The Scary Truth
In an article written by David Weldon of ThinkAdvisor, titled Most Americans Illiterate Regarding Retirement Income Planning, I learned that 80% of Americans have little to no understanding of basic retirement income strategies! The American College of Financial Services conducted a Retirement Income Literacy study on a group of 60 to 75 year old Americans in an effort to test their understanding of how to make their hard earned savings last through retirement. The basic 38 question quiz resulted in 80% of respondents receiving a score of ‘F’ (Fail)! This by itself highlights a major concern and it is important that retirees understand that their vision of retirement is at risk every day!
Here are the four risks of retirement you never saw coming… or at least 80% of your clients didn’t:
1. Market Volatility Risk: On October 9, 2002 the S&P 500 Index® dropped 49% and then again on March 9, 2009 we experienced a drop of 57%. This is twice in the past 14 years that we have seen the market cut in half.
“However, despite these drops, over this same time period the S&P 500 Index® grew 21%.” With time and patience the ability to recover from losses is present, although you may not have the time to wait! For example, if you were planning to retire at this time next year and the market drops 50% today you will require a 100% return over the next year, just to break even!
2.Longevity Risk: People are living longer today than ever before on average a 65 year old male today can expect to live to age 84 and a 65 year old female can expect to live to age 86. In addition about 1 out of every 4, 65-year old’s today will live to age 90, and 1 out of 10 will live past age 95! At a time when 50% of people are living beyond average life expectancy, it’s no wonder the number one concern of pre-retirees is outliving their income!
3.Interest Rate Risk: An individual bond is generally considered conservative
and is unaffected by changes in interest rates, as long as you hold the bond to maturity. However, many investors enjoy the interest income potential and diversification of bond funds which can actively buy and sell bonds prior to reaching maturity and are therefore
subject to interest rate risk. For example, if your bond fund has a 5-year duration, a 1% rise in interest rates would result in a 5% drop in value, conversely a drop in interest rates would result in a gain. So why is this so important today? Over the past 33 years bond funds have historically done very well as we have generally experienced a decreasing interest rate environment.
It’s no secret however that today we are in a historically low interest rate environment giving more concern to the risk of rising rates in the near future.
4.Inflation Risk: The purchasing power of $1.00 is the key factor when it comes to inflation risk. Today, $129 of good’s would have only cost you $100 in 2004; this means that the purchasing power of every dollar today is worth $0.78 when compared to a dollar 10 years ago.
If you’re thinking to yourself, “yeah, everyone knows that inflation is a problem” but still not getting the gravity of the risk, then let’s look at it another way… The Federal Reserve estimates that there is approximately $11 trillion dollars sitting in cash holding. Assuming that you had been in a low 15% tax bracket over the past 10 years, your bank would need to have paid you interest of 3.035% per year on your $100 just to break even with inflation. How much interest is your bank paying you? Are you sure it’s enough to keep up with inflation?
A Solution to the Risks
One potential solution to these four risks of retirement may be a Fixed Index Annuity. A Fixed Index Annuity has the ability to:
- Remove market volatility risk by protecting principal during a down market, which takes downside risk out of the picture.
- Provide a guaranteed stream of income that will last for your lifetime when you elect to add a lifetime income rider. This is an optional benefit/feature that can be add to a fixed index annuity contract, usually for an additional charge, that will often provide an annual growth to the income rider account coupled with an age based withdrawal factor.
- Deliver upside potential growth based off of the performance of a market index which lowers the interest rate risk associated with a bond fund, but maintains the conservative allocation by protecting principal.
- Provide the potential for higher interest crediting that than available with other safe / fixed interest options. This allows you the opportunity to keep up with inflation, protect purchasing power and defer taxes.
Do you hold yourself out as a financial professional? Do you understand the many risks to retirement and have the ability to verbalize the problems that exist and the potential solutions that are available to solve them? If so, are you using that knowledge to educate the American people? If 80% of Americans who are currently at retirement age cannot pass a basic test on the topic then we need to understand that the greatest risk to their retirement would be for us to hold on to that information. I am ready to work at this together, are you?
David Weldon, ThinkAdvisor. (2015, April 9). Most Americans Illiterate Regarding Retirement Income Planning [Article]. Retrieved from http://www.thinkadvisor.com/2015/04/09/most-americans-illiterate-regarding-retirement-inc?page_all=1
1. Genworth. (2014, October). Managing Market Volatility. Retrieved from https://pro.genworth.com/riiproweb/productinfo/pdf/160890B.pdf
2. Genworth. (2014, October). Outlasting Longevity Risk. Retrieved from https://pro.genworth.com/riiproweb/productinfo/pdf/160890D.pdf
3. Genworth. (2014, October). Overcoming Interest Rate Risk. Retrieved from https://pro.genworth.com/riiproweb/productinfo/pdf/160890C.pdf
4. Genworth. (2014, October). Defusing Inflation Risk. Retrieved fromhttps://pro.genworth.com/riiproweb/productinfo/pdf/160890A.pdf