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Robo advisers can be very practical and efficient for investors. While robos generally are beneficial as they often invest in low-cost funds and ETFs, ideally, they should also include quality single-premium immediate annuities (SPIAs) and deferred-income annuities (DIAs) to simplify investment planning and allow retirees to spend more.
SPIA and DIAs are within the category of guaranteed income products (GIPs), which we refer to in this article. GIPs offer a stream of income payments that begin at a certain age, often at a retirement age of 65 or 70 or later in life, and continue until either death or a predefined period, such as 20 years.
Robos should add GIPs for at least three reasons. Robos are designed to take the burden of figuring out what to invest in away from individuals. They can automate the accumulation of guaranteed income, which makes people happier in retirement. Third, they can choose quality, low-cost products for individuals. Here is more on each of these benefits.
Investing is complicated
Investing can be complicated and time-consuming, but GIPs provide an answer. Most Americans are not financial experts, and even experts don’t know how an investment will perform. Trying to understand the markets and the value of various retirement investments can turn into a full-time job, just as retirees are trying to wind down their careers. Say you are investing with the goal of having $50,000 a year in retirement holdings to cover your expenses. If you plan to put in $1 million, how do you go about reaching your target? A robo could invest a $1 million portfolio into a portfolio of stock and bond mutual funds and ETFs. If we use the 4% rule, individuals could expect to take home $40,000 a year before taxes. Alternatively, if they had bought an annuity earlier in life, they would have higher cash flow on the same investment. Annuity rates are approximately 5.09%-5.27%, which would mean retirees earn $50,900 to $52,700 a year. In a third option for those who want both guaranteed income and to see their investment grow with the market, individuals could split their portfolio so that, for instance, half is in GIPs, and half remains invested in stock and bond mutual funds/ETFs, allowing for upside beyond what the GIPs can offer. In our example, more than $25,000 annually would be guaranteed and the individual could follow the 4% rule on the investment portfolio, which in some years might allow for a higher income than annuitizing the full portfolio.
Retirees are happier with annuities
Research studies show individuals are better off with guaranteed income in their retirement portfolios. Retirees are generally afraid to spend. During their working years, the average investor is worried about saving enough, so they limit their spending. That same investor tends to spend on an as-needed basis in retirement, as they don’t know how long their nest egg will last. Instead of fully enjoying their savings, retirees may avoid vacations or other passions to curtail their spending due to worries about paying for their future healthcare and nursing home costs.
But with GIPs, retirees can enjoy a steady income stream that works better for their lifestyle than a lump-sum retirement account. Retirees with more guaranteed income tend to spend about 14% more than those who rely heavily on nonguaranteed sources of income, like portfolio assets. Retirees with guaranteed income also spend with less stress and can enjoy their savings with greater peace of mind, as they have a regular income for the rest of their lives. People spending more money will be happier than those fearfully holding on to their assets before they die. With GIPs, retirees will be able to enjoy more of their hard-earned savings.
Robos can help
GIPs are difficult for the average investor to compare and access in a convenient way, but robos could bridge that gap.
There is a lack of standardization in how annuity information is presented. The costs and terms associated are often perplexing, which means it is virtually impossible for retail investors to compare annuity options without the aid of a professional or special analytical tool. Additionally, individual investors’ own biases and behaviors present significant challenges when investing in markets. For example, they tend to avoid spending money on information when additional guidance is often highly beneficial.
To make matters more difficult, few employers offer annuity options to their employees – in 2019, fewer than 10% of employer plans offered an annuity option. Without the help of an employer, who would normally provide necessary institutional aid and point investors in the right direction, retail investors face a land mine.
Enter robos. Robos can make obtaining a quality low-cost GIP simple. Financial companies are in a better position to choose appropriate GIPs than individuals, as professional market participants are paid to be informed. Additionally, robos could partner with a company like Blueprint, an annuity marketplace, to automate the contribution and decision-making process based on each individual’s needs.
Conclusion
For investors seeking a low-maintenance retirement planning process, GIPs and robos together can make retirement smoother, simpler, happier, and increase retirees’ sense of security. It is time for robos to fill this need.
Jasmin Sethi is the CEO of Sethi Clarity Advisers (SCA), a boutique consulting firm providing expert regulatory and business strategic advice to companies in the financial services industry. As a Harvard trained lawyer-economist, she is a thought leader on issues pertaining to how the asset management industry and financial regulation impact ordinary individuals, and particularly, freelancers.
Jennifer Luong is a research associate at SCA and a rising junior at Harvard College. She is interested in financial planning for the middle class, impact investing, and social equity at large.
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Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.