An interesting point was brought up at this week’s CFA Institute’s Financial Analysts Seminar: retirement is a long enough period of time for something to go haywire. The point was brought up by Barton Waring, a retired chief investor officer for Barclays (which is now BlackRock). He raised the topic during a discussion about retirement income and annuities.
As I’ve written about before, life-spans have a right-tail risk in terms of economics. The longer you live, the more money you will need. The Social Security Administration’s actuarial table lists the life expectancy at 76 years for men and 81 years for women starting at the date of birth. These estimates encompass all those who die prematurely (due to accidents, crime, etc.) as well as those who experience shorter life-spans due to illnesses (cancer, heart disease, etc.). As you reach a certain age, your life expectancy increases because all those who have died previously are excluded from the projections.
Let’s assume a couple retires at age 65. The odds of at least one spouse making it to age 85 are pretty good, particularly for the wife. That’s 20 years of retirement to fund. Fellow men, if we make it to 85, our life expectancy gets extended out to past 90. That’s 25 years of retirement to fund. Live to 100 (and the Social Security Administration’s actuaries think nearly 3% of women will as of 2013), the retirement time span is pushed out to 35 years. You get the picture. Now think about what’s happened over the past 35 years: the rise of personal computers, the ending of the Cold War, Blockbuster Video opening, the 1987 crash, Japan’s market crash and (still ongoing) economic slump, the dissolution of the Soviet Union, the S&L crisis, Yahoo/eBay/Amazon/Pets.com launched, the collapse of Long-Term Capital, Netflix started, the bursting of the tech bubble, the collapse of Enron, the housing bubble, the iPhone introduced, the 2008 financial crisis, Blockbuster Video’s bankruptcy, negative interest rates and Yahoo’s auction of its internet assets.
Now, think about your annuity provider and your life insurance company. What are the odds of something occurring to adversely affect them over the next 35 years? And what are the odds of some event you didn't anticipate actually occuring? Insurance companies have failed before. For instance, annuity provider Standard Life of Indiana failed in 2008.
What could cause an insurance company to fail? Bad management decisions, including how the portfolio is invested. A period of financial turbulence brings such decisions to the surface. Bad market conditions will also adversely affect your portfolio and compound your potential headaches.
State insurance commissioners can determine when an insurance company has become insolvent and seek authority to seize the company’s assets. In such instances, policyholders who are state residents can receive coverage up to certain limits. These limits are determined at the state level, but most states provide at least $300,000 in life insurance death benefits, $100,000 in cash surrender or withdrawal values for life insurance policies, $250,000 in present value of annuity benefits and $300,000 in long-term care benefits. The National Organization of Life & Health Insurance Guaranty Associations has a longer explanation of what happens when an insurance company fails. Keep in mind that another insurance company may honor the policies and contracts as well.
There are steps you can take to protect yourself. Check the financial health of the insurance company you are buying a contract or policy from. Consider transacting with more than one insurance company as well, especially if the total dollar amount spent on annuities and/or life insurance policies is significant. The same logic applies to your brokerage and bank accounts. In doing so, make sure you strike a balance between the desire for financial institution diversification and the complexity of managing multiple policies and accounts. Having too many accounts and policies can create financial management problems for you, your spouse and your heirs.
- The Costs of Owning an Annuity – Stan Haithcock lists the costs you can expect to incur with various types of annuity contracts and gives guidance on how to assess a carrier’s safety.
- Assessing Your Life Insurer’s Financial Performance – Brian Fetchel explains how to analyze a life insurer’s financial statements.
- Which is Better: 4% Withdrawals or Annuities? – TIAA Institute compared following the 4% rule against annuitizing and found doing both is a good option.
- IRA Rollover Chart: Rules Regarding Rollovers and Conversions – This helpful chart shows what types of retirement accounts can be rolled over or converted into another type of retirement account.
There are no changes to the Model Shadow Stock Portfolio this month. Two new stocks were added to the probation list—CDI Corp. (CDI) and LMI Aerospace (LMIA)—because of negative trailing earnings per share. Four of the 30 stocks currently in the portfolio qualified for purchase at the end of June, unchanged from last month. These companies are Key Tronic Corp. (KTCC), L S Starrett Co. (SCX), Salem Media Group Inc. (SALM) and Willis Lease Finance Corp. (WLFC).
There are no changes in the holdings of the Model Fund Portfolio this month. However, there are changes in the portfolio rationale, which will likely bring about changes in the holdings in the near future. AAII founder James Cloonan will discuss these in his column in the forthcoming August issue of the AAII Journal.
The August issue will also introduce the Level3 Passive Portfolio next month. This portfolio will be based on research presented in Cloonan's upcoming book, Investing at Level3.
The AAII Model Shadow Stock Portfolio, which is a real-money collection of micro-cap stocks, climbed 1.3% in June. The Model Shadow Stock Portfolio outperformed the DFA U.S. Micro Cap Fund (DFSCX), which was down 0.2% in June. Year to date, the AAII Model Shadow Stock Portfolio is up 3.1%, compared to the S&P 500, as represented by the Vanguard S&P 500 index fund (VFINX), which is up 3.8%. Since its inception in 1993, the AAII Model Shadow Stock Portfolio has a compound annual average return of 15.2% versus the Vanguard S&P 500 Index Fund, which has gained 8.9% a year, on average, over the same period.
