Fixed Annuities Provide Most Retirement Income When Future Markets Are Down

Life would be much easier for everyone if we had a crystal ball to see into the future.  Since we don’t, we need to be prepared for all possible scenarios in life, especially when it comes to planning for retirement.  Steve Vernon of CBS Moneywatch uses some helpful graphs to help us “Choose the best ways to generate retirement income.”  When you are figuring out how much income you will receive from your retirement savings, the current economic conditions should only be one of many things you look into. 

It’s important to see how your different options for generating retirement income will change based on good market conditions and bad market conditions as well.  So-called scenario planning is a good way to see how your income generator will work in both best and worst case situations, as well as everything in between.

In the first graph, made by Dr. Wade Pfau, six different retirement income strategies are evaluated in a negative economic future. 

The guaranteed income of the different annuity products performed the best when future economic conditions were negative.  Inflation-adjusted annuities provided the highest income after 30 years out of all six strategies researched.  They were followed by the immediate fixed income annuity, which provided the second highest income after 30 years.  Fixed annuities are not affected by market performance, so when markets decline, they certainly pay off as a good investment. 

Using constant systematic withdrawals, equivalent to the 4% rule, proved catastrophic in a negative economic environment.  Retirement income dropped to zero after 20 years and there was nothing left for the remaining 10 years that were studied, not to mention any additional years that you may actually live.

Both graphs use the same scenario to get their results: a 65 year old couple with $100,000 in retirement savings.  The second graph determines how your inflation-adjusted retirement income would change if economic conditions proved to be more favorable in the future than they are today.  In this scenario, you get the most income from strategies that invest your retirement income and pay you a percentage of that.

This makes sense, but are you willing to take the gamble on the markets being favorable right when you decide to retire?  Since the fixed annuities listed don’t change with the markets, they provided the least income of the studied methods when markets were up at retirement.  But their income was consistent in both graphs, something that provides peace of mind during retirement.

Behavioral science has shown that we as humans are more hurt by financial losses than we are pleased with unexpected financial gains.  What this and these graphs show us is that diversifying retirement income strategies may be the best way to protect and provide income in the future.  

Always be prepared with guaranteed income in case the scenario that you hope to happen is not the true life situation.  By assuming the worst and preparing for that with guaranteed income streams, you are protected either way.  If you want to use some of your retirement savings in the markets just in case the scenario is favorable, that could be a good option too.

Weekly Markets Commentary, David Joy, Chief Market Strategist, Ameriprise Financial — October 15

With Days to Go, Investors Still Banking on a Deal

It is now Day 15 of the government shutdown, and just two days away from presumably hitting the debt ceiling. Until we know how this standoff unfolds, it is nearly futile to focus on fundamentals. Government economic reports have been delayed, confidence indices have fallen, and third quarter earnings season and its accompanying guidance is just getting underway.

It is a fair bet that the shutdown will have a discernibly negative impact on fourth quarter economic growth, and on earnings growth as well. The full extent of any damage won't be known until the impasse is resolved.

Beyond the prevailing uncertainty, there are a few interesting aspects of current market behavior that may offer some insight into what investors are really thinking. The first, and most obvious, is that not counting the two day run-up to 1,725 that followed the Fed's no-taper announcement in September, stocks are trading near their all-time high, as measured on the S&P 500. And it is the cyclical groups that are acting the strongest.

Clearly, this is not a market that expects a default to occur.

This same attitude seems to be reflected in the price of gold, which has fallen 3.5 percent since the shutdown began. The VIX index is also lower now than when the shutdown began, although it did spike sharply last week when a deal seemed less likely than it does now. The yield on the ten-year note has risen while the shutdown has been ongoing, from 2.61 to 2.69 percent.

Each of these reactions betrays little concern for the possibility of default affecting investors in the intermediate to longer-term. Defensive positioning can be seen in short-term Treasury securities that would be impacted more severely in the event of a default. For example, the yield on bills maturing on November 7 has climbed sharply from 2 basis points to 25 since the shutdown began. But that is more a function of the calendar and the expected length of a default, should one occur.

So far, there is little evidence that any significant economic damage has been done. Research firm ISI reports that compared to the experience of the 1995 government shutdown, this time there has been a far less pronounced downturn in its proprietary company survey, particularly among capital goods firms. And, after falling at the steepest rate since 2008 last week, the three-day moving average Gallup survey of economic confidence actually rose on Sunday.

So clearly, the overwhelmingly prevailing view is that some kind of a deal to extend the debt ceiling will be reached in time. And that is probably likely. We have become inured to these episodes over time, and have come to expect last-minute resolutions. Reportedly, progress toward a deal is being made, albeit slowly. But we will all breathe a little easier when it is finally in hand.

However, even if a deal is reached, there will remain the lingering issues of fourth quarter growth and earnings, and what impact the shutdown will have on each. There is also the potential chilling effect of any new short-term debt ceiling deadline, if that, in fact, is part of any deal that is struck.

Already, some economists have lowered their fourth quarter growth rates by between 0.5 and 1.0 percent. But so far that has not been the case with earnings expectations. According to The Wall Street Journal, citing numbers from FactSet, aggregate analyst estimates for fourth quarter S&P 500 earnings were lowered just 0.14 percent between September 30 and October 10.