Portfolio volatility and the sequence in which returns are realized play a unique role in portfolios subject to regular retirement withdrawals. Specifically, volatility affects a portfolio with systematic withdrawals much more negatively than portfolios with systematic contributions. Moreover, negative re-turns early in a withdrawal program can create disastrous initial conditions from which recovery is nearly impossible.

Financial advisers can use annuities and other techniques to manage this risk. Consider a client who in December 1999 was looking forward to working on his golf game and traveling during his retirement. Following conservative advice from his adviser, the client figured he could safely draw $40,000 a year from his $1 million nest egg to supplement his Social Security income and allow for inflation-adjusted increases for the next 30 years or so. Being entirely invested in broadly diversified equities, the client was more than a little disappointed that after only three years, his inflation-adjusted withdrawals and the market’s ensuing poor performance had eroded his portfolio to less than $538,000. By that time, his withdrawals represented almost 8% of his dwindling portfolio value — a rate that is hardly sustainable. Strong positive returns over the next five years improved matters modestly. But by the end of last year, the client’s portfolio had grown only to about $670,000, by which time withdrawals were still 7.3% of the portfolio.  Although the client in this scenario is fictitious, his predicament is real. ALLOCATION SHIFTAvoiding severe initial negative returns is critical to sustaining withdrawals over long periods. A simple approach to managing this risk is to shift to a more conservative asset allocation as retirement approaches and during those early retirement years. Advisers can return to a more aggressive posture afterward. Contrary to conventional wisdom, retirees can often accept more risk as they age, because the horizon over which withdrawals must be sustained shortens. A related strategy is constructing a laddered portfolio that earmarks specific assets for particular withdrawal years. For example, cash can be used to fund the first three to five years of withdrawals, and intermediate bonds for the next three to five years. The equity portion of the portfolio can be reserved for withdrawals that begin at a later date. The equity portion then has a chance to recover from an early bear market, if it occurs, without being crippled by withdrawals. Like the asset allocation strategy, equity will tend to grow proportionately as the cash and bonds are liquidated early on.  However, these strategies don’t effectively address longevity risk as do fixed annuities. Including a deferred annuity in the ladder strategy provides a fixed stream of income after a certain point in time — say, 20 years — significantly reducing the amount of precautionary savings necessary to sustain withdrawals over a conservatively long-term horizon. An article in the January/February issue of Financial Analysts Journal shows that deferred annuities are much less expensive than immediate annuities and efficiently transfer longevity risk to insurance companies that can better diversify it. Variable annuities can also manage the problem effectively. Guaranteed-minimum-income benefit riders, for example, give the annuitant the ability to annuitize a guaranteed amount of principal at a specified rate at some future date. If the underlying portfolio suffers from negative returns in early retirement years, the annuitant can still choose to receive a stream of fixed income. This kind of VA protection is like a put option on an equity portfolio and typically costs 0.5 to 0.8 percentage points in extra management fees each year. Unlike a standard put option, its cost is uncertain and spread out over a number of years rather than set at a fixed price today — an arrangement that obscures the price. Equity-linked annuities provide similar protection. Most of the annuity premium is invested in a fixed annuity. The remainder is invested in a series of equity index call options. Like a variable annuity with a guaranteed-minimum-income rider, they are designed to provide potential upside return in exchange for a slightly reduced fixed income. Investors can construct similar results themselves by combining a diversified equity portfolio with an index long-term equity anticipation security put option or by combining a fixed annuity with a Leaps call option. With expirations up to three years, Leaps can protect investors during the critical early years of retirement. This do-it-yourself strategy is often far less costly. Cost is vital. The protections offered by a variable annuity can be eliminated if the cost of acquiring them is too high. As part of their due diligence, advisers need to understand and communicate the material nature of the products they sell and know whether similar products with lower costs, risk or complexity are available in the marketplace. 

When it comes to human behavior, there is a long list of things that never seem to change. Among the top 10 is our deep reluctance to admit that we sometimes need help. The crazy thing about it is that this reluctance only comes into play when it concerns the areas of our lives that are most important. A Sunday afternoon duffer will move heaven and earth to get tips from some “Tiger Woods Wanna Be” on how to shave a few strokes off his game. Yet the same man often must be dragged kicking and screaming to the doctor for a check up. Quite likely he would be equally reluctant to seek professional help if he is unsure about how to handle his retirement savings, i.e., about how to create an income stream that will last throughout his retirement years.

