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Are there alternatives to bonds that hold up over the long-term?
The retirement income landscape has changed dramatically over the past two decades.
And a big part of my job at Quantum is working directly with advisors to provide them with client-centric solutions that address these changes, including the need for lifetime income with protection from market volatility and longevity risk.
These days, fewer of your clients can depend on a company pension. The traditional assumptions, like the 4% rule about safe withdrawal strategies from a 60/40 portfolio, generally no longer apply. There may not be any money left if your clients plan to simply ride out the market’s volatility over a 20- to 30-year retirement time horizon.
Until recently, there haven’t been many strategies to diversify your clients’ portfolios, protect their savings, and offset the risk of outliving their income. But there is an alternative. The fixed indexed annuity (FIA) offers income growth comparable to bonds, a portion of market upside based on the performance of a market index, downside protection, and lifetime income with the selection of a rider (inflation protection is also available).
FIAs are contracts between the owner and an insurance company. They’re not investment vehicles. They can provide retirement savers an alternative to crafting a portfolio made up of simply stocks and bonds.
But don’t just take my word for it.
Roger Ibbotson, a world-renowned economist, challenged what he called “conventional wisdom” of the traditional stock and bond portfolio’s application for retirement savers in research published in 2018. His research showed that, over a 90-year period, FIAs can outperform bonds with similar risk characteristics and offer better downside protection.
But why even consider an FIA? The conventional wisdom tells us that stocks have beaten bonds by a wide margin over long periods of time and that when we’re young, we should allocate more heavily to stocks. Because stocks are typically riskier than bonds, as we age and approach retirement, the same conventional wisdom suggests to reduce risk and shift a greater portfolio allocation to bonds.
For Ibbotson, the problem can be accepting that conventional wisdom without considering other alternatives. While it’s prudent to de-risk portfolios when approaching retirement, are bonds the best option?
“I’ve always recognized you have to de-risk, and we see that bonds are not necessarily the way to go today because the yields are so low,” Ibbotson said in a March 2018 article in Wealth Management. “It’s pretty hard to have a falling rate environment today, when yields are below 3 percent on bonds.”1
It’s been a year since that interview, and yields on 10-year U.S. Treasury notes have been flirting below 2.00%. For retirement savers, following the conventional wisdom that presents two potential pitfalls.
First, while the lower risk of investing in bonds may be appropriate the older we get, the returns may disappoint or be insufficient to maintain necessary income in retirement.
Consider the 4% rule. It was popularized in the 1990s when interest rates were generally at least 100 basis points or more above 4%. Yet that strategy may not have worked well for clients drawing down since 2002 when rates have barely broken above the 4% target. It is further complicated by the performance of the stock side of the 60/40 portfolio, which may have been negatively impacted by the market’s sharp downturns in the 2000-2002 period and again in 2008.2
Second, yield compression has definitely benefited bondholders’ returns from capital gains. But how likely is it that bond investors will realize as high a return from capital gains in the coming years as they have realized in the recent past? If rates were to rise, future capital gains could potentially become capital losses.
So how can your clients potentially realize a lower-risk return that is also an attractive alternative to traditional fixed income options like bonds? How can they also stay invested in the market and participate in a portion of the upside, while being protected from market risk?
The FIA could be that alternative. Here’s why.
Hypothetical return simulations from 1927 to 2016 found that, net of fees, FIAs had an annualized return of 5.81%, compared to 5.32% for long-term government bonds and 9.92% for large-cap stocks. Ibbotson’s research also simulated, or stress-tested, how an FIA would perform under different scenarios when interest rates are unchanged or increase over a three-year period, and when equities are unchanged, decline or rise.3
Compared to a traditional 60/40 portfolio of stocks and bonds, portfolios that include an FIA with bonds or substitute the bond portion entirely with an FIA underperform only when interest rates are unchanged and equities are unchanged to down.
Quantum has exclusive access to Roger Ibbotson’s research. As part a Quantum partnership, you also get access to our insurance platform, featuring FIAs with exclusive product designs, patented features and a broad range of industry-leading strategies from companies with household names. Your clients get to continue to participate in a portion of market growth, accumulate assets and stay on track for retirement. We think that’s a win-win!
Contact me directly for more information: 800.440.1088 JORDAN MCGRATH
1 “Ibbotson: Fixed Indexed Annuities Beat Out Bonds,” Diana Britton, Wealth Management.com. March 7, 2018. Retrieved from: https://www.wealthmanagement.com/insurance/ibbotson-fixed-indexed-annuities-beat-out-bonds
2 Company pensions, for most, are a thing of the past. Data published in 2018 show that only 4% of private industry workers had access to a defined benefit pension plan, while 13% had access to both a defined benefit plan and a defined contribution plan, according to the U.S. Bureau of Labor Statistics, National Compensation Survey. Retrieved from: https://www.bls.gov/ncs/ebs/benefits/2018/ownership/private/table03a.htm
It was popularized in the 1990s when interest rates were generally at least 100 basis points or more above 4%. This is based on historical 10-year Treasury yields. Daily Treasury yield curve rates going back to 1990 are available here: https://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yieldAll
The market’s sharp negative years in the 2000-2002 period, and again, in 2008. We refer to the S&P 500’s historical annual returns, available here: https://www.macrotrends.net/2526/sp-500-historical-annual-returns
3 The research is based on simulations using dynamic participation rates and uncapped index crediting strategies of a generic large cap equity FIA. Call us at 800.440.1088 for your copy of Fixed Indexed Annuities: Consider the Alternative, by Roger G. Ibbotson, PhD.
The Quantum Group USA, LLC and its affiliates are not affiliated with Roger Ibbotson or Zebra Capital Management, LLC.
*Guarantees and protections of fixed indexed annuities are subject to the claims-paying ability of the issuing insurance company. Fixed indexed annuities are contracts purchased from a life insurance company. They are designed for long-term retirement goals, and also intended for someone with sufficient cash and liquid assets for living expenses and unexpected financial emergencies, including, for example, medical expenses.
**A fixed indexed annuity is not a registered security or stock market investment. As such, it does not directly participate in any stock, equity or bond investments, or index. Gains on indexed accounts are based on participation rates and other conditions offered by the issuing insurance company. Withdrawals are subject to income tax, and withdrawals before age 59½ may be subject to a 10% early withdrawal federal tax penalty.
This material is for informational purposes only and is not intended to provide any recommendations or tax or legal advice. We encourage you and your clients to discuss your tax and legal needs with a qualified tax and/or legal professional.
FOR FINANCIAL PROFESSIONAL USE ONLY – NOT FOR USE WITH THE PUBLIC
The Quantum Group USA, LLC. In CA. d/b/a Quantum Distribution & Insurance Services.