As clients approach/enter retirement, their risk tolerance shifts from higher growth/earning potential to safety/less growth potential. Saving a lifetime of earnings while receiving a meaningful rate of return becomes the most important factor for most, if not all retirees. This week we break down the different growth vehicles and how each fits your client’s needs.
Cash: We have all heard “cash is king” but is that still true? A recent article highlights Warren Buffet's statement made during a recent Berkshire Hathaway annual shareholder meeting: "Inflation has begun to accelerate due to multiple factors including increasing demand and struggles with some areas of the supply chain, as well as just easier comparisons with the pace of a year ago. The core personal consumption expenditures price index, which excludes volatile food and energy prices, rose 1.8% in March, the fastest pace since February 2020. The headline number increased 2.3%, the quickest pace for that measure since 2018."
The pace in which US Government is printing money and the rate at which they are spending is a factor of why inflation is on the rise throughout 2021. Even the White House is anticipating a rise in inflation: "We think the likeliest outlook over the next several months is for inflation to rise modestly…..We will, however, carefully monitor both actual price changes and inflation expectations for any signs of unexpected price pressures that might arise as America leaves the pandemic behind and enters the next economic expansion."
CDs: Traditionally, CDs have been utilized by senior market clients for consistent rates of return. I have found two things to be true: First, if you ask a client with CDs in their portfolio how long they have held their CD, they're not sure and are unable to answer the question. Second, ask them how much it is paying, and again they will not have an answer. Clients that were sold CDs have simply renewed them each year. With CD rates below 1%, you have an opportunity to provide them the same look and feel of a traditional CD, but with significantly higher rates and tax deferral.
Fixed Annuity/Multi-Year Guarantee Annuity: Traditional fixed annuities or “trust-me rates” have been taken over by the MYGA market. The downside to a traditional fixed annuity is the rate is only guaranteed for one year. At the end of the year, the carrier has the right to change rates and in most cases, they do not go up, this is where they get the name of “trust-me rates”. The alternative to fixed annuities and CDs are the MYGAs. Consider a MYGA to have the same look and feel as a traditional CD or fixed annuity, however 1) the rate can never change and is locked in for the duration of the policy and 2) the client receives tax deferral.
Fixed Index Annuity: The FIA straddles the fence for risk versus reward. Clients that are seeking upside earning potential but do not wish to participate in market loss are the ideal candidate for a fixed index annuity. While providing greater earning potential than CDs or MYGAs they fall short of the potential earnings from VAs, mutual funds or stocks. If an index returns 10%, would your client be comfortable earning 7% knowing that if the market were to drop out the following year, they would lose NOTHING. This is where the FIA becomes a meaningful conversation point to retirees. FIAs allow for pre-retirees and retirees to still obtain an meaningful rate of return with risk, straddling the fence of risk vs. reward.
Bonds: For the foreseeable future, the bond market is going to be a challenge. In a flat or rising interest rate environment, many advisors are looking at riskier bond solutions or moving to the ETF market for returns. Bonds have always been utilized for a portion of a fixed income portfolio, however in order to find the same alpha, a muni bond just won't cut it anymore. The data is supporting the movement away from the bond market and we are seeing an uptick in the ETF market space, which we will cover in a moment.
Variable Annuity: A VA is still a great solution for the right client. That being said, we opened this discussion around retirees and pre-retirees and how their risk tolerance has moved from growth to safety. With that in mind, the VA is built for higher growth opportunities, but also takes on downside risk as the client can incur a loss. Typically, VAs are known for higher fees making the hurdle rate harder to achieve. Don't forget the impact of sequence of returns, in addition to distributions and the fees associated with VAs.
Mutual Funds: As I shared in the bond discussion, there has been a large movement to with ETFs. In most cases, I wouldn’t give this much thought, but this is not in today's market. The red flag that goes up around the ETFs is the number of “keyboard investors”. COVID and 2020 brought upon many changes that we had not anticipated. One of these changes was the amount of the workforce that a) was let go from their job or b) were asked to work remotely. Both of these factors increased the number of investors that were self/day trading. This sector of investors lacked the assistance of a financial professional and the guidance that the ETF market is not a short play but a long term play. When an investor catches wind of a market downturn, they will SELL. This will lead to an implosion of the ETF market, as we've seen.
Stocks: What an interesting time to be in the market. Volatility has come screaming back but yet many investors are looking to capture the last big upside swings. I find this interesting as most of us that were in the the financial services in 2008, know all-to-well that the market is overdue for a correction. It's commonly accepted that a correction takes place on average every 3 years, yet has not happened for over a decade. Looking back, the market dramatically fell in just a couple of hours in 2008. With that in mind, investors need to consider if the last-minute upside wins in the market hold a long-term importance? How do you break the news to your clients should a dramatic market fall erode 40% of their nest egg - all because of greed and short-sided actions? Maybe now is the time to position your clients' earnings in products that offer more safety?