What no one wants to talk about, ever, in terms of retirement planning is the sequence of returns and the impact on retirement planning. I am bringing this up now as we wrap up the worst 10 year period ever in the S&P 500 we have ever had. In fact, technically, this is the only official 10 year period of time the S&P 500 has ever been negative. I say officially because the 10 year period is subject to interpretation, but regardless we are looking at a period of time wrapped by 2 of the worst periods ever to invest in the equity markets. In other words this decade had the mother of dumbbell negative returns ever.
What the impact of this 10 year period has had on retirees will be felt for the next couple of decades. Essentially, many retirees or pre-retirees have been wiped out or will have to drastically alter their lifestyles in order to make their money last. While I could easily blast the likes of Scott Burns, Suze Orman and a million other drive by financial advisor writers for dispensing horrible advice that they likely did not even follow themselves, I will not. They simply told people what they believed to be true because they used flawed logic and ridiculous assumptions that normal financial advisors would have dismissed as idiocy, not that they are innocent either, but they were the targets of these writers inept ridicule for long enough.
The simple fact is this, everything has a cycle whether we are talking about the Earth, the moon or the markets they all of a cycle. When we look at market returns sometimes the cycle shows an unmanaged index does substantially better than managed money while at other times managed money does better than the unmanaged index. Over the past 15 years we saw the unmanaged index do better than managed money, but will that trend continue? Unlikely. That cycle has run its course from my point of view, sure there will be stand out sectors, but that is it. If you go back in time to the 1970’s it is fair to say that this theory of mine pans out and managed accounts did better than the unmanaged indexes, but you know me, let’s not let the facts get in the way of what they pawn off as the truth.
The beginning of this decade should have been the warning sign for those following the advice of the financial rags who themselves have never ran money or witnessed what it is really like to lose someone money. Instead they blast brokers for making money and tell you to buy an index fund because over the long-term “nothing outperforms the S&P 500,” how’s that working out for you? Simply put, they did not know their history and they over simplified a very complex thing, your retirement planning. Retirement planning is complicated and deeply personal and no one, I really mean this by the way, should ever take their retirement planning advice from the TV or newspaper.
With hindsight on my side, unfortunately, it is now clear that these people did not know what they were talking about. Not only that, but their intentions are now out for everyone to see. One person mentioned already, who always advocated Vanguard index funds, opened an RIA firm and will gladly manage your money for a small fee, even though he said brokers were crooks before, unless he is the broker I guess. The other person sells binders for $50 or $100 that you can buy at Staples for $10 or $20, but since they are branded with their logo or some other nonsense they are worth more, I am still trying to figure out why that is. Either way, to their legions of devoted followers their betrayal means nothing or they will continue to mindlessly follow them, which is astounding to me, even though they destroyed their wealth. Here is what I mean.
The sequence of returns is the timing of returns, either good or bad, and the impact on your portfolio. This is the most important aspect of investing and the biggest ‘Black Swan’ there is because it is out of your control. This is why asset allocation is so important when you are talking about your serious retirement money. I have a larger portion of play money that I speculate with, but you better believe that my real money, my retirement money, is not in some E-Trade account with my finger on the buy/sell button all day long. I have a plan with my real money and I do tinker with it occasionally, but only when I feel the need to be more conservative or more aggressive, but it is professionally managed, not by me, to keep my emotions out of the game. However, the sequence of returns is always ignored by most gurus I read or listen to and it will devastate you if you are not careful.
If you invest and instantly lose 10% for the first couple of years it takes you a very long time to regain those losses or exceptionally high returns for a few years. It is even worse if you are taking income from your portfolio which is the case for many retirees, unfortunately. I am going to concentrate on those taking income from their portfolios in this example, just 5% income I might add, because many Boomers retired either in 2000 or in the last few years, either way you will get the point. I am not even going to show you the double whammy of the dumbbell negative returns because that is so depressing it is not even funny. In fact, this will be and is such a serious problem I am not sure what can be done about it because literally millions of Boomers are in serious trouble now.
