While many retirees and soon to be retirees continue to rank their #1 fear as outliving their money, very few financial advisors and money managers know how to address this fear head on. Creating retirement income used to be simple and straightforward by using a balanced portfolio of stocks and bonds (often called a 60/40 portfolio) and only withdrawing a reasonable 4% per year to supplement your social security or pension. Unfortunately, what was once investment gospel is now investment lore as the 60/40 strategy and 4% rule have proven to be ineffective and even dangerous.
A recent study conducted by
Fidelity and Vanguard have recently stepped into the ring with the current heavyweight champions (insurance companies) to solve this problem with the creation of "payout funds" or "income replacement funds." Tragically these well meaning funds have failed to arouse significant interest and in Vanguards case have ended up merging all their funds into a single fund, which in the industry is the kiss of death. Tamiko Toland, managing director of the mutual fund research and consulting firm Strategic Insight summed it up well:
There is no guarantee in the design of those things, and that's just how they work...these funds were always vulnerable to significant drawdown events and it just so happened that 2008 came around the corner not long after these funds incepted. I always felt that they were a useful niche product but no replacement for solutions that offered more of an income guarantee.
Many pros consequently turn to annuities for that much needed income guarantee, but only for a portion of your overall income needs. So, with mutual funds out of the picture as a viable choice for predictable retirement income where do you turn? The answer as it turns out isn't so simple. The most difficult financial decision of your life is how to take your accumulated life savings and create a "personal pension" that you cannot outlive. It's a totally different way of looking at your money, the focus goes from how to accumulate more to how do I de-accumulate and take income. The best place to start is with some age old wisdom that still holds true today: diversification.
Diversification is THE secret to creating a long-lasting "personal pension" in retirement. By combining the pros and cons of a variety of investments it's possible to achieve more than a 4% income yield in retirement. Here's a simple recipe to follow for someone who's 55 years old, but keep in mind that there isn't a perfect investment, everything has a pro, con, and "string attached," it's how you blend these tradeoffs to achieve harmony in your income plan:
1. Growth: 45% Allocation - Traditional managed high dividend stock portfolios, sector-specific bonds, and diverse ETFs can still play an important role in your income strategy. Master Limited Partnership ETFs like Alerian MLP (AMLP), iShares Preferred Stock ETF (PFF), Powershares Senior Floating Rate Debt (BKLN), and Peritus High-Yield Bond (HYLD) are good examples of how to play income and potential growth.
2. Insulation: 20% Allocation - Opportunistic REITs and Secured Floating Income investments offer very little market correlation, inflation protection, and high dividend yields generally in the 5-7% range. There are 2 varieties of these alternative investments, public and private. The public variety are liquid and easily bought and sold, but they come with more correlated market risk which hampers diversification. The private variety are generally ill-liquid, but have no market correlation which helps during volatile markets.
3. Protection: 35% Allocation - Annuities, specifically the lower-cost fixed/hybrid variety are the only vehicles that offer principal protection and the certainty of guaranteed income. Look for A rated companies with an above average solvency ratio (a measurement of how easily the company can pay claims). When comparing fixed/hybrid annuities the most important factor is how much cash-flow they can generate at a specified age. Some experts like to "ladder" annuities by spreading funds among 2 or 3 accounts with varying maturity dates with the goal of creating a higher yield.
Rob Russell offers advisory services through Centum Capital Advisors, LLC, an independent RIA.
