Why ROI is the wrong metric for guaranteed income

Investors are settling into the “next normal” and many are watching for signs of a sustained economic recovery. There are some bright spots. June data from The Conference Board suggests that consumer confidence is on the rise. The stock market was up in July by more than 40% from its March lows. But as new COVID-19 cases emerge across the country, investors can expect that prolonged market volatility is here to stay.

Historically, increased market volatility has prompted a flight to quality in which investors seek out safe, stable places to park their money and generate steady returns. With fixed-income investment yields remaining low and the decade-long bull market still fresh in investors’ minds, your clients are likely wondering where to find safe investments. Perhaps annuities have come up and your clients are unsure about whether locking in guaranteed lifetime income now is right for them or whether it might make sense to wait for interest rates to rise.

If annuities are part of your planning conversations, clients who have been managing their own investing will want to compare guaranteed income to traditional investments and managed accounts. They’ll likely want to understand the potential return on investment if they just invested or purchased an annuity. Here are three reasons why that comparison doesn’t work — and spoiler, most portfolios should include investments and guaranteed lifetime income.

1. AN ALTERNATIVE TO EITHER/OR

When constructing retirement portfolios, advisers often split investments into traditional (e.g., stocks and bonds) and insured (e.g., immediate or deferred income annuities) assets because each plays a different role in achieving clients’ retirement goals and is different in the value it provides.

Traditional assets can generate strong returns that support further portfolio growth but come with volatility and are not guaranteed. Income annuities eliminate longevity risk and help support higher spending by providing guaranteed lifetime income, but do not have the potential to generate returns as stocks and bonds can.

As such, you can help clients see that income annuities should be viewed and considered as what they truly are — insurance products that help eliminate some risks. Comparing them to traditional assets and focusing on rates of return undermines the value they provide and misses the fact that they have additional value aside from asset accumulation.

2. A PORTFOLIO TO MATCH A MINDSET SHIFT

During the accumulation phase, retirement savers are focused on growth. You’ve helped them understand the value of diversification and allocation strategies, and why it’s important to start saving for retirement early so their assets have time to grow. They also understand the cost of their investments against how much those investments have earned over time. It makes sense for savers to want to think about guaranteed income through this same ROI lens. Once retirees reach the decumulation phase, their calculus and their mindset change. Instead of thinking about how much their portfolio will grow, most think about whether they will be able to achieve desired outcomes — in other words, will they generate enough income to continue enjoying a comfortable lifestyle.

This requires a whole new set of equations — with one variable, mortality, that will always be unknown. To account for this, advisers help their clients with income planning, which generally includes identifying clients’ safe withdrawal rate against their desired lifestyle and retirement goals. Because these goals can change and be affected by the unexpected, like a health event (or a global pandemic), it’s a good idea to build in ways to ensure basic expenses in retirement are covered. This is where annuities shine because the income generated ensures that retirees cannot outlive their savings.

Further, our research shows that income annuity owners can spend the rest of their assets more freely and are often able to be more aggressive with other investments because they have the peace of mind that their basic income needs will be met. There are emotional benefits to guaranteed income as well: People get more satisfaction from pension, annuity and Social Security income than they do from other sources of income, according to a 2017 consumer retirement income planning study New York Life conducted.

3. FOCUSING ON GAINS IGNORES WHAT CLIENTS LOSE

Although retirement is becoming longer — lasting 30 years or more for some — most people have been working for longer than they are living in retirement and have become conditioned to focus on saving rather than spending. This can be a challenging shift once a client stops working. We often see people spending only Social Security or pension income and dividends and interest earned on their portfolios. Some even continue to save in retirement.

Retirees can be spending more. In fact, when looking at retired households in America that have between $100,000 and $1 million of nonhousing wealth, we found that these retirees could be spending roughly $350 billion (about 35%) more than they are today. That said, more spending can be dangerous when clients are pulling from accounts that fluctuate with the market, which can subject the portfolio to sequence-of-returns risk.

Because retirees are conditioned to keep accumulating and are afraid to spend what they’ve worked so hard to earn, many are forgoing the kind of retirement they envisioned. Whether that includes travel (when it’s safe to do so), helping a child or grandchild with educational expenses or more dinners out, a singular focus on returns means clients are missing out.

Instead of identifying clients’ guaranteed and steady income sources and encouraging them to adjust their lifestyles to fit within that budget, advisers can help clients determine their basic and discretionary expenditures and create dynamic strategies to fund them.

While it’s tempting for investors to say, “If I invest a certain amount I could make X and if I buy an annuity, I could make Y,” this approach compares apples to oranges and ignores the role that guaranteed income plays in offering peace of mind and the assurance that a retiree cannot outlive their savings. Discussing retirement outcomes, risk tolerance, and income needs with your client will help determine the right balance of investments, annuities — or, likely, a combination of the two.

[More: Managing risk in retirement: Lessons from COVID-19]

Phil Caminiti is a vice president with New York Life Insurance Co. and is registered with an affiliate, NYLIFE Distributors.

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