An 87yo couple friends of mine are moving to a facility and must demonstrate that whatever nut they have (say 100k, just guessing) must be invested somehow. I believe that's the story anyway. They have serious health issues (afib, COPD, more) but it is not inconceivable that they could keep going for years, maybe even a decade --- pretty far from being inconceivable, actually. They're inclined to buy an annuity of some sort (AARP-associated) and get 8% for both or 10% for one. I am so disposed against (but otherwise ignorant about0 annuities --- immediately elimination of all the money at hand in exchange for brief certainty blah blah --- that I was thinking of suggesting some alternatives, but know nothing of the stable-value world or anything like it. I probably could not in good conscience urge them toward BERIX or OSTIX, even. There must be some fee advisers here who deal with this issue. I could try to pitch a bond-heavy blended something or other and point out to them that there would not possibly be total loss and they would have access to much more than 8k a year no matter what. But not sure that would fly, or that I could make the argument persuasively. Thoughts? TIA much.
Comments
Hope they have more than 100k. But I would think "invested" can be anything from a savings account to a brokerage account.
Here's an article I found from bloomberg:
businessweek.com/magazine/content/09_28/b4139074385496.htm
Regards
I regret that you are presently confronted with this delicate and sensitive investment issue. Indeed, with age, investment options vanish and emotions are high. We all are forced to address this issue at some point.
This problem is surely not in my competence wheelhouse. Also. I mightily resist making specific investment recommendations. However, my wife recently acted on this challenge, and even today, she is helping a daughter-in-law chase down some elder care options. So, currently, we are haunted by a similar problem with some tough choices.
As an initial step, I propose you assess a realistic life expectancy to scope the timeframe. Using recent social security tables, an 87 year old male has a current 12.4 % likelihood of passing away this year, and a projected additional life expectancy of 5.02 years. The 87 year old statistics for a female is 9.5 % and 6.03 years, respectively. So there is indeed a small probability that one member of the family could survive for a decade.
Based on these limited experiences and the life expectancy tables, I suggest you consider a short term corporate bond fund. Given their low costs in all categories, you might want to throw the Vanguard Short Term Investment Grade Admiral mutual fund (VFSUX) into the candidate hopper.
That fund, over timeframes of 1 to 15 years, has recorded a positive Sharpe ratio so it consistently delivers returns over government Bills and also outdistances inflation.
Over 1 year to 15 year time-spans it has registered standard deviations that are about one-half of its returns for each measurement period (data from Morningstar). That translates to a less than 5 % likelihood that the fund will generate negative returns for any single year. This low likelihood and low volatility should lessen the worries from older folks.
The low 0.10 % expense ratio for the admiral shares ( $ 50 K minimum) is attractive as is dealing with Vanguard’s management stability. A customer has easy and immediate access to the fund. This fund option is worth a moment or two of reflection.
I wish you good luck and success in addressing this emotionally charged matter.
Best Regards.
Thanks again, just writing out loud
Opinions on annuities vary but a lot of them aren't necessarily from a good understanding of them. The sleazy channels through which many of them are sold doesn't help either.
The biggest problem is that people (even some here) don't understand risk and what risk management is and they may not understand the concept of insurance either. All this comes from a lack of intuitive understanding of probabilities.
Annuities are a mixed investment and insurance product. As such, they behave differently from both.
There isn't a mystery to how annuities work. Any individual has two financial risks - market risk and longevity risk. There are ways to manage this but there is always a cost to managing risk. So, it is a trade-off between the potential impact of negative consequences of risk and the cost impact of reducing it. This depends on the individual circumstances.
Annuities work by taking on market risk and longevity risk but for a price. They introduce an insurer stability risk, but I will neglect that for the moment because that is handled differently.
If you knew you were going to live exactly for X years, there is no longevity risk and you can take market risk by investing the money. The problem here is one of cash flow because if the markets enter a bear period, you cannot assume an income flow without risking shortfall. If you had an investment product that guaranteed some X%, then you can take longevity risk by investing and drawing down based on that return. But the problem is one of shortfall if you were to live longer than you expect.
Annuities try to solve that and aren't by themselves evil, only bad fit depending on circumstances.
Annuities are NOT instruments to give you better investment returns or let you come out ahead than investing in your own. Nobody can offer annuities if that was the case.
Hypothetically, imagine if you could invest by yourself based on some assumption of market returns and longevity, AND you could take out an insurance on market downturns or longevity so you got paid only if the market went down or you lived longer. There would be a premium cost to that insurance that would eat into the investment returns. If you never needed that insurance, you have paid a non-refundable cost but you got a guarantee in case that wasn't the case. If you needed that insurance payout, then you MAY come out ahead. That is the way insurance works and this is what annuities basically are.
