Income is the Wrong Goal for Your Clients
One of the biggest threats clients face in retirement is chasing higher investment income. I’ve seen people go back to work because they concentrated on income and lost their principal. Income is the wrong goal, particularly since much of so-called income is just a ruse allowed by regulators.
Don’t get me wrong, I certainly understand the desire for income. Our clients are savers who have spent their entire lives squirreling away a part of their income to build a nest egg. The thought of spending it down is terrifying to savers, even though clients understand they can’t take the money with them after they pass.
I’ll address two mistakes: income illusions and income that risks principal. Then I’ll propose a better strategy for our clients.
Income that isn’t
It’s illegal to sell something for even a trivial price claiming it will extend your life expectancy if there is no data to support the claim. Yet, it’s completely legal to take people’s life savings and trick them into thinking the return of their own money is income. Here are a couple examples of trickery:
- Individual muni bonds. The most common and, in my opinion, egregious trickery comes in the muni-bond market. I’ve examined well over a hundred client statements that appeared to show handsome income from owning individual muni bonds. The trick goes like this – the broker buys an AA-rated muni bond at $110 that pays a $5 coupon or yields 4.45% ($5 / $110). That’s so much better than a muni bond fund such as the Vanguard Intermediate-Term Tax-Exempt Bond Fund (VWIUX) yielding 2.60% as of September 21, 2018.
The trick is that the bond is going to mature or be called in four years at $100 par so, over that period, $10 of that income proudly displayed on their brokerage statement is just return of their principal. Thus, in simple terms, half of that $5 coupon is return of their own money and the actual yield is closer to 2.23% before the broker charges 0.50% to “manage” the bond portfolio. I’ve had several conversations with the regulator, MSRB, on why this is allowed and its executive director, Lynnette Kelly disagrees with me that this is trickery. Of course the MSRB is a self-regulatory agency and this trickery benefits the industry.
- Single-premium immediate annuities (SPIAS). Why buy a CD yielding 3% when a SPIA yields 6% income, depending on the client’s age? Fork over $100,000 into a SPIA and that $6,000 income is attractive and guaranteed for life. The problem here is simple to explain – at a 6% payout, the client must live 16 years and 8 months (1/.06) just to get their principal back. It’s like buying a bond with a duration of the rest of the client’s life at a time when interest rates are near an all-time low. So that “guaranteed income for life” not only isn’t income, it guarantees the client will have maximum exposure to inflation risk. Sadly, a SPIA is the least ugly of annuities – guaranteed returns from variable annuities are far worse since the return comes in the form of an annuitization later on, at below-market rates rather than cash.