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Friday September 8, 2017

Annuities, Bonds, and Bad Advice

Recently I was working with a client on analyzing and reallocating his IRA investment portfolio. The portfolio was substantial (over $3M) and was 40% Equities, 40% Bond, and 20% Cash. I really liked this allocation for someone his age (70) and told him that the only real improvements would be using a responsive, tactical investment management platform and to improve his Bond Allocation. The fees on the products and funds he held were already low at an average cost of 1.14%.

In assessing the Bond Allocation, using Morningstar’s X-ray Analysis, we found that over half the total was held in High-Yield or junk bonds. While there is nothing inherently wrong with holding a portion of one’s Fixed Income allocation in High Yield Bonds as a means of diversification and improving the overall yield, a 60% allocation seemed a bit high. Moreover, the total yield on his Fixed Income/Bond allocation was only 3.4%.

I came back to this client with the suggestion of replacing his Fixed Income/Bond Allocation with a combination of Fixed Index Annuities. The criteria I used for my recommendations were that any fees associated with these FIA’s should be comparable to his current annual cost of the Bond Allocation, which was .96%., that any annuity carriers we considered should have a credit rating of A+ or better, and that we could reasonably expect to exceed the current yield of his Bond Portfolio.

Many leading advisors (myself included) view a fixed indexed annuity (FIA) as another fixed income asset and allocate them accordingly:
• An alternative to low yielding bond allocations.
• Allows the investment professional to be as “active” as necessary in other areas of
the wealth management process.
• Provides a range of interest crediting methods with both capped and uncapped
strategies managed by leading investment banks.
• Provides for an ongoing guaranteed income stream for the client and spouse if desired.

The two FIA’s I recommended for this client had internal fees of .95% and .4% respectively, for an average cost of ownership of .675% annually, lower than the current cost of his Bond Funds. The performance of these annuities were tied to underlying diversified stock indices that were managed with volatility controls and had the ability to shift allocations monthly. Disclaimer: Index Annuities are never meant to be a competitor for true equity investments and are not direct investments in the underlying market indices. A reasonable return expectation for this type of product would be between 3½% – 5% over time, with negative index periods earning a 0% return. That’s why they are a viable substitute for bond positions.

This would remove the Market Risk, Credit Risk and Interest Rate Risk associated with his current Bond Allocation, lower the overall annual cost and potentially improve the annual returns. In addition, there is the option of a guaranteed lifetime income that would protect the client (and his spouse) from the risk of extreme longevity. While there are substantial surrender charges in the early years to withdraw more than the annual free amount, Required Distributions from IRA’s are never penalized and that’s all the client anticipated ever withdrawing. Seemed like a no-brainer. Except that it wasn’t.

When we finished with the analysis of the FIA’s, their performance data, reasonable projections, and the financial data on the carriers that offer the products, we scheduled our next meeting for the following week to begin the transfers and implementation of this strategy.

This next meeting is where the process fell apart. Why? Because his (adult) kid heard somewhere that annuities weren’t a good thing to do. While I’m sure that this child is smart, expertise as an elementary school teacher doesn’t qualify one to render complex investment advice. But that’s sometimes how it goes; blood is thicker than 25 years of experience and numerous advanced planning designations. In these situations I just have to let it go or run the risk of insulting the client by impugning the intelligence of their oh- so-smart progeny.

In my opinion, Index Annuities are actually over-hyped and oversold by agents (often posing as fiduciary advisors) as the silver bullet for everything investment related. Cable stations and weekend radio shows are filled with agents dispensing advice about how Index Annuities are the answer to whatever ails you. Market-like returns? Index Annuities! High Growth, No Risk? Index Annuities! Erectile dysfunction? Index Annuities! The only thing more annoying is former TV stars telling people to stockpile gold for the coming financial apocalypse.

Why are annuities so over-hyped? Because they pay commissions. Earning commissions on these products is not inherently wrong or against the best interest of the client, unless the product is not properly positioned and/or sold for the wrong reason – strictly for earning a commission.

But there’s no doubt that annuities can and do solve many of the challenges faced by retirees. The puzzle has been that consumers, and advisors to a large extent, don’t understand where annuities fit or how to use them effectively.

For me there are three primary uses for annuities in my practice – replacing Bonds or Bond Funds with a more efficient alternative in a client’s comprehensive financial plan, filling a defined need for current or future income, or for that client that just can’t stomach any real market risk.

A Wall Street Journal article once referred to income annuities as “super bonds,” which is not the most accurate term. A more appropriate term would be “actuarial bonds.” Extensive research in the field of Retirement Income Planning concludes that income annuities significantly improve retirement outcomes over what is possible with bonds or bond funds.

Unless of course your clients’ kids heard something from somewhere and doesn’t like them.

