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Income Annuities Help Eliminate Sequence of Returns Risk

A lot of Americans face the possibility of having to fund a retirement that lasts thirty years.  It can be difficult without a pension and with a Social Security system being pushed to capacity.  But it is possible to save enough money and make sure that money lasts for as long as you live.  U.S. News & World Report told us “How Retirees Can Build a Portfolio for the Next 30 Years” in an article by Kate Stalter.  There are two things you have to focus on to make this happen.  You need to protect your nest egg and create an income stream that will carry you through retirement.  Doing both of these requires a balance that you might need a financial professional to help with.  Believe it or not, managing emotions is one of the most important jobs of a financial advisor.  They have to help you keep your emotions regarding finances in check along with making logical decisions about what you should do with your money.

We’re almost seven years out from the financial crisis of 2008 that took a big chunk of money from a lot of investors, but the emotions surrounding that event still run high.  It’s difficult to balance risk and return, especially when markets can be tumultuous.  Investing is not all about the numbers; it’s important to manage the emotions that go along with the ups and downs of the stock market.  It can really hurt your overall returns if you are making portfolio changes often because of market changes or news stories.  Studies show that your overall returns are worse the more you change your portfolio.  The article does not recommend investing in individual stocks because you truly never know what could happen to that company in the next thirty years. Their recommendation is to use broad index funds.  This approach also helps to avoid the sequence of returns risk.  This happens when you have to start taking money out during a down market.  It is almost impossible to make up for the losses in both return and assets in this unfortunate situation.

This is why a lot of people turn to income annuities with some of their retirement savings.  We talk a lot about Wade Pfau’s important retirement income research.  His solution to the sequence of returns problem is to put your money in a combination of stocks and a fixed single premium immediate annuity.  Even though this strategy takes some of your money out of the stock market, it offers insurance against market downturns early in your retirement.  He recommends income annuities as a bond replacement.  Pfau says that you can certainly account for the sequence of returns risk if all of your money is in stocks, but it requires a mindset that many Americans don’t have.  You have to reduce your spending and expenses during the years that the markets are down.  I don’t know a lot of people who would enjoy reducing their spending when they could’ve kept it the same by using an income annuity for fixed payments.  It’s difficult to plan for the future because you truly don’t know what is ahead.  Including an income annuity in your retirement plan allows you the peace of mind of knowing that you will continue to receive a fixed amount of income monthly regardless of what happens in the stock market.

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