Why You Should Put the Least Amount of Money into Fixed Annuities

I bet you don’t hear it often, but if you’re going to use fixed index annuities (FIA’s) as part of your investment portfolio, you may want to make sure you put the least amount in to get the job done.  This way the bulk of your money can be positioned into long-term growth.  Most investment advisors like myself that have also been in the business for decades know the importance of growing money, not just for the first ten years after retirement, but maybe 20, 30, 40 years.  I have plenty of clients that started in their 60s and are now in their 90s.  Your retirement might be 20 to 40 years long.  So your investments still have to be in a position for/of growth.

Ibbotson studies have shown fixed index annuities have outperformed bonds, especially in the last 7 to 10 years. Furthermore, equities outperform both bonds and fixed index annuities.   If you’re going to be retired, chances are you’re going to rely heavily on your retirement portfolio.  So you can find the full Ibbotson report here.

Magic Number

If you retired today, chances are you have hit your magic number.  And no, your magic number is not your lottery number.  I have found that most retirees work their whole lives to accumulate a certain value in their investment portfolios, and they think they're going to need that for retirement.  So let’s just say its $1 million. As an example, you have a husband and wife working, and you get to $1 million, and you say, “That’s it, we’re done, we are out of here, and we’re going to retire.”  Now, very rarely do I see people in their 60s say, “Well, I need to have $1 million, but I think I’ll wait until I have $3 million.”  Most retirees don’t want to work into their 70s or 80s.  What they want is they want enough money to have a decent retirement.

So yes, $1 million is a lot of money, but if most of your money is in IRAs or qualified plans, well, you’re going to lose 15 to 25% when you take it out.  Now, if you think about that – if you have $1 million and some of that is taxes, and you may be retired for 30, 40 years, that’s not a lot of money.  But you’ve decided that you and your spouse, it’s time to enjoy life, and you decide to retire.  You look at your finances; you look at your income, you figure it’s going to take $80,000 to $90,000 to live on.  You got Social Security and some pension income that’s going to give you about $40,000, $45,000.  So you're going to have to take about $40,000, $45,000 out of this $1 million portfolio.

So once again, like in your accumulation phase, you're back in the position of growing money.  And again, as the above Ibbotson studies show, equities have historically done double what bonds do and not quite double what fixed index annuities have done over a long period.  Equities may giveyou the most bang for your buck, but most retirees can't go all in because of the volatility. So instead, they choose an allocation to dampen the volatility.  Unfortunately, bonds and CD rates are still pretty low, and that puts annuities into play. Obviously, if interest rates were better like 5 or 6% on CD’s, that would be the better option.

Let's Talk Allocation

As an example, let’s say you're the above-stated couple.  You need about 4- 4.5%.  You would gauge yourself as very conservative.  You're nervous about the markets, and you're nervous about retirement.  So you probably should have an allocation maybe 5 or 10% in cash or shortterm bonds.  That should provide you money to live off next four years.  Maybe have 20% into fixed index annuities just because of the higher historical return of cash or bonds and the guarantees.  Remember the guarantee of the fixed index annuity is not losing 20 -40% and then 50% in the next bear market.  You have upside potential that’s capped, but that’s alright.  You're giving up downside potential to have limited upside potential.  So this is still going to leave you 60 - 70% that you're going to need to employ in long-term growth. So what’s the problem?

The Bear Market is the Problem

You will find investing during retirement is much different than you were investing during your employment years.  In my experience, your success in retirement is going to be determined by how much of your total portfolio you’ve allocated to equities, what allocation of asset classes you're using, and even more importantly, what is the investing strategy that’s being employed today. Let’s say you only need to withdrawal 1 -2% per year instead of the 4 or 5% like the above couple. Now, if you have the same $1 million and maybe one of you have a good pension income, but you can actually invest more conservative. Well, it’s kind of counterintuitive, but because you have more, you can take less risk, but it doesn’t mean you have to.

If you’re the type of couple that wants to enjoy life more, you're willing to accept more muted returns; maybe you should only have 30 or 40% into the markets.  You could allocate maybe 10 to 20% into short-term bonds or CDs, maybe 30% into fixed index annuities, and maybe the rest into equities.  You’re going to need to have a percentage of this in long-term growth.  I would use short-term fixed index annuities with maturities of five to seven years.  Once again, I would recommend spending your cash and your short-term bonds first.  The next bucket to access just may be the annuity bucket.

The real key is to have a plan. Very few people have come into my office, or I’ve talked to on the phone that has a distribution income plan from their portfolio. Every investor is different.  I’ve found that is not only every investor different, but every investor is different during bull markets and bear markets.  Years ago, people used to tell me that they were long-term buyand-hold investors. Well, a couple of bear market beat down changes the fearless investor into a conservative investor. So one strategy can be to put the least amount of money into annuities that you can to get the job done.

You don’t want to do any more than you have to. If you’re concerned that your allocation is wrong, you're concerned that there’s no distribution plan, you’re wondering can annuities help you, and you're concerned that you seem to have an investment plan that’s not keeping up with market returns.

Is your current annuity not performing? You know, the market has been giving double-digit returns for years. However, you’re not seeing it. Are you confused about your income options? Do you have an income rider that you don’t understand? Are you an annuity orphan? Well, maybe I can help. I certainly would be glad to. You don’t even have to come to the office, just shoot me an email or give me a phone call. I will either contact you directly or respond to your email. If you want to set up a time to talk to me on the phone, give my office a call.

Sincerely,

John Romano, CFP®