Morningstar Advisor - December 2010/January 2011 - (Page 40)

Spotlight Creating Portfolios That Confront Retirement’s Risks By James X. Xiong and Thomas Idzorek Adding longevity insurance to a portfolio is a delicate process. Here are the primary factors you’ll need to consider to do it correctly. In trying to rebuild battered retirement portfolios in a low-return, volatile investing environment, retirees and their financial advisors are confronting dual challenges: returns is not important. During retirement, the sequence of returns becomes crucial. Fortunately, investors and advisors have access to effective tools to combat these risks. New research from Ibbotson Associates shows that investors can mitigate both longevity and investment-performance risks with a carefully constructed combination of longevityinsurance products, which offer investors a guaranteed income stream, and traditional assets, such as exhange-traded funds and mutual funds. What is the best combination? That depends. After running hundreds of simulations, Ibbotson created guidelines to help advisors and their clients set the optimal allocations in their retirement portfolios to insure an income for life. Ibbotson’s research shows that advisors and clients must weigh a number of variables that depend on each client’s situation and goals. Annuity Divide Longevity risk, or the risk that retirees will outlive their savings. The average 65-year-old retiree can expect to live another 20 years. Record numbers are expected to live past the century mark. Living a long life has its pluses, but it creates considerable uncertainty around how much money people will need to fund a retirement. Some retirees unnecessarily adopt frugal lifestyles out of fear of facing financial ruin, while others spend too much too quickly, depleting their savings to unsustainable levels. The intensity surrounding the annuity debate is unfortunate, because emotionally charged decisions seldom lead to good outcomes— especially during a time when many retirees are trying to rebuild their portfolios after experiencing substantial losses in the 2008 financial crisis. If the market meltdown wasn’t putting enough pressure on retirement portfolios, the paradigm shift away from defined-benefit pensions to defined contribution pensions, long life expectancies, rising health-care costs, and uncertainty surrounding Social Security benefits dramatically have. To respond to these challenges, advisors and retirees are considering ways to turn a portion of their retirement portfolios into pensionlike income streams. Innovations have taken place in the development of longevity insurance that make it possible for today’s retirees to build a secure retirement. Insuring Income for Life Investment-performance risk, or the risk that poor returns will reduce the value of retirees’ savings. Once in retirement, the income flowing from a portfolio made up of stocks and bonds is very sensitive to market fluctuations. A series of ill-timed downturns in the market can drastically increase retirees’ longevity risk, forcing them to substantially lower their standard of living. When investors are accumulating assets in the years before retirement, the sequence of the portfolio’s Annuities can be expensive and hard to understand, and determining how and when a retiree should use them can be confusing and difficult to determine. Among advisors, few products are as polarizing and provoke more emotions. At one extreme are advisors who refuse to consider the use of annuities under any circumstances. At the other extreme, unscrupulous, or uninformed, advisors make egregious annuity recommendations. The first widely available form of longevity insurance was payout annuities, also called immediate fixed annuities. With payout annuities, an investor purchases an annuity contract with a lump-sum payment. In return, the insurance company promises to pay the investor an income stream for as long as he or she lives. Many investors balk at this type of insurance because they are reluctant to exchange a large amount of their net worth for 40 Morningstar Advisor December/January 2011

Table of Contents for the Digital Edition of Morningstar Advisor - December 2010/January 2011

Morningstar Advisor - December 2010/january 2011
New on
Letter From the Editor
What Strategies Do You Use to Help Retirees Hedge Against Longevity Risk?
Investment Briefs
Four Picks for the Present
Scaring the Swiss
Tech Is the Apple of Managers’ Eyes
How to Read an Sec Filing
A Strategy That Loves Performance Chasers
Things Fall Apart, Even in Industrials
A Future in Questions, Not Answers
Research Over Chocolates
Creating Portfolios That Confront Retirement’s Risks
Building in-Retirement Portfolios to Last
On the Lookout for Guaranteed Income Streams
What Fires Up Mairs & Power
All Aboard!
Aiming at Alternatives
Stuff Your Stocking with Out-of-Favor Bargains
Stable, High Yields (No Bonds Included)
Mutural Fund Analyst Picks
50 Most Popular ETFs
Undervalued Stocks with Wide Moats
Twelve Bee, Huh?

Morningstar Advisor - December 2010/January 2011