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Preretirement Standard of Living – Guaranteed

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Most retirement plan goals are designed around maintaining your preretirement standard of living — already a big challenge.  There are many difficult challenges faced by people every day — growth is uneven, security can sometimes be a dream, and hopes aren’t always fulfilled.

Most people feel more pain from unexpected economic losses than they feel pleasure from unexpected economic gains (a phenomenon behavioral scientists call “loss aversion”). That means that you may want to place more emphasis on the unfavorable scenarios than on the favorable scenarios to make sure your income would be sufficient even during bad economic times.

Some people mistakenly think that once they stop working their only choice is to draw down on their savings until they run out of money. But pre-retirees and retirees can still make changes that can help their savings last longer.  This occurs through the peace of mind you will experience knowing that you’re putting a plan in place to maintain the financial, emotional, and your physical well-being.

Lifetime Guaranteed Income is a major void in many pre-retiree and retiree’s retirement income plans.  People are living longer,  and with life expectancy increasing, retirees should plan on having their savings last another 25 to 30 years, so they need more.  Because rates of returns have fallen, they need a bigger pile.

In retirement, your money needs to continue to grow in order to fund what could be a 30-year retirement. Investments come in all shapes and sizes; stocks, bonds, mutual funds, ETFs, real estate and other alternative investments such as gold or other commodities.  Some of these investment vehicles come with more risk than others.  The key when structuring your investments for retirement is to ensure your investing based on your risk tolerance.

Which approach is best: relying on guaranteed, fixed income like Social Security, counting on the interest and dividends off bonds and stocks, harvesting the hoped for growth in the stock market or guessing correctly a safe withdrawal rate, or using some of your money to buy a guaranteed income annuity?

What does investment risk really mean in retirement?  These days a popular method of income production involves a calculated guess at how much one can safely withdraw monthly from a balanced portfolio of stocks and bonds. The balancing act comes when trying to be consistent and safe, while providing adequate income.

With safe government bonds now producing pitifully small yields, the overall return you can expect from a balanced portfolio of both bonds and stocks has shrunk accordingly.  As a result the 4-per-cent rule should be replaced by a 3-per-cent rule.  Most experts these days say withdrawing about 3 percent annually is about right. Much more and you run the risk of running out of money during retirement.

Stock index funds are performing superbly as the bull charges ahead.  Contributing to the rush into index funds has been the unusually strong performance of Standard & Poor’s 500-stock index recently.  The S&P 500 crossed above the psychological 2,000 line for the first time.

However, let’s look at the actual numbers. The S&P 500 over the last 15 years has yielded an average annual return of only 4.5%.  Add in the effects of inflation and that 4.5% translates to only a 2.2% increase in real purchasing power.  But don’t look for them to protect you when the market stumbles.  Index funds are designed to give you all the upside of bull markets and every bit of the downside of bear markets.

The scale and speed of the rally has raised questions about market valuation and some worry stocks will get hit once the Fed winds down its ‘quantitative easing’ bond-buying program.  In our view, the market is getting close to the top and we would perhaps expect growth for another 12-18 months, but certainly not at the rate we’ve been seeing.

Markets have been able to reach the target in part due to the Federal Reserve’s policy of injecting liquidity into the market through its bond-purchase program to keep interest rates low in recent years. After supplying huge amounts of liquidity to the economy during the Great Recession, the Fed is now cutting back on its purchases of securities, and it is at least beginning to consider when it will start pushing interest rates above the near-zero level where they have been for the past few years.

Social security is more like a government annuity. A certain amount of income over and above what you can count on from Social Security would be nice. So to create additional monthly income that will last as long as either of you are alive, secure a guaranteed income annuity. For a specified lump sum of money, an insurance company will guarantee a specific monthly income amount as long as either spouse lives, even past 100. The upside is that you can never outlive your income.

Insurance can provide two main benefits in retirement. Insurance products such as fixed annuities can be used to turn your lump sum savings into a reliable income stream in retirement for life.  The other important function of insurance is it works to protect the money you do have saved from the high-costs associated with injury, sickness or death.

Lifetime Guaranteed income. The inflation-adjusted annuity, along with an immediate fixed income annuity, provides the highest amount of income at 30 years. The reason is that the amounts of retirement income generated by these two annuities aren’t impacted by investment performance.

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Tuesday, August 26th, 2014 Wealth Management

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