 If you have questions (and most retirees do) about finding reliable help in this area, then read on.

In my experience as a financial advisor I have run into all kinds of investors. Some like a more conservative approach, some more aggressive, some only invest when there’s a full moon and the stars are aligned with Venus. Thus I have grown to understand that there is no one way to pick a financial advisor or one investment plan that will fit all types of investor personalities.

 Advisors come in many different shapes and sizes and carry different titles and educational backgrounds. I have in my carrier come across everyone one of them and believe me there are good and bad everywhere.

First, decide exactly what kind of advice you are seeking.  Perhaps all you want is someone who can give you an educated second opinion on a recent investment decision. If, however, you are looking for a firm or individual to provide you with on-going, long term investment advice to help you achieve your financial goals, you will need to do some real research. This decision is too important to be treated lightly. Your aunt’s sister’s brother-in-law may have worked for Merrill Lynch for 30 years, but that doesn’t make him an expert on what you need to ensure your financial future.

Get detailed information on background, qualifications, and efforts to keep abreast of changes and developments in the field. Ask as many questions as you feel are necessary. The best planners and money managers welcome questions, as a sign of your knowledge and willingness to work closely with them. Don’t forget to ask about certifications for those who will be working directly with you.

Pay particular attention to the level of experience of the person or firm. Ask how long the planner has been in practice. Ask about experience in retirement planning, the number and types of firms with which he has been associated, and how that experience relates to his or her current practice. Ask about the planner’s experience (or the experience of the firm) in dealing with retirees and other clients whose financial situation is similar to yours. 

 There is no substitute for experience when it comes to the financial markets. When finding an advisor to assist you, it’s best to pick someone who’s been around the block a few times.

Most retirees or those about to enter retirement have at least one (if not all) of the following concerns:

1. Protecting their savings
2. Creating and protecting their retirement income stream, and
3. Protecting their heirs.

 Roll these concerns all up together and we see that the underlying issue is risk management. Invested properly, annuities can be a significant anecdote to these problems, especially for retirees.  An annuity is an investment designed for retirement. It is a written contract between you and an insurance company. The contract allows you to potentially accumulate funds and then provide lifetime income payments.

 Fixed, Immediate, or Variable: Which Annuity is right for you?

 There are two main categories of annuities immediate and deferred. Within each of these there are two sub-categories, fixed and variable.  

Fixed Annuity:

 With a fixed annuity, you invest your capital with an insurance company which promises to pay you interest and return your capital at an agreed upon future date.  Just like a bond or C.D.  

The safety has to do with the rating of the insurance company, once again, much like a bond, make sure the insurance company you are using is rated ”AA” or higher. Rule of thumb: Invest in the best. After all, we are choosing this investment option for the safety. Do not compromise of this issue.

Fixed annuities, like all annuities offer the advantage of tax-deferral. You will be required to pay taxes on profits when you withdrawal the money at ordinary income tax rates. If you choose to reinvest, current tax will not be owed. This must be considered when comparing the rates on fixed annuities as compared to other fixed income investments. And that’s exactly how you should approach this investment choice. Shop and compare before you buy!

Know also that the choices of rates and maturities vary from company to company. Consulting a financial advisor before making your final decision is, as always, prudent since they should have access to many insurance providers and that will make it easy to quickly compare current rates.

Immediate Annuities

This type of annuity is a fairly straight forward investment choice. You turn over a certain amount of your money to an insurance company which in return agrees to pay you a certain amount of money for a specified period of time or the rest of your life.

Once you invest in an immediate annuity, the insurance company keeps your principal. It is not returned to you at any time. You give up the rights to your money in turn for an income stream. It is not given to your heirs either.

So when investing in an immediate annuity, be sure to live a very long time. It will drive the insurance company crazy! Knowing when you will die is the only true way to know if this choice is right for you.

The immediate annuity rate an insurance company quotes you fluctuates from week to week, just like the rates on a C.D. One week an investment in an immediate annuity may net you $1000 per month, and the next week $950. So the direction of interest rates will affect the timing of when you should purchase an immediate annuity. Once you buy it the rate is set for life so you may not want to invest your capital all at once. Spread your purchases out a bit especially when rates on moving higher. 

