Breathing New Life into Retirement Portfolios:
The Battleground for the Life Annuity

A Retirement Security Institute report, January 2008 (20 pages)

New Report shows overwhelming evidence about annuities’ role in retirement portfolio

Stakeholders in the retirement market need to re-think what retirement security means in terms of financial planning. A large gap exists about how to diversify a portfolio to work toward retirement and to make it last through retirement.

This new report about what an ideal portfolio would look like and the related risk profiles of investors may breathe new life into the discussion on retirement portfolio issues. An analysis of several scholars’ work illustrates the cost-effectiveness of an annuity strategy. Compelling evidence is presented about life annuities’ (also known as income annuities) important role in a retirement portfolio.

Stakeholders seem to lack a comprehensive view of the details or the principles which should guide these decisions for retirement security. But also, even sophisticated investors are making “terrible mistakes” with their 401(k) plans. Channel bias may play a hand in the distortion of retirement portfolios.

It is time to re-balance the mindsets of those making retirement choices for others and present another side to the story— that of personal safety. Some of the finest minds in the financial world suggest this as a first order of business. The report is written in a professionals-friendly style with tables that illustrate key ideas.

A few key ideas from the report follow:

• The diversified portfolio approach practiced for over 50 years is in need of updating.
• A new framework exists which considers the safety of the individual first before the returns of institutional investors.
• A retirement portfolio should hedge against longevity risk and allow for sufficient, regular income.
• A variety of assets, based on safety, market returns, and aspirational goals, should be in one’s consideration set for the optimal portfolio.
• Lifetime income annuities are recommended by top scholars and knowledgable finance writers as a primary tool to accomplish important financial goals in retirement.

While geared to educate professionals serving the retirement market, the paper offers perspective for anyone working in the retirement market, including the retiree. Sources of information are well-documented for further research by any reader. The paper frames the issues of retirement security differently than what is available today. There are many very good resources, but none with the most relevant and succinct information and analysis.

An excerpt follows:

Preface

This report attempts to focus on the broader context of the financial assets which represent today’s retirement planning dilemma. Questions such as: How do I plan for a potentially long retirement? What mix of assets will achieve my goals? are hopefully being asked and answered by competent advisors. This analysis presents some of the most advanced thinking on the subject of retirement income planning for the professional advisor. (Any specific advice will, of course, require consultation with a knowledgable advisor regarding any individual’s portfolio.)

This report offers an enhancement to Markowitz’s modern portfolio theory, basically the diversified portfolio concept. A new framework exists that, I believe, addresses the needs of the time—for year 2008 and onward. It has flexibility and can be simplified to address most any individual’s planning situation.

“The Truth About Annuities and Retirement Income” was written after researching the most noted authors on the subject of personal finance, risk management, and longevity. That consumer guide was an application of some of the theoretical work done by noted scholars of risk management. Its goal was to show how the fixed income annuity is a formidable asset class and a helpful ally on the bumpy road of retirement income planning.

But a broader context was needed in my mind regarding the combinations of assets held in “everyman’s or everywoman’s” portfolio of assets. Through a fortuitous event I received an enlightening article published in an academic journal in my mailbox. Ashvin Chhabra’s pioneering work and elegant application of his framework, adding to Markowitz’s modern portfolio theory, opened my eyes to the puzzle of the decades ahead in retirement planning.

The paradigm has shifted. The era of defined contribution retirement plans, self-directed IRAs, and entitlement uncertainty creates a whole new level of self-sufficiency and need for knowledge. It could be the best of times—or the worst of times, as some scholars suggest. I suggest it should be the most calculated and strategic of times.

Table of Contents

Preface	1
Introduction	3
A Diversified Portfolio	4
A New Framework	5
The Ideal Portfolio	6
An Annuity Strategy	8
Why an Annuity Strategy	9
Incorporating an Annuity into a Comprehensive Plan	10
Scholars’ View on Annuities	12
Classifying Assets	15
Conclusion	16
References	17

 

Author Jennifer Warren utilizes her 15-year background in economic and policy analysis alongside the most credible information available. The RSI combines its work and analysis with top academic researchers’ findings in the field of risk management and individual finance decisions. For more information about Jennifer Warren visit www.conceptelemental.com.

 

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