The Cost of Guarantees

Guaranteed income can cost you money when the investment doesn’t even keep pace with inflation.

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The volatility of the stock market sent investors scampering in July, as evidenced by the amount of money pulled from stock mutual funds. The net outflow from stock funds was $31.61 billion in July, according to the Investment Company Institute. August numbers are not available yet but are estimated to top $54 billion.

Where is all this money going? Money market rates are well under 1%. The ten-year treasury is just barely over 2%. The latest rate of inflation showed the consumer price index (CPI) annualized at 3.6% which makes the real return for both of these “safe” investments negative.

The insurance industry is capitalizing on this situation by offering to take on the risk for investors by offering guaranteed income for life. The pitch makes the argument that at least part of your retirement income should be guaranteed. Considering the poor return in stocks over the past three years this would seem to make a lot of sense. Unfortunately, this is very short-sighted. Life expectancy for a couple retiring today at age 65 is close to 30 years. What is the cost of this guaranteed income over a thirty year life expectancy?

David Loeper with Wealthcare Capital Management did an excellent study on the cost of guaranteed income in his article “How Much Is That Guarantee in the Window?” The article explores the case of an annuity with a 5% guaranteed withdrawal rate which is a very popular feature being offered today. Mr. Loeper compares the return on $100,000 invested in the annuity to the return of the same investment in a balanced portfolio of 60% stocks and 40% bonds. The study covered 637 thirty year periods going back to 1926 where the investor takes a 5% withdrawal annually. In all of the possible time periods, the balanced portfolio always ended with more money than the annuity. There was even a 50% chance the balanced portfolio would return $441,896 more!

Don’t let fear drive you to making a poor long-term decision based on short-term volatility. Maintain your balanced portfolio.

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Rodgers & Associates answers questions like these every day.

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