Immediate annuities are becoming more popular as retirees look to supplement other sources of income like social security and pensions. They want to know that check is coming in month after month, year after year no matter what.

Variable Annuities:

In the first two examples, the investor knew ahead of time, at a minimum, what the return and income stream would be. When investing in a variable annuity, the return is variable and unknown.

When you purchase a variable annuity contract, your money is invested into sub-accounts. These sub-accounts are like mutual funds. They are professionally managed and invest in stocks, bonds and a wide variety of other market sectors. .

You may choose the sub account(s) you prefer just as you may choose a mutual fund. If they do well you will have more money in the pot, if they don’t you will have less.

The variable annuity does offer a guaranteed income payment based on your initial investment but the goal with a variable annuity is to grow you capital to a higher level which, at some point you can turn into a larger income stream.

The primary difference between a variable annuity and a mutual fund, aside form the tax deferral advantage of the annuity, is that you can also purchase guarantees, called riders, to protect yourself against potential declines in you annuities value. There are, however, many different types of riders. Consider them carefully before making a purchase as each adds an additional cost along with the benefit. For more information on riders, visit www.livelongliverich.com.

Surprisingly few new retirees or pre-retirees have a plan for the allocation of their portfolio assets. However, if your portfolio is to be a source of financial security during your retirement years, then it must be carefully tended, like a garden, so that it continues to grow. Apart from the obvious benefit of additional resources during your retirement years, there are a number of factors that reinforce the necessity for continued portfolio growth.

• Inflation erodes assets, which could make it necessary for you to lower your standard of living, not a happy thought.
• You might be forced to make withdrawals at a percentage rate that is higher than your portfolio is actually earning. This substantially shortens the life of your portfolio. Remember, your goal is to make your assets last as long as you do, or longer.
• With medical science now making it possible for us to live longer, maintaining steady growth in your portfolio’s assets takes on a completely new level of importance.
• Finally, a weakened portfolio necessarily limits what you can pass onto your heirs.

In the event that your retirement income alone will not cover your post retirement expenses, ideally the earnings from your portfolio will make up the difference. Even if you are one of those who have saved enough so that you will not have to work after you retire, your portfolio will require regular attention if it is to help support the lifestyle you wish to enjoy during retirement.

Asset allocation is part of the general retirement planning process, the goal of which is to determine the optimal allocation prior to the selection of individual assets or classes of assets. Put a different way, asset allocation establishes your portfolio policy. Your funds are invested in various types of assets thus allowing you to achieve your financial goals and take advantage of risk reduction through optimal portfolio diversification.

The three basic types of asset classes are stocks, bonds and cash. The percentage of each asset class in your portfolio depends on a number of variables, including but not limited to your financial goals, current savings and investment plan, time horizon and risk tolerance. Bear in mind that over 90 percent of the performance of your portfolio is predicated on how the assets are allocated.

To reduce risk (and maximize return), select asset classes that compliment each other. Bearing in mind, once again, that you are likely to live twenty-five to thirty years into retirement., keep at least a portion of your assets in equities for the long term.New retirees (or those retiring soon) are often tempted to switch their portfolios into a very conservative mix. Although such a mix may protect your portfolio from a decline, it also limits growth potential. If during your working years you maintained a balanced combination of stocks, bonds, and short-term investments, and if you have made periodic adjustments as needed to maintain the right mix of growth, income, and stability, you may not need to make changes in your portfolio when you retire. As you get further into retirement, however, you will need to consider shifting to a more conservative mix.Asset allocation is the single most important step in making your retirement years the golden years you thought they would be. It is better to spend your time to get this step right instead of worrying about the individual investment themselves. 

What are wealth managers saying to clients who are invested in some areas that are no longer so safe?

Here’s what H Craig Rappaport, author of “Live Long, Live Rich — Creating Your Retirement Paycheck,” writes:

If something has materially changed regarding the risk and the expectations for the investment, then a decision needs to be made whether or not the risks are still in line with the reward and the clients risk profile. All too often it is the advisor that is afraid to call or too stubborn to admit they are wrong that causes the larger financial losses. Especially when it comes to retirees, advisors need to make sure that the reward warrants the risk for this vulnerable set of investors.

