generate higher retirement income than is available from other lower-risk investments.

The risk is that you die ‘early’ and made a bad deal – but you’re dead, so you don’t care! Those who live on get the extra gravy. Since most people are approaching retirement without enough money, this will be one of the best options for not running out.”

Given the recent economic climate, immediate annuities are becoming a good option for an increasing number of investors. For one thing, fixed immediate annuities are a relatively safe way to take some of your money out of stocks in a volatile marketplace. It used to be that bonds offered a better value than immediate annuities, but now bond rates are low and lots of people are concerned that if interest rates go up, bonds will lose value.

For many retirees, immediate annuities can be a valuable part of a sensible, well-diversified portfolio that provides income for life.  Indeed, in today’s low interest environment, immediate annuities are a uniquely important tool for many retirees.  Under Federal law, annuities can only be issued by life insurance companies. However, it is important to realize that insurance regulation is a matter of state law in the U.S., so annuity products available in one state may not be available in another.

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Tuesday, February 5th, 2013 Wealth Preservation

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