From the July 2009 issue of Boomer Market Advisor • Subscribe!

Retirement lessons never learned

Economist John Ameriks says that when an airplane crashes, people do not question the laws of aerodynamics, they investigate what went wrong with the plane. In the case of a severe recession, boomers are questioning the basics of equity investing, especially those who no longer think that equities are a very good investment over the long term.

Financial advisors are questioning their basic beliefs about equities based on the past nine months. It's far too soon for that. One danger is that many people will avoid equities too long, remain in low-paying fixed investments and miss a major upturn.

There are two lessons to be drawn, one for those more than five to ten years from needing to draw income from their investments and another for those close to needing to take income or taking income from their investments. (I use the term taking income rather than retirement because many people do not start drawing income from their investments as soon as they retire. To the extent you delay drawing income you can wait for the equity market to recover.)

For those who do not need to take income for five to ten years the key lesson is that financial downturns occur regularly and are actually investor opportunities. Over the past century there have been more than 30 bear markets, with drops of at least 20 percent. Accumulators tend to feel bad about these temporary losses of values, but they shouldn't. Buying low is a plus. New investors should be told that expecting a number of bear markets during their accumulation period is a good thing. If they are disciplined they can try to buy more equities when values are depressed and this can help them accumulate more money for retirement.

Clients who need to draw income soon, or who are actually drawing income, face a different situation. While buying low is helpful, selling low can be devastating. A market downturn right before someone needs to start selling some equities to fund basic expenses can cause a drop in overall values, and the retiree will never recover.

The solution, however, is not to move significantly to fixed investments. These investments simply do not produce enough retirement income. Basic rule of thumb is that retirees start by spending 4 percent to 5 percent of their assets and then raise that spending 3 percent a year to cope with inflation. But that depends on a substantial investment in equities. If they allocate a lower proportion to equities they will only be able to spend 2 percent to 3 percent of their assets. That will not be enough for most.

Lesson: We need new strategies for those who cannot wait for the market to recover. One approach is to make more use of investments in equities that provide principal protection.

There are several types of annuities that provide this. Some, like those with guaranteed minimum accumulation benefits guarantee that the account value will not be lower than the amount invested at some future time. This product provides a great deal of flexibility and the cost of the guarantee tends to be low. Other products guarantee a minimum amount of income for life that can be derived, even if the account value drops to zero. Using these guarantees five years before income must be taken means that the client will benefit from any market gain, but will be protected substantially against a steep market decline. When income is taken it will not be withdrawn from a depressed value. I am not suggesting the entire equity portfolio be placed in these guaranteed products, only enough to provide enough income that other equities can have time to recover if necessary.

We should refine ideas about how to incorporate these guarantees into our basic ideas about asset allocation for those who need to take income now, or before the market has a full chance to recover.

Mathew Greenwald is president of Washington, D.C.-based Mathew Greenwald and Associates.

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