It is ego that often leads to disaster. If you ask the investors, most have not called their advisors and asked them to be heros.

In fact, 61% of American workers are “at risk’ of not being able to maintain their current standard of living after they retire, noted research from the Center for Retirement Research of Boston. The cause of the dip in living standards was the cost of health care. Even if employees remain working until 65, fully 44% will not be able to maintain their desired standard of living. American retirees are considered to be at-risk if their combined savings along with Social Security and pension benefits tumble at least 10% short of the income needed to sustain the same standard of living they earned during their working years. The risk was greatest for generation Xers born between 1965 and 1974 with 48% in danger of not keeping up with standards of living post retirement, according to the report

H. Craig Rappaport, author of “Live Long, Live Rich: Creating Your Retirement Paycheck,” writes:

We are in a recession psychologically; the data just hasn’t confirmed it economically. It will. The average market selloff prior to a recession is close to 15%. As soon as the data, the GDP, turns negative, which appears to be coming in the first quarter, equity markets tend to turn higher anticipating a recovery. Markets generally rise about 10% in this period and another 8% after the recession ends.

Investors should be focused on those sectors that tend to do well exiting a recession: consumer cyclical, basic industry, technology and capital goods. Financials also do very well but there is concern whether they will participate.

The vast amount of wealth that many predicted would be transferred between the “greatest generation” and the baby boomers is looking to be a bust.

The much-ballyhooed $17 trillion that is supposed to change hands over the next 20 years may be far less, because of longer life expectancies, increased medical costs and estate taxes.

“The World War II generation wealth transfer has been less impressive than many predicted and it likely will not grow much further,” a new Consumer Wealth research report by Tiburon Strategic Advisors says.

“The median value of a baby boomer’s inheritance is $48,000; very few have received more than $100,000. Specifically, only 2% of those baby boomers who received an inheritance received more than $100,000. Furthermore, the coming wealth transfer faces several limiting factors, including immediate spending, longer time in retirement, health-care costs, taxes and wealth concentration.”

These factors are creating savings anxieties from baby boomers.

Baby boomers are continually worrying about amassing enough money for retirement and how to make a limited pool of savings last for a lifetime, Tiburon reports, adding that “some seniors now fear outliving their money more than death itself.”

Income, savings, taxes, expenses and expectations aren’t adding up to Golden Years for all that many people.

Consumers with investable assets of $100,000 and below control only $3 trillion of total investable assets. On the other end of the spectrum, consumers with $5 million and above in investable assets control $7 trillion of total investable assets. The largest chunk of investable assets is consumer households with investable assets between $100,000 and $5 million, controlling $12 trillion of total investable assets, according to Tiburon’s report.

But when you spread the wealth like that, you find that the minority of households controls the most amount of money. That means the majority’s share of capital assets is far, far less on an individual basis.

Take income. Consumer households’ net income peaks between the ages of 45 and 54. Consumers under the age of 25 and over the age of 65 earn an average of approximately $25,000 annually. Between the ages of 35 and 44, “the period where most people have decided upon a career and begin to build it,” Tiburon notes, the average household earns $55,000.

“Understandably, the average income of those between the ages of 45 and 54 is considerably higher, as people are at the peak of their productivity and experience,” it says. Households in this age group earn an average of $62,000, according to the report.

Sixty grand annually is still not enough over that short period of time to create a big enough retirement kitty. Add to that the fact that consumer household personal savings have decreased 140% since 2004 — to negative $82 billion — and you find people scratching their heads over what to do about retirement income.

Misplaced Hopes

Many people expect to get pensions but, curiously, don’t have them.

“Consumers are counting on income from pensions but won’t receive it; 62% of consumers expect to receive pensions when they retire, however only 41% say they or their spouses are currently covered by a pension,” Tiburon says. “This provides a very strange and worrisome gap because it presents a 21% gap which represents people that are counting on a pension, but do not believe they or their spouses have one.”

There is, of course, Social Security, but that isn’t enough for most people to live at even their current standard. And if Social Security gets privatized, who knows how much it will bring or how it may be spent.

One thing is for sure: the rich don’t have to worry: They still, as noted, control 90% of the assets in this country. But divide the rest of the pie up and factor in dilution and you aren’t left with much for the average income earner.

Indeed, that’s worrisome.