The AAII Model Fund Portfolio fell 0.4% in June and is now up 2.9% year to date. The portfolio, which was started in June 2003, has a compound annual average return of 8.1%, just below the 8.2% average annual return of the VFINX over the same time period.
Earnings season picks up steam with nearly 200 S&P 500 companies reporting. Included in this group are 12 Dow Jones industrial components: Apple (AAPL), Caterpillar (CAT), Du Pont (DD), McDonald’s Corp. (MCD), United Technologies Corp. (UTX), 3M Co. (MMM) and Verizon Communications (VZ) on Tuesday; Boeing Co. (BA) and Coco-Cola (KO) on Wednesday; and Chevron Corp. (CVX), Merck (MRK) and Exxon Mobil Corp. (XOM) on Friday.
The Federal Open Market Committee will hold a two-day meeting, starting on Tuesday. The meeting statement will be released on Wednesday around 2:00 p.m. ET. The CME’s FedWatch tool signals a 97.6% chance of the target rate remaining between 0.25% and 0.50%. Expectations for no rate hike at the September meeting are currently at 80.0%, but these expectations are very much subject to change.
The week’s first economic reports of note will be the May S&P Case-Shiller home price index (HPI), June new home sales and the July consumer confidence report, released on Tuesday. Wednesday will feature June durable goods orders and the June pending home sales index. June international trade data will be released on Thursday. Friday will feature the first estimate of second-quarter GDP, the Chicago purchasing manager’s index (PMI) for July and the University of Michigan’s final July consumer sentiment survey.
San Francisco Federal Reserve bank president John Williams will make a public appearance on Friday.
The Treasury Department will auction $26 billion of two-year notes on Monday, $34 billion of five-year notes on Tuesday, $15 billion of two-year floating rate notes (FRN) on Wednesday and $28 billion of seven-year notes on Thursday.
- 16 Financial Ratios for Analyzing a Company’s Strengths and Weaknesses
- Avoid the Top 10 Mistakes Made With Beneficiary Designations
- 18 Recommendations for Minimizing Inheritance Conflict
The further ascent by the Dow Jones industrial average and the S&P 500 index into record territory did not translate into higher optimism among individual investors. The latest AAII Sentiment Survey shows bullish sentiment—as well as neutral sentiment—declining, and bearish sentiment rising. The changes were modest, however.
Bullish sentiment, expectations that stock prices will rise over the next six months, pulled back by 1.4 percentage points to 35.4%. Optimism is below its historical average of 38.5% for the 37th consecutive week and the 70th out of the past 72 weeks.
Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, slipped 0.9 percentage points to 37.9%. Nonetheless, neutral sentiment is above its historical average of 31.0% for the 25th consecutive week.
Bearish sentiment, expectations that stock prices will fall over the next six months, rebounded by 2.3 percentage points to 26.7%. Pessimism was last lower on April 20, 2016 (23.9%). The historical average is 30.5%.
While optimism among individual investors remains below average, it has still shown recent signs of improvement, with bullish sentiment above 30% for the third consecutive week. To put this into perspective, optimism has only stayed above 30% for a span of three consecutive weeks just one other time this year (February 24 through March 9).
A lack of perceived viable investment alternatives, economic growth and upward momentum in stock prices is encouraging some individual investors about the short-term direction of stock prices. Giving reason for caution or pessimism is global economic uncertainty (including Brexit), the prevailing level of valuations and disappointment with corporate earnings growth. The presidential election and monetary policy are also impacting individual investor sentiment.
This week’s special question asked AAII members what they thought about the S&P 500 rising to new record highs. Responses varied, as did the reasons given for those responses. About one out of three respondents (34%) either think the recent rally will not last or are concerned about its short-term sustainability. There was not one consensus reason given for this opinion, though several respondents believe the underlying fundamentals and/or macroeconomic conditions do not support the new highs. Several others anticipate a pullback or a correction occurring sometime this fall. Slightly more than 11% of respondents have the opposite opinion and think stocks could continue to rise. A nearly even number of respondents attributed the new highs to a lack of good alternatives for investment dollars. About 9% aren’t surprised or say the new highs were expected. Nearly 8% of respondents expressed skepticism about the rally, saying that stocks are being inflated by loose monetary policy.
Here is a sampling of the responses:
- “I think it shows that people have no place else to put their money.”
- “Enjoying the ride up, but the underpinnings are scary in their comparative height above the norms.”
- “I think it still has a ways to go up.”
- “This is too heady at this point and leads me to believe the market is going to have a big pullback in the next six months.”
- “This high is fool’s gold. It is unsustainable.”
- “Not a surprise, given the gradual improvement in the economy.”
Bullish: 35.4%, down 1.4 points
Neutral: 37.9%, down 0.9 points
Bearish: 26.7%, up 2.3 points
Local Chapter Meetings
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June 23, 2016 The Debate Over Retirement Income Strategies