But for actual research, I suggest the following blogs:
https://retirementresearcher.com/
http://www.theretirementcafe.com/
http://squaredawayblog.bc.edu/

Tuesday August 4, 2015

How 401(k) Plans Have Failed Us

The following is excerpted from an article in Think Advisor Magazine by Alicia Munnell of Simply Money:

The 401(k) is America’s most common retirement plan and is also its most misused plan.  The 401(k) is a ‘failed experiment’ in retirement planning and there’s plenty of blame to go around. Let’s declare 2015 the year we officially recognize 401(k) plans as a failed experiment in retirement planning. And let’s give some credit for that to plaintiffs’ attorneys, the Supreme Court and the Department of Labor.

To be fair, lots of credit also goes to the CFOs and HR professionals who cut costs on 401(k) plans to bare bones and failed to educate employees about how to use their investment options. Let’s not forget the fund companies that enjoyed years of large fees without scrutiny, or third-party administrators who used higher internal expenses to rebate the company’s costs back to the employer. Financial advisors who pocketed 12b-1 fees and other forms of trailing commissions can’t be completely overlooked, either.

Imagine how recent lawsuits would have gone if the 401(k)s had done a good job. What if the plaintiffs had sued about plan expenses and the companies’ response had been “We use those fees to cover advice services to all plan participants, with advisors who come on-site once a week”? I did this in the early 2000s for a $100 million plan. We gave the company relief from fiduciary responsibility. We were on-site, did financial plans, asset allocation, explained rebalancing—at no additional cost to the plan participants. We were paid with 12b-1 fees, which we split with Putnam, the plan provider—we took 12.5 basis points and didn’t feel underpaid.

So what’s the problem? Maybe it isn’t the fees workers pay but that they don’t get the service they deserve.
The 401(k) has become a feeding trough for financial institutions and service providers that routinely rip off participants. Why? Not because of the fees, but because participants don’t know how to use them—and no one is willing to take responsibility for guidance.

Just this year we have the following facts to ponder:

  •  • Participants left $24 billion in company matching funds unused because they didn’t save enough to claim the full match.
    • In 2014, only 10.5% of plan participants changed the asset allocation of their account balances, and just 6.6% changed the asset allocation of their contributions.
    • Approximately 21% of savers who can borrow from their 401(k) plan have outstanding loans—so they’re using their retirement funds as a piggy bank.
    • Roughly two-thirds of investors think they pay no fees for their investments, or have no idea how or how much they pay.
    • At the same time, 53% of households are at risk of being unable to maintain their standard of living in retirement.

What if participants in large plans are paying too little to have their assets managed and, therefore, are not getting the help they need? If you doubt this, just grab a copy of the yearly report from AON Hewitt—or any retirement plan consultant—about participant behavior in the plans they administer. This is not a survey; it’s a report on the millions of accounts AON Hewitt administers and what their owners do or don’t do with their funds when they get no real input or advice.

It’s not a pretty picture. Inertia rules. Did none of these employees have any reason to change their investment choices? Did none of them get a few years closer to retirement? Get divorced? Have children? Did the allocation they picked five years ago not need rebalancing after the supersonic run-up in large U.S. stocks?

More troubling, AON’s clients—the plan participants surveyed for the report—make up approximately half of the Fortune 250. Assume for a minute these companies have their pick of the smartest people around, and pay better compensation and benefits than many other firms. If these workers can’t get investing right, what does that say for the rest of us?
Where did companies go wrong? Ironically, it started with fiduciary concerns about their liability for investment returns if they, the employers, invested on the employees’ behalf.

To solve the problem of liability, companies chose to give their employees self-direction, rather than take responsibility for performance. They had a choice and took the easy one. It seemed like a simple enough strategy for getting the employer off the fiduciary hook, but it was a mistake as far as the workers’ financial well-being was concerned. For every worker who succeeded with a 401(k), there were scores who never signed up, never invested beyond the default or, worse still, bought high and sold low in a panic. If the employees had gotten help, guidance, direction—would they have brought these lawsuits?

That brings fees back into focus. If you pay a fund company very little, that’s what you’ll get from them in service. These are organizations set up to manage money, not educate Americans about financial planning. But if the fees were well-spent, employees would benefit.

No one has been putting the plan participant—the worker, the consumer—first; not the plan sponsors, the plan providers, the asset managers nor the government. The Department of Labor has been trying for a few years to figure out how to have a fiduciary standard that could be functional at the worksite.

It’s time to call it like it is and redo the 401(k). That’s going to require more time and expense on everybody’s part, but this is a case where you get what you pay for—or at least you should.

401(k) participants deserve a real plan. I personally would recommend charging everyone a fee that came out of plan assets and covered a basic level of advice for every participant. Participants should then be able to choose from a fee-for-service menu that could include more frequent financial planning, advice on assets held outside the plan, asset allocation, rebalancing, etc. The extra fees would be deducted from their 401(k) balance. The cost of these services, given the scale of most investment firms, would be modest compared to what they might cost an individual investor, owing simply to scale.

A plan that used a robo-advisor could set fees at a very low level, probably around 20 basis points. A hybrid version would couple a robo-advisor with human beings at the local level and cost more.

