by Brian Swerdlow
Many retirement researchers claim that as the economy becomes more chaotic, those with traditional 60/40 portfolios could experience substantially better performance than those who’ve taken on added risk.- Brian Swerdlow
Many retirees and pre-retirees enter 2024 burdened by fears of further monetary instability, inflation, and perhaps even social unrest. Some of these pre-retirees and retirees are so afraid they’ll make the wrong money decisions that they are almost paralyzed. Since they cannot decide which investments they should make or how to balance their portfolios correctly, many who do make critical decisions go headlong into riskier assets in a desperate bid to outpace inflation. Significant numbers of seniors, many of whom are only 2-3 years from retirement, are allowing their worries about running out of money to prompt them to take on more risk.
As a full-service safe money and income advisor, I encourage some of my clients to eschew unproven, untested portfolio designs in favor of a more traditional retirement plan. This type of retirement blueprint typically entails placing 60% of their cash into safe money and market-risk-averse assets such as fixed annuities, bonds, life insurance, or other non-market-correlated products. This structure leaves 40% for riskier assets. It’s highly possible that a portfolio weighted with safe money products could outperform an all-equities portfolio over the next ten years. After all, during past bear markets, risk-averse instruments such as bonds and annuities outperformed stocks and reduced volatility in retirement accounts.
Can annuities protect against inflation?
Annuities are just one of the products I used to help protect client portfolios against inflation risk. Annuities offer several benefits, especially if you’re within a few years of retirement age. Depending on the kind of annuity you purchase, you will not only create an income stream, but you could also guarantee a legacy for loved ones. Some annuities also give you options to help pay for long-term care needs.
An annuity works inside a 60/40 portfolio design by:
- Giving you a reliable and predictable income stream that you can’t outlive
- Shielding against volatility since it is a non-market-correlated asset. Ensuring you have guaranteed protection of your principal. One complaint some financial advisors make against annuities is that they won’t give you 100% of the market’s upside. However, with the right type of annuity, you won’t lose what you’ve gained or invested either.
While much of the marketing you see for retirement-oriented financial products, such as fixed index annuities, focuses on the income side, an annuity can be helpful in other ways as well. For instance, even annuities with level payouts can be structured so they function as hedges against inflation.
Laddering is one popular approach to building an increasing income stream. When you incorporate a laddering strategy, you combine different annuity types to create “income rungs. ” Some laddered plans have second or third rungs containing guaranteed roll-up annuities. A roll-up annuity may increase the odds that your ladder will pace or possibly even exceed inflation.
Laddering, however effective it might be, is a little on the complex side. Building a workable laddering strategy means partnering with an experienced and qualified retirement planner. You and your planner must then devote attention to your plan’s design, execution, and continued maintenance. If you are considering a laddering approach, it’s definitely worthwhile to seek advice from someone who has experience in ladder design and implementation.
Other annuity products exist that take into account the adverse effects of inflation. For instance, you can purchase an annuity with a built-in cost of living adjustment or COLA. COLA-adjusted annuities often use formulas based on a cost of living index. Understand, however, that annuities increasing income can sometimes start out with lower interest rates than level payout annuities. However, they will often outpace the lifetime income amounts of level products, especially if you are retired for many years.
What’s better, a bond or an annuity?
As you probably know, bonds are debt instruments that give a holder regular payouts for a fixed time and a return on the initial investment. Bonds are found in investment portfolios of both pre-retirees and retirees. Just like an annuity, a bond can be used as a method of supplementing other income sources, such as pensions or Social Security. Terms for most bonds run from three months to 30 years or longer.
Bonds can indeed give you a predictable income source. Bonds also generally earn higher yields than annuities. However, unlike annuities, the income you get from bonds is for a finite period. If you need to continue generating cash, you will have to re-invest when the bond matures. Bonds are also less flexible regarding how and when you can take earnings. Although it’s rare, it is possible to lose principal you invest in a bond if, for example, the issuing entity defaults.
Do bonds hedge well against inflation?
During the last two major bear markets, an all-bond portfolio significantly outperformed riskier allocations and had less volatility. Notably, the all-bond portfolio continued to outperform the all-stock portfolio until around 2017. Many experts believe that even assuming rising interest rates and permanent inflation, bonds and similar safe money products will nominally outperform stocks during the next decade.
Conclusion
If you are someone trying to decide how many fixed products you should add to your retirement blueprint, you might want to consider these factors.
- If you purchase bonds and are wrong about the direction of interest rates or inflation, you will still get 100% of your principal back, plus interest, when the bonds mature.
- If I add fixed annuities, I will have guarantees and no loss of principal.
- If I am mistaken about the direction of the stock market, I lose not only capital but the time value of my money.
If you’d like a confidential review of your current retirement plan or if you want to discover more about annuities or other safe money products, contact my office today.
