The annuity market is booming and for good reason. The economic and market upheavals experienced in 2022 were the perfect crucible for testing past paradigms and received wisdom about retirement planning and portfolio construction.
Clearly not all of them were up to the task. Old chestnuts like “a safe portfolio withdrawal rate is a sufficient retirement income plan,” or “bonds provide ballast to an equity portfolio,” or “advisors always know best what will work for their clients,” were cracked open by the definitive end of the longest bull market in history and the return of an inflation rate not seen since the heydays of disco.
And the test is not over yet. Following are some key takeaways from the year that was and some thoughts about what lies ahead.
Rethinking the 4% Rule & Managing Portfolio Risk
Retirement is more challenging than ever before with people retiring earlier and living longer, and sources of guaranteed income, like pensions, disappearing. This year’s market mess exposed the unnecessary and inherent risk in a 60/40 total return portfolio for retirement income. The market crashes of the past 15 years have shown diverse asset classes moving in unison down. Portfolio diversification no longer provides the measure of risk management it used to.
Unfortunately, clients and advisors were reminded of the significant risk a poor sequence of returns risk poses to retirement portfolios 100% invested in the market. The 30% stock market plunge this spring laid bare the limitations of the 4% Rule, a limited withdrawal guide dating to 1994 that evolved into a widely embraced retirement income strategy during the 13-year bull market.
With the Rule’s creator, Bill Bengen himself, abandoning the market and sheltering in cash during this year’s upheaval, we all were reminded that the 4% Rule was designed to be nothing more than a guide for portfolio withdrawals and not a retirement income plan. Bengen was not alone in abandoning his own guidelines for the 4% Rule as annuities saw historic inflows of an incredible $300B.
The Rise of Commission-Free Annuities
Related to the 4% Rule’s struggles is the growing realization that its reliance on a 60/40 mix of stocks and bonds to fund retirement is wanting. Bond yields have been in a secular decline for years, but their shortcomings in funding income had been masked by capital increases on the equity side from the bull market. That dynamic faded quickly in 2022 and left many advisors and investors looking for alternatives.
The continued expansion of modern, no-load annuities that eliminate the conflict of interest for fee-based advisors, has enabled them to incorporate powerful guaranteed income solutions and risk mitigation strategies in clients’ financial plans. As nearly every leading carrier now provides a range of products for RIAs, advisors now have access to a wide range of options for lifetime income, asset protection, and growth to meet client needs before and during retirement. These new tools give advisors strong solutions for the many clients concerned about the declines throughout their portfolios.
Also importantly, no-load annuity solutions are being integrated into leading wealth management desktop software packages, allowing advisors to seamlessly manage and bill on clients’ annuity assets alongside other investments in the portfolio.
Understanding the Client’s Best Interest
I’ve been working with RIAs for the majority of my career and one of the consistent themes I hear during market downturns is their need to play psychologist for their clients. “Stay the course” is the predominant message advisors try to deliver, but for many (to include Bill Bengen), this advice is difficult to adhere to during difficult times. Perhaps this is because their portfolio is mismatched to their psychological preferences – many clients just aren’t wired to stay calm when watching their savings shrink by 30%.
I’ve long said that if you want to understand what’s in a client’s best interest, ask them.
This year, a new tool became available to help clients articulate their needs and preferences for sourcing retirement income. , The Retirement Income Style Awareness (RISA) Profile was launched by leading retirement researchers Wade Pfau and Alex Murguia earlier this year, giving clients a framework to tell their advisor what they want. Backed by data science, the tool represents a first step in retirement income planning to ensure a client’s income plan aligns with their preferences and is a plan they can stick with over the course of their retirement. It’s a classic “win-win” for the advisor and their client and takes the guesswork out of determining the income solution that is in the best interest of each client.
The Test Continues
I’m not going too far out on a limb here by suggesting that the test that started in 2022 is far from over. The Federal Reserve has made it clear that it is intent on beating inflation into submission and will err on the side of an overly restrictive monetary policy to ensure it succeeds. The risk, of course, is an economic recession and the attendant equity market volatility and return to near zero short-term interest rates that will invariably follow, undoing the recent yield pick-up.
Tests can sometimes be stressful, but they are almost always useful. To the extent they challenge old ways of thinking and old ways of doing things, they can identify shortcomings and make all of us better. For clients and advisors that have already evolved to embrace new and better tools to manage risk and create reliable income, they’ll be prepared. For those that haven’t, it’s not too late to cram.
Here’s to 2023 and ringing in the new.
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