Boomer clients are desperately seeking return potential from income-generating products -- the sooner the better. We all know annuities can get it done. But where are the other safe havens? Are there any left?
For advisors who are accustomed to using advanced, often complex investment vehicles, the past year has provided a back-to-basics Income Generation 101 refresher course.
"Last year I put more [client] money in CDs (certificates of deposit) than I ever imagined I would in my life," says John Freiburger, CLU, ChFC, CFP, principal at Partners Wealth Management in Naperville, Ill.
That's not a lament so much as an observation. Advisors have had to adjust their distribution strategies and revert to using the simplest safe-haven types of instruments. This is especially true in light of the market collapse and the risk-averse mindset it has wrought among many investors. Wealth managers such as Freiburger are leaving no stone unturned in the quest to provide clients with a diversified, protected income stream. From basic, off-the-shelf vehicles such as bank CDs and money market accounts to more obscure instruments such as equipment leases, all income-generation options are on the table these days, says Nolan Baker, CSA, a retirement distribution specialist and co-founder of the Retirement Resource Center in Maumee, Ohio. "It's sort of a Swiss Army Knife approach. You are forced to think creatively and use all the tools you have at hand."
When it comes to the income component of a portfolio, "there's no one method or approach that works for all situations," says Garth Bernard, president and CEO of Sharper Financial Group, a Boston consulting firm specializing in retirement income solutions. "You really need a combination of approaches, and with those approaches, there has to be an investment piece along with an insurance piece."
Surging demand for fixed annuities (both deferred and immediate) indicates that more investors are using them for the insurance component of their income-generation strategies. But annuities aside, what other income-oriented tools should be on an advisor's Swiss Army Knife? Here are some to consider:
Non-correlated assets, including real estate investment trusts, equipment lease funds and energy funds, are worth a look for the steady returns they provide. Not only are they providing returns in the range of 6 percent to 9 percent, REITs are "about as tax-friendly [an income vehicle] you're going to get," he says, "because they are depreciating [the value of] their properties and providing income. There is also the potential to realize gains from the ultimate sale of properties."
Equipment lease funds are also "a very good alternative" for income-seekers, contends Baker, because they provide modest but steady returns. Besides equipment leases, Freiburger says he's been utilizing a variety of other debt vehicles as income sources, including funds that purchase receivables at a discount from hospitals, which often yield attractive, double-figure returns. "Debt is the new equity," he explains. "There are all sorts of alternatives like that in today's world."
Freiburger likes domestic energy funds for similar reasons. "They can crank out income for years," he says, "and on top of that there are significant tax benefits."
And believe it or not, despite recent bad press, new, more evolved versions of target-date mutual funds are also emerging as viable income-generation tools, says Bernard. "These are what I call protected-growth vehicles - funds that emphasize protection or preservation of principal over a defined accumulation period, with equity participation on the upside."
So-called "high watermark" funds are one such vehicle. Besides protecting principal, he explains, they give investors who hold shares to maturity (and reinvest all dividends and distributions) the highest net asset value attained prior to maturity. Maturity periods typically range from five to 15 years.
For income needs, Bernard suggests another emerging class of managed payout funds designed to distribute income on a monthly basis over a set period of time, such as Fidelity's Income Replacement Funds. "These aren't true target-date funds, but you pick your horizon - say 10 years - and the fund targets a level of income over that span."
One "blind spot" for managed payout and target date funds, cautions Bernard, is their lack of downside protection.
"There is no guarantee the target [income] will be achieved." Indeed, many managed payout funds had to lower their monthly payouts as a result of severe fund depletion in 2008. Timing is another shortcoming, he notes. "Funds with a designated period for distribution are basically asking you to pick the date of your death."
Income-minded investors are also flocking to bonds and bond funds. "One of the reasons bonds are looking so attractive," explains Freiburger, "is that people are scared to death of equities."
Tax-free municipal bonds, corporate bonds and high-yield (junk) bonds each have a role to play within an income-generation plan, he says. High-yield bonds might fit investors who are prepared to assume greater risk in exchange for greater upside potential. Corporate bonds generally are a less risky play and offer higher yields than most muni bonds, notes Freiburger. But in evaluating them, he says, keep timing in mind, since "people can take a hit if they have to sell before maturity." Tax-free munis are also worth a look for their combination of solid returns and tax benefits. Whatever bonds you use, consider laddering them, he advises, to reduce interest-rate risk.
Bonds are hot, but don't overlook stocks as an income-generator, says Freiburger, who nowadays is inclined to recommend certain preferred stock for its ability to "crank out a fairly nice dividend." Well-chosen preferred stock, he explains, "provides a stable income stream, with upside potential. You're thinking short-term and long-term."
Despite less than spectacular rates, traditional bank CDs are appealing as a temporary reservoir for funds that will ultimately land in a long-term investment vehicle, says Freiburger, chiefly because they provide investors with FDIC insurance. Since CD rate spreads are narrow, he notes, "there's not much advantage to going out more than a year" with traditional CD investments.
Not all CDs are created equal in terms of their income potential. Baker lately has been recommending clients invest in structured CDs, whose rate of return is linked to some extent to the performance of the stock market, giving investors an opportunity to participate in positive movements of the market (up to a predetermined cap) while providing principal protection (FDIC insurance) on the downside. "It's a shorter-term alternative to an annuity, like a fixed income annuity," he explains. "That appeals to boomers, as does the FDIC insurance protection, plus the ability to get really great returns."
Treasury bills, Treasury notes and TIPS (Treasury inflation-protected securities) are also viable vehicles for parking money for shorter terms of one to five years, according to Baker and Freiburger. Interest rates on T-bills and Treasury notes "are not particularly exciting," Freiburger observes, so it's wise to keep terms to two years or less. Investors who want inflation protection can turn to TIPS, which afford that protection in exchange for somewhat lower rates than those of T-bills, for example. They also carry longer maturities - a minimum of five years, compared to a year or less for T-bills and two years for Treasury notes. "I'm recommending TIPS," explains Baker, "because I believe inflation will be a big issue in the near future."
One final piece of advice from Freiburger to those evaluating income-generation tools, direct from the once-burned, twice-shy school of investing: "If the return sounds too good to be true, it probably is."