Here we see someone who decides to retire and rolls over his 401K and listens to a buy and hold indexing guru. They decide to invest into a generic fund and let it all ride thinking that 5% withdrawals should suit them just fine, since he is told the market averages 10% over the long-term, another farce I might add. Unfortunately for this investor he got suckered into a bad time to invest and the market fell 10% for the first 2 years he owned his fund, but no problem writes the financial guru, just hold on and everything will be fine, really? Well, you tell me if everything looks fine to you.
Exhibit 1-1
Keep in mind, I am not showing any other negative returns, not even a negative 1%, and I am showing +8% returns for every other year in this illustration. I am also showing a straight 5% withdrawal rate, not ever a little more for the grand kids, to pay the taxes or medical bills, just 5%. This person runs out of money in about 20 years with 2 negative years right off the bat and they did not even look that bad, 10% market declines are, well, normal right? That is just one illustration of the sequence of returns and how they can impact the investor, not imagine if I put in the 2008 50% decline in there, there would not be anything left. I also ran this with 6% withdrawals, but the only difference is it gets uglier faster.
There is nothing you or I can do about the sequence of returns, but I have never seen something so important ignored before. While we are wrapping up the worst decade on record for stocks don’t you think we should talk about this stuff a little bit, especially since Boomers are about to retire in droves, well they were at least. Frankly, those bond funds everyone is slamming right now, do you know why they are so popular, not that I agree with it I might add, but they are so popular because they have positive returns on the 5 and 10 year benchmarks. Look at equity portfolios, most funds look horrible, except some managed funds I might add, but in comparison investors are saying, well sure this fund only did 5%, but it is better than the -3% I did over 10 years, so buy it.
I may sound bitter, but this is serious stuff that people just take so lightly and it drives me nuts. CNBC is now all about entertainment, not about serious news anymore which is a shame. The personal financial gurus are all about selling their latest book rather than helping people do real things, but maybe it is the peoples fault when you have to have a segment called can I afford this. People, if you have no money in the bank, in debt up to your eyes, make $50K a year, then no you cannot afford a $700K house, it is common sense. However, even though they are getting calls like this it does not justify giving out poor advice, ignoring history, not understanding the sequence of returns, the basics of asset allocation, vilifying brokers, picking on products – yes folks a variable annuity turned out to be the best product in the world to buy in 2000, and simply recommending index funds because they are index funds – a monkey could do that.
The Asian markets were mixed with the Nikkei trading flat, but China and Hong Kong are down about 3 and 4% respectively. The US futures are volatile, which is not uncommon in overnight trading, but showing a small loss at the open for the US.
Korea did cut interest rates by .75% which is a first emergency cut since 9/11/01. This shows continued world wide efforts to try and stop the pending global recession. These efforts will have some impact, but will not stop a recession.
As stated before, Asia is an indicator of how deep the recession could be as they are our manufacturing center. With the Nikkei at 26 year lows there is major pain heading our way. While the events we have right now are unprecedented and the emergency measures may stem much of the pain it is clear that only time will tell whether these efforts will have worked or not.
The times we live in right now are historic. We staved off the complete insolvency of the world banking system, which was a very real situation on 10/10/08. The world almost went bankrupt, it was that severe. However, the governments have stopped a potential major depression, but we still face the toughest recession, borderline mini-depression, is still on the horizon.
In the meantime, we expect, obviously, choppy trading in the AM and a relief rally by the end of the day. Of course, this is speculation, but indicators point to some strength in the markets, for a change. We could see a dramatic rally in the near future, perhaps spectacular like the 900+ point rally on the 13th. We recommend selling into that strength when it happens as you will be able to buy stocks cheaper soon after that potential rally.
These are the times when variable annuity living benefits are earning their “high” cost. All the pundits who said they are too expensive and recommended index funds instead should all be fired. They are flat out wrong, unless 40% declines in portfolios are a good thing…
RESTON, Va.–(BUSINESS WIRE)–NAVA, the Association for Insured Retirement Solutions, announced today first quarter results for the variable annuity industry. The combined net assets of U.S. variable annuities decreased 6.0% to $1.40 trillion at the end of the first quarter, as compared with the end of the fourth quarter of 2007. Net assets increased by 0.5% relative to the first quarter one year ago.
variable annuity total sales, also known as premium flows, for the first quarter was $41.6 billion, a 1.7% increase from the first quarter of 2007. First quarter net sales, also known as net flows, of $7.2 billion showed an increase of 12.3% from first quarter 2007 net sales of $6.4 billion. The mix in premiums for the first quarter showed that 64.2% of the total sales were in qualified plans and 35.8% in non-qualified plans.
