Does Guaranteed Income Really Make Sense as a 401k Option?
(Part two in a three part series)
If we are to believe the results of recent surveys, 401k investors currently have an overwhelming preference for guaranteed income investment options rather than traditional growth options. Hilary Martin, a financial planner from San Jose, California, blames the behavioral phenomenon known as “recency” for the these results which show young investors wanting to invest their retirement savings in guaranteed income options. Curt D. Knotick, CEO at Accurate Solutions Group in Butler, Pennsylvania cites the specific events that may have triggered this recency response. He believes the lure of the guarantee makes sense given “that with the media on Wall Street and the Big Banks and with the meltdown of 2008 still fresh in their minds, the idea of guaranteed investments is a big emotional appeal to them.”
Recency may also explain the reaction we’ve seen from both the IRS and the DOL, who announced in February 2012 a new policy encouraging the use of the “longevity annuity contracts” in retirement plans.
Whatever the motivation, it’s clear the recent market turmoil has left wounds that are long to heal. “Young investors exited the Great Recession scarred,” says Michael Lecours, Financial Advisor for Ohanesian/Lecours in West Hartford, CT. “Their small, and likely aggressive, portfolios took a significant hit,” he continues. Lecours sees this as their first experience with investing. He doesn’t think they remember the strong bull market of the 1990s and, as a result, they’re view of investing, in general, may be tainted, even to the extent of likening it to gambling. Lecours says young investors see the market “as being too risky. That leads them to something safer, more predictable – something fixed. They know what they’re getting, and they don’t have to worry about assets decreasing.”
Timothy R. Yee of Green Retirement Plans, Inc. Oakland, CA, believes this skepticism helps explain why, to some extent, we are harkening back to a desire for a DB plan. Yee says, “The younger folks now – with their increased desire for goods and spending habits – are seeing they are going to have to keep working and might not be able to retire. This is why I think they want fixed income. What they are asking for is a guarantee – a security blanket – and this is the closest they can come to it.”
But, despite their popularity in polls and the imprimatur of government regulators, do fixed income investments really make sense for young workers investing for their retirement?
Many financial advisers continue to sing the praises of asset allocation, and so it’s not surprising to hear them justify the existence of fixed income assets in an investor’s portfolio, even if that investment needs to grow over a 30+ year period. “Some fixed income allocation is prudent and should be included,” says Charles C. Scott of Pelleton Capital Management, Ltd. in Scottsdale, Arizona. Still, he warns, “You now need to be cognizant of the potential impact of rising interest rates in the future, so the free ride in bonds for the last 30 years is at an end.”
Brian Solik, President and Founder of Wealth Preservation Strategies of NJ in Toms River, New Jersey, says “It’s impossible to know whether a guaranteed account or gambling on Wall Street will make more money down the road, but it makes sense for this age group to have at least some of their retirement money secure.”
Other advisers are more confident in historic returns and openly question whether it makes sense for young investors to opt for guaranteed income products. “In most cases, it doesn’t,” says Rich Winer, President and CEO of Winer Wealth Management in Woodland Hills, California. The reason for this is simple math. Ibbotson data suggests once an investors time frame exceeds 20 years (this typically includes investors under 50 years of age), equity performance yields greater returns than fixed income performance – even for the worst performing periods. Winer sums it up thusly: “The longer the investment time horizon, the less most investors should have in fixed income products.”
Knotick concurs with this sentiment, saying “with age and time on their side, they can stay invested.” Indeed, if the focus is truly on time horizon, investment decisions may be different than what surveys suggest. “The role of guarantees in a portfolio has everything to do with time horizon,” says Nick Richtsmeier, Regional Vice President at Trilogy Financial Services in Denver, Colorado. According to Richtsmeier, “For money that young investors plan on using in the very near term, low-risk investments may be preferred. For retirement money, avoiding market risk at any cost unfortunately exposes them to a different and equally dangerous risk: to the corrosive power of inflation.”
Unfortunately, investors of all ages have a tendency to forgo the long-term and instead opt to wallow in the turbulent seas of the short-term. “Young investors need to stop micro managing and worrying about the day-to-day fluctuations in the market,” says John E. Hommel of Private Client Asset Management, Inc. Garden City, NY. “A well-diversified portfolio with a tactical portion will perform over time. I have a client that lost almost half his account in 2008-2009, but stayed with the investments and has recouped everything plus!”
Fundamentally, however, it may come down to financial literacy. Courtenay Shipley of Shipley Capital Advisory in Nashville, Tennessee and Alexandria, Virginia, argues young investors are no more or less educated when it comes to investing than the rest of the workforce. She asks, “Do those surveyed think a ‘guarantee’ or having ‘guaranteed income’ means they don’t have to actively save money for retirement on their own from their paycheck, but rather that it’s provided for them another way?” She questions if the respondents aren’t in fact asking for a pension – a retirement plan that is the responsibility of someone else, not them
For Mathew Goldberg, President of Manhattan Wealth Management Group in New York City, this attitude is something he sees every day. “The thing that confirms this in the marketplace is young people’s hesitancy to invest in stocks,” he says. “The question I hear most from my younger clients is ‘how much can I lose?’ A little bit of education and information usually puts their negative perceptions to rest.”
Martin says, “Age isn’t really relevant at all.” Again, she cites the lack of education, as seen through the evidence of her own experience. “I understand those under 30 are confirming they’re interested in guaranteed investments,” she says, “but what they say they want doesn’t change the fact that guaranteed investments would be a horrific choice for them to make at this point in the asset accumulation phase of their lives. $100,000 invested today in the stock market would likely be worth $1,300,000 in 30 years, and that number is based on 200 years of stock market data. So-called guaranteed investments (what does that even mean? What investment is guaranteed? There isn’t one), if they offered half the return of the stock, would lower that yield from $1,300,000 to just $375,000. I call that evidence!”
In light of this, and despite the apparent growing popularity of including annuity options in 401k plans, are 401k plan sponsors heading in this direction only making things worse for themselves? We answer this in our final installment.
Part I: Will Plan Sponsors Leave the Under 30 Crowd Doomed to Repeat 401k History?
Part II: Does Guaranteed Income Really Make Sense as a 401k Option?
Part III: How Do 401k Annuity Options Increase Plan Sponsor Fiduciary Liability?
Interested in learning more about this and other important topics confronting 401k fiduciaries? Explore Mr. Carosa’s new book 401(k) Fiduciary Solutions and discover how to solve those hidden traps that often pop up in 401k plans.