These options all have one goal: get participants’ investment behavior to match their investment goals. That will translate into growing account balances and shrinking lawsuits. And yes, whoever provides the service would be held accountable for the job they do. Isn’t that how it should be?

Tuesday July 28, 2015

Social Security Financial Outlook: The 2015 Update

The following is a summary of this year’s brief from the Center for Retirement Research at Boston College.

By: Alicia H. Munnell; IB#15-12

The brief’s key findings are:
• The 2015 Trustees Report shows little change from last year:
a) Social Security’s 75-year deficit declined modestly from 2.88 percent to 2.68 percent of payroll.
b) The deficit as a percent of GDP remains at about 1 percent.
c) Trust fund exhaustion moved back slightly from 2033 to 2034, after which payroll taxes still cover about three quarters of promised benefits.
• The shortfall is manageable, but action should be taken soon to restore confidence in the program and give people time to adjust to needed changes.
• In addition, the disability insurance program needs immediate attention, as its trust fund is expected to be exhausted next year.

To read the entire brief go to:
http://crr.bc.edu/wp-content/uploads/2015/07/IB_15-12.pdf

Thursday July 9, 2015

The Business of Risk

Cyber threats have created an interesting conundrum in which the criminal perpetrators are frequently more tech savvy than those responsible for preventing their crimes or apprehending them. And the situation, at the moment, doesn’t really show signs of improving.

Several national security experts recently issued recommendations to help address the problem. They referred to the issue as a “black elephant — a dangerous crossbreed between the ‘black swan’ risk (capable of producing unexpected outcomes with enormous consequences) and the ‘elephant in the room’ (a large problem that is in plain sight).”

[CLICK HERE to read the article, “We Don’t Need a Crisis to Act Unitedly Against Cyber Threats,” from Knowledge@Wharton, June 1, 2015.]

[CLICK HERE to read the article, “RSA Conference: Is Hiring Hackers a New Thing?” from Adeptis Group, May 6, 2015.]

[CLICK HERE to read the article, “Security Companies Hire Hackers, Ex-Spies to Fight Cyber Attacks,” from Bloomberg, April 14, 2015.]

While hackers certainly present a grave risk at the national level, frequently the outcomes are more personal. Sure, it’s a real blow to companies like Target and Home Depot for their data to be hacked, but ultimately it’s their customers who may suffer more relative damage.

And as great as technology is, the more we integrate it into our lives, the more risk we face of being personally “hacked.” For example, what a wonderful convenience to be able to lock and unlock our homes and cars using our cellphones, even when we’re out of town. But consider the benefit to a criminal who hacks into a person’s phone and unlocks the house and car, making for easy theft while knowing the owner isn’t home. It kind of makes the old-school, trusty German shepherd seem a bit more attractive for warding off potential burglars.

[CLICK HERE to read the article, “Data breaches may cost less than the security to prevent them,” from TechRepublic, April 9, 2015.]

[CLICK HERE to read the article, “Black Hat 2014: Security experts hack home alarms, smart cars and more,” from CBS News, Aug. 6, 2014.]

Then there are the security breaches that don’t make the headlines. For example, a data breach at a local vendor that results in unauthorized charges to your bank debit card, PayPal account or other online vendor. These sporadic incidents can range in damages from a minor inconvenience to lost hours trying to identify the issue, resolve it and get your money reimbursed.

Naturally, it makes sense to protect your own data as much as possible instead of relying solely on vendor and government solutions. For example, experts recommend using a credit card instead of a debit card. Relevant to this advice, it’s a good idea to revisit any of your accounts where you may have entered your bank account or debit card information, even if you only use your credit card with those accounts. Consider what card information is stored at accounts such as Amazon, eBay, Etsy, PayPal, Netflix and other online merchants you might frequent.

And with another nod to the old-school approach, consider using cash instead of credit at places where they habitually take your credit card out of sight for a few moments (long enough to record its information) — such as at restaurants and fast-food joints.

[CLICK HERE to read the article, “7 Reasons Your Debit Card Makes You a Target for Fraud,” from MagnifyMoney.com, Oct. 22, 2014.]

[CLICK HERE to read the article, “New ways to prevent credit-card fraud,” from Consumer Reports, May 28, 2015.]

One thing we’ve learned throughout history, no matter the threat, is that the best time to prepare for a disaster is before it occurs. This applies not only to cyber threats, but to health care screenings and creating a plan for retirement security. The more we educate ourselves and the more we plan, the more prepared we are when something unexpected occurs.

We are here to help you feel more confident in your financial strategy — now and in the future. Please give us a call at 770-778-5242 or at: wctucker@thewoodvillegroupllc.com.

We are an independent firm helping individuals create retirement strategies using a variety of investment strategies and products to custom suit their needs and objectives.

This content is provided for informational purposes only. It is provided by third parties and has been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed. If you are unable to access any of the news articles and sources through the links provided in this text, please contact us to request a copy of the desired reference.