Net Sales as % of total sales 17.3% 18.6% 20.3% 18.3% 15.7%
Source: Morningstar, Inc.
The mix of net assets by investment objective showed that $783.5 billion, or 56.1% of $1,396.6 billion total assets, was held in equity accounts. This is a decrease of 6.1% as compared with the first quarter of 2007 when $834.0 billion, or 60.0%, was held in equity accounts. The mix also shows that $262.9 billion, or 18.8% of assets, was held in fixed accounts.
About annuities — With the decline in availability of employer sponsored pension plans and proposed changes to Social Security, an annuity is an integral component of a retirement plan. It is a long-term retirement investment vehicle offering a combination of insurance benefits, guaranteed lifetime income payments and tax-deferred savings. variable annuities allow individuals to invest in a variety of underlying fixed and equity funds, and provide returns based on the performance of these funds. Only annuities protect retirement assets against market volatility and guarantee retirement income that cannot be outlived.
About NAVA — NAVA, the Association for Insured Retirement Solutions, is a non-profit trade association located in suburban Washington D.C. NAVA provides a variety of services to the industry including educational forums, research, and conferences aimed at furthering the development and understanding of fixed and variable annuities, income annuities and variable life insurance.
1 Total Sales (also called total premium flows) represents the sum of new sales (all first-time buyers of a contract, including inter- and intra-company exchanges) and additional premiums from existing contract owners. Net Sales (also called net flows) represents Total Sales minus surrenders, withdrawals, inter- and intra-company exchanges, and benefit payments.
For years The Hartford’s Director variable annuity was the rock of the variable annuity industry. For almost a decade it was the best selling broker sold variable Annuity product, behind TIAA-CREF. Last week that legacy came to an end as the Director variable annuity ceased to exist for new investors and was folded into the Hartford Leaders product.
The Hartford’s Planco division once boasted that the Director product will always be the best selling variable annuity with the Leaders product a close second. Sadly, they were the last to see that the writing was on the walls years ago and single managed variable annuity products were irrelevant. In 2005 they tried to turn the ill fated Director Annuity around by introducing a multi-managed approach, they added some 55 different sub-accounts from various managers.
What they did not count on was that their success with the Hartford Leaders product would undo what they were trying to accomplish. The Leaders variable annuity had 4 main fund families that went deep, offering many sub-accounts from each manager. All of the fund families were top shelf names, American Funds, Franklin, MFS and AIM which are among the top selling fund families in the advisor arena. The Director annuity though went for the shallow and wide, offering many Hartford sub-accounts but only a smattering of other money managers.
The Leaders annuity saw huge growth, from nothing in 2000 to $10 billion or so in recent years. That success, in our opinion, tainted the efforts of the Director product. Also, the other issue was saturation of the marketplace with both the Leaders and the Director wholesalers covering the same advisors. It was total overkill.
It was no surprise that the Director failed, it was too little too late.
Today is the last day to mail your taxes and as many people now know their investments also come with tax liabilities. Many people will tell you that investing in mutual funds is a better idea than using a variable annuity because of the long-term capital gains treatment. The irony is that the long-term tax treatment is only relevent to sales of your mutual funds that are more than 12 months old and only on a portion of your total mutual fund distributions.
The vast majority of your distributions from your mutual fund account was probably short term income distributions. That means that the gains from this account will be taxable at your ordinary income tax bracket, not the famed 15% long-term capital gains rate that many claim you will be taxed at.
With turnover rates of mutual funds hovering around 100% annually it is highly unlikely that you will pay long-term capital gains on your investments in the future, unless you sell your fund. To add insult to injury the sub-prime meltdown has handed investors hefty losses on their mutual funds and now they owe taxes on a fund that lost them money.
With a variable annuity you would have circumvented both of these situations. The tax deferral would have shielded the investor from taxes and a living benefit would have preserved the investors income or principal, depending on what type of benefit they bought. To find out what type of benefit is right for you go to Annuity IQ to find out more.
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