The way the annuities are priced aren't a mystery. The insurance company calculates present value of cash in reverse with assumptions on market returns and longevity. So, they can calculate a payout schedule for which the present value is the amount you want to put into the annuities. They are also managing risk and they are not nonprofit, so they account for that in two ways - one, with an insurance pool they reduce longevity risk, the same way life insurance works and they give you a payout whose present value is less than the amount needed for the annuity. The cost of doing business is accounted this way. There is nothing inherently evil about this, just an evaluation of whether the insurance premium is worth the insurance.
What are the alternatives? Investing on your own. People who suggest you can do so and prevent cash flow or shortfall problems if you have a long enough period really don't understand risk. Investing gives you return for taking a risk, if the returns were such a no-brainer, why would the markets give you those returns?
The key to understanding this is that there are different kinds of risks and some people have better ability to take on some risks than others and therefore can get a return for them. For example, if you have a time period over which you don't need liquidity, than you can get higher returns over someone that cannot take that illiquidity risk. The longer the time period, the better the returns. You can do this easily in the accumulation phase but not necessarily in the drawdown period and so you cannot assume those guaranteed results if you need liquidity.
The instruments that provide a return without liquidity risk may require you to take on other forms of risk, a common one being inflation risk. Or, it could be interest rate risk. This may create a shortfall risk if in a drawdown period and so some people may be able to take it on better than others and so get returns for it. So, there is no getting around the fact that every option has some risk you are taking on, if you expect a return. No amount of looking at the past is going to change that. Rewards may be commensurate with risk but not guaranteed by it.
So, the decision comes down to evaluating what risks one is able to take and the products that are right for it.
The starting point for this in a drawdown period is an evaluation of the financial requirement, both in terms of the absolute minimum needed (to avoid large consequences such as getting evicted, not getting health care, not having food, etc) that people can survive on if necessary and a desired need that will let them enjoy life as they would like to. The former is where you want to take the least risk.
Ideally, if you have enough capital you can self-insure not because you will be a better investor but you don't have as much of a shortfall risk and you can take on cash flow risk in down markets from the buffer.
Most people don't have that much capital in retirement years, so the calculation becomes difficult.
The next option if the above is not feaaible is a combination of annuities and investments. Ideally again, buying an annuity for that absolute minimum calculated above to take care of minimum cash flow risks and investing the rest taking on shortfall risks for the "discretionary amount" may be an option with lower amount of capital than self insuring all risks. The older the people get, the more feasible this option gets.
If there isn't enough capital to even guarantee the minimum with everything in annuities, then the reality is that one is underfunded and not something that can be fixed easily. The only option might be to take market and longevity risks and hope for the best in the time left.
There may be a partial solution by buying annuities with inflation risk taken by you than annuities that take on inflation risk for you as well and hence more expensive.
The above is a framework for that calculation for each specific person. Annuities may or may not be a good fit depending on personal circumstances and the price of available annuities for the risks outsourced.
In any case, the decision shouldn't be based on uninformed or uncertain (by being unfamiliar) opinions on annuities, they are just another financial product with good and bad applications. Just avoid the sleaze channels through which annuities are often sold and explore the options available in the context of the needs of this couple. That is the best one can do.
Let me just highlight and amplify a couple of your points. This is something I've stated in other posts (though not quite as clearly). IMHO, the greatest value of annuities is in covering the minimum cash flow needed (after adjusting for SS and other pensions). Because that is a necessity. Beyond that, it is a tradeoff between certainty at a cost (the "vigorish" of the insurance) and the risk of an investment downturn.I'm not sure about "ideally", but this is a key point. People who don't annuitize are self-insuring, though they may not think of it that way. There is an opportunity cost to self-insuring (setting aside reserves) - it's not free. For shorter life expectancies, the opportunity cost is higher, because one has little if any time to recover from an investment downturn. Or, as cman wrote: "The older the people get, the more feasible this option [using an annuity for the minimum needed cash flow] gets."
Reiterating and combining a couple of other points: annuities are not evil and many people don't understand risk and insurance. IMHO the latter is sufficient to explain why annuities specifically, and insurance in general are said to be "sold" rather than "bought". This lack of understanding also invites unscrupulous sales and the design of products that are salable rather than well suited to real (as opposed to perceived) needs. None of this leads to the conclusion that all annuities are necessarily evil (though some particular products are especially vile).
One last point on the selling of the product. I have a personal bias against AARP-branded products. AARP is charging a fee for the branding, which needs to be paid for by the insurer, and ultimately by the policy holder. Even if AARP served as a "Good Housekeeping Seal", there are other insurers who are well rated and may offer better products (without having to pay the licensing fee). That said, it is essential to check that the insurer is financially sound and that you are comfortable it will be able to meet its liabilities for the duration of the policy (here, about a decade).
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