Issue link: https://resources.envestnet.com/i/1527488
Annuities as an Asset Class for Fee-Based Advisors l 10 © Envestnet 2022 Stocks create risk. Seeking this higher investment return requires the retiree to accept portfolio volatility with a growing allocation to stocks. Spending from investments further heightens sequence risk. A few poor returns early on could easily derail the attempt to support that 5 percent spending rate for as long as the plan targets. While it is possible to obtain the higher returns necessary to support a bigger spending level in this way, there is no guarantee that this approach will be successful. The stocks strategy provides greater upside potential for wealth to grow, but it also creates greater downside risk that the retiree will not be able to meet the spending goal throughout retirement. The range of potential outcomes widens. The introduction of stock market risk requires two additional elements for the decision-making of our risk averse retiree. What failure probability does she comfortably and willingly accept that her portfolio will not be able to support spending through the planning age? As well, how high of stock allocation is she willing to accept, in terms of her ability to stomach the daily volatility experienced by her investment portfolio? With volatile investments and a fixed spending goal, some probability for portfolio depletion must be accepted by anyone seeking upside growth potential through the equity risk premium. Annuitized assets do not provide upside in the sense that a legacy would be left when markets do well, but they also eliminate downside spending risk. The long-lived do receive a form of upside through mortality credits. The effective return from the annuity matches what the stocks needed to earn to support those longer retirements. For our example in which we said that stocks required a 4.2 percent return to fund a 5 percent distribution rate for 40 years, an annuity is providing this same return to an owner who happens to live this long. For our example in which we said that stocks required a 4.2 percent return to fund a 5 percent distribution rate for 40 years, an annuity is providing this same return to an owner who happens to live this long.