For anyone getting closer to retirement or already retired, portfolio design dominates client-advisor conversations. Today, there's another talking point in the mix: bonds yielding very low rates. With this said, how should someone approach portfolio allocation?
First of all, traditionally speaking, bonds help investors to generate healthy portions of their yearly withdrawals through the yields they produce, while stocks help to add growth components and inflation hedges. With yields so low and the price of bonds so high, investors would have a yield-to-maturity of only a couple of percentage points. What can one do to help generate more yield/income without undue risk?
An idea to consider is looking at index annuities. Roger Ibbotson, who is very well known for his work on asset allocation, did a study from 1926 to 2016 comparing long-term bonds to uncapped index annuities. In this study, his research showed that uncapped index annuities outperformed long-term bonds by about .50 percent. (For more context on this, Google Roger Ibbotson white paper index annuities).
Why is this significant?
Index annuities offer a level of downside protection that bonds do not; and therefore, are considered a safer investment.
Indexed annuities are insurance contracts issued by an insurance company. In issuing these contracts, it gives the owners of the contracts downside protection from market losses while tying the underlying performances to indexes. If structured properly, they can give investors the ability to get moderate returns with low levels of risk. Depending on how the annuities are structured, the internal fees/expense ratio can be minimal or nothing.
Do not confuse this type of annuity with variable annuities. An index annuity performance is tied to an index with the money not being invested in the market but credited based on how the chosen index performs.
Variable annuities are invested in the market and do not give the same level of downside protection that index annuities give. Also, variable annuities typically have high expense ratios with all-in fees coming in at 3 percent or more in some cases.
Please understand that these products are not all built the same; therefore, it is important to discuss this with an advisor who understands them and could help determine the right fit per person. I believe that in a world where interest rates are low, bond prices are high and yield to maturities are at unattractive levels, it is worth discussing this often-overlooked product as a sleeve of retirement used as a bond alternative. Annuities could be an integral part of long-term retirement strategies, providing direction to overcome risks and important optimal benefits to help protect financial futures.
~ Lee Williams offers products and services through Nowlin and Associates. He also offers securities and investment advisory services through Ameritas Investment Corp. (member FINRA/SIPC), which is not affiliated with Nowlin and Associates. Contact him at 334-703-3454.