When Planning For Safety Consider The Alternatives

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“It’s not what you make that counts!”

Exhorts friend and mentor Ed Slott in an interview we recently conducted. “It’s what you keep – after taxes!” Ed Slott has a top-rated show on public broadcasting called ‘Retire Safe and Secure.’ Ed’s message about retention is in sync with the current preference among retail investors for capital preservation over accumulation.

In a recent op-ed published in Bloomberg, Jim Bianco notes that so-called Moms and Pops on Main Street haven’t connected with Wall Street’s clever acronyms of FOMO (fear of missing out) or TINA (there is no alternative).

Despite the impressive strong performance registered by stock market indices this year, retail equity fund outflows are at record levels seen at least since 1992. The data shows that retail investors are mainly opting out of stocks and into bonds to preserve their capital.

Bianco writes that the modern wealth manager influences or directs these asset flows, and that the public is getting what it wants via 60/40 equity/bond portfolios. As a CFP® practitioner, I am hopeful that the public is making this choice after assessing a plan with alternatives. A solid financial plan includes assumptions, the pros and cons of a recommended course of action, and, importantly, other ways to achieve the end goal. In the 1940s, Leo McGivern of the New York Daily News wrote, “Last year over one million quarter-inch drills were sold – not because people wanted quarter-inch drills but because they wanted quarter-inch holes.” An older demographic, having witnessed two significant drawdowns in 2000 and 2008, wants quarter-inch holes – a safe and secure retirement. Has the public considered all of the tools available at their disposal?

Fixed annuities are one alternative for that portion of the portfolio that needs to be protected. When used for medium- to long-term retirement income planning and held through the period when surrender charges apply, fixed annuities can shield a portfolio from market risk. These contracts provide the buyer with guarantees based on the strength and claims-paying ability of the issuing insurance company. With fixed annuities, the insurance company holds a diversified portfolio of bonds as part of its general fund. Guarantees also extend from the preservation of funds to the distribution of these monies in the form of income that cannot be outlived. Fixed annuities are not designed for shorter-term planning, so some of the drawbacks to be considered are any contingent surrender charges and or immediate access to all of the funds.

Why should retail bond investors contemplate alternatives and at least consider transferring the risk of loss at this juncture in time? Bond prices and bond yields move in opposite directions. We know that interest rates are currently at historic lows, but according to this chart from Visual Capitalist, at 670-year lows! The sheer volume of triple-B-rated debt (the lowest possible rating to still be considered investment grade) has ballooned during this expansion. Investors and analysts have been raising their concerns about credit quality. Economist Jim Rickards points out that “with so much debt on the books, even modest rate increases will cause debt levels and deficits to explode as new borrowing is sought just to cover interest payments.”   We should also consider the concept of bond duration. When a bond is issued with a low coupon rate or has a low yield to maturity, that bond will have a high duration. As a result, that bond price should move sharply lower with a one-percent increase in interest rates.

A friend of mine told me recently that she and her husband had built up a nice nest egg and that they wanted it to be safe and for it to generate income. They began with the end in mind, as Stephen Covey used to say, but didn’t want to get lost in all of the technical jargon as to how this goal was to be accomplished. As McGivern famously wrote, consumers want holes – and not drills. Hopefully, these retail bond investors looking to preserve their capital are not operating under the belief that “there is no alternative.” A complete financial plan encompasses investments, insurance, along with tax planning. Recall Ed Slott’s nostrum that it’s what you keep after taxes.

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