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The Secret to Minimize Risk and Maximize Returns

Kelly Shaw

I’ve been a financial advisor for over 22 years, and one thing I’ve learned is that when most clients approach retirement, they consider themselves conservative investors. Yet in 22 years of examining retired clients’ asset mixes, I find that most are actually allocated more toward a moderately aggressive mix. Why is there such a discrepancy between what they want and what they have? The reason is that most of them don’t have a very clear picture of what retirement looks like to them – what it will cost them for that lifestyle, and how long they will actually live. Then to compound matters, they truly don’t know what type of real return they need or how to set up their portfolios to accomplish that goal.

Clients want to maximize returns with as little risk as possible, but they also still want to grow their accounts. Most of them only know how to invest long-term for growth because most of their financial advisors have only been trained on how to grow assets or gather assets, but haven’t been trained on distribution during retirement. Most advisors are still operating on the old rule of thumb that it’s ok to take 4% income from a portfolio, index for inflation, and then you should be safe. Wrong – big wrong! Studies have proven this wives’ tale false, with disastrous results.

A recent study conducted in 2013 by Dr. Wade Pfau, professor of retirement income at The American College, Dr. Michael Finke, professor and Ph.D. coordinator in the department of personal financial planning at Texas Tech University, and David Blanchette, head of retirement research at Morningstar Investment Management, showed that if you took only 4% withdrawals from your portfolio and increased your payment to account for inflation, you would have a portfolio failure rate of 57%. Yes, up to a 57% failure rate. In the study, he said that with a 2.5% withdrawal rate there is only a 10% chance of failure. That’s like getting on a plane and having to sign a disclosure form saying you have a 90% chance of landing safely but a 10% chance of crashing! Would you take that chance? I wouldn’t.

So, what’s the answer?

A study by The Wharton Business School of the University of Pennsylvania conducted by David Babbel, Geoffrey VanderPal, and Jack Marrion has helped us with that answer, as well as a recent study by Ibbotson and Annexus Research.

Let’s look at the facts: Most clients say they are willing to accept 50% to 60% of the upside of the market, as long as they can stay in that 10% to 15% maximum drawdown if the markets tumble. That’s why they typically have an equity-to-bond mix of 40% to 60%. They believe this will give them good upside while allowing for a lower downside. Unfortunately, that is not the case, as we saw in 2000 to 2003, and again in 2008 to 2010. The markets dropped 40% to 60% in both of those downturns, and a lot of people who had recently retired or were near retirement saw their portfolios drop anywhere from 30% to 50% over each of those downturns. This problem was compounded if those clients were taking withdrawals at the same time to supplement their retirement income. This resulted in many retirees either having to go back to work or put off retirement until they could recoup their money.

Since then, there have been numerous studies done on how to minimize risk and maximize returns to preserve and protect portfolios for retirees, particularly in markets like the current one with wild up and down swings. One is the 2013 Ibbotson study done in conjunction with Annexus Market Research, which found what I believe is the perfect mix of assets to be able to safely generate income and enjoy a stress-free retirement for a 30-year period. They found what I think is the Holy Grail of retirement income planning, a proven method to maximize return and reduce risk for a 30-year retirement that starts at age 65 and lasts until age 95. I know this may sound like a long time, but according to the Social Security Administration, a married couple age 65 has a 50% chance of one spouse living to age 95.

So, let’s take an average couple age 65 who needs to generate income in retirement of roughly 4% of their investment portfolio per year. We’ll need to index that income for inflation at about 2.2%. We’ll assume they have a million-dollar portfolio, so our starting income is $40,000 a year. So how can we optimize for income and minimize risk? Now, let’s say it’s a retirement account – maybe an IRA or 401k. The clients have done their research and decided to start taking Social Security at age 66 utilizing a file-and-suspend strategy. This strategy will maximize their lifetime income and grow with cost-of-living adjustments (COLAs) every year. However, they are still roughly $30,000 a year short to fund their lifestyle. That is why we need $40,000-$10,000 taxes=$30,000 net. If we assume a moderate inflation rate of 2.2%, how will we do?

If you have $1,000,000 invested, with 20% into equities and 80% into bonds, taking a 4% withdrawal over that 30-year period of time provides the income we need, and after 30 years there’s roughly $300,000 left in the account for what’s called residual wealth or legacy wealth. This is the money left to your heirs at the end of the 30-year period, which is fine as long as you die on time. But what happens if you live much longer?

Now, let’s take the same scenario, except let’s increase equities to 24%, place bonds at 36%, and then place 40% in an indexed annuity that provides us with an income guarantee we can never outlive. We are able to generate the same income, but it now leaves $825,000 left for our heirs – our legacy. It provides us with a 69% reduction in risk, an improvement of $535,000, and a 184% improvement in our account balance after 30 years.

If we do the same thing, but instead of 40%, we put 60% in the annuity, then what happens? The new asset mix is 16% equities, 24% bonds, and 60% in the indexed annuity. After 30 years, we still have $817,000 left in our account, with a risk reduction of 79% and $525,000 in residual legacy.

This shows that you can still have your cake and eat it too. In other words, you can still be invested in the market and you can still be invested in equities and bonds, but at the same time, if you want to lower your risk, get better returns, and have better guaranteed income, then you may want to think about putting roughly 40% in an indexed annuity. I think that’s the perfect amount of money to put into a safe, secure, properly structured indexed annuity. If done correctly, that will give you guaranteed income for life, as well as index for inflation.

The same scenario works if you don’t need income and are only concerned with growth; it increases growth by 10% and reduces risk by 18%.

With some of the newer annuity products provided today that have an income rider available, you can get a 6%, 7% or 8% – in some cases, even a 10% – guaranteed roll-up/increase on the income account values each and every year. Some have 4%, and whatever you make on your account values each and every year. These accounts can be indexed to market indexes like the S&P 500 index, the Dow Jones index, a defensive Dow strategy, a gold index, a real estate index, a blended index that could incorporate European markets, or a commodity index. There are dozens of options available you can take advantage of to help preserve, protect and grow your portfolio.

In the last 20 years since indexed annuities were created, they have actually become their own asset class. They were designed to perform somewhere between bonds and equities, but with zero risk. It’s become the perfect marriage of risk and return. I don’t believe that over the long-term 30-year period they will outperform the market, but during short bursts of five to 10 years, they can actually outperform basic markets like the S&P 500, because when the markets drop 20%, 30% or even 40%, they have no downside. They can’t lose money or your previous gains that were locked in, so during good times you can capture 60% to 80% of the upside of the market every year or two with no downside risk. You can lock in your gains every year and have increased or higher death benefits if that’s important to you. You can have income benefits, so you can turn on the income riders and guarantee your lifestyle income as long as you’re retired. If you’re fortunate enough to live into your 100s, you’ll always have the income you need for long as you live.

About the Author:

Kelly Shaw, of SAVE Inc. Financial, has been in the financial services industry for over 20 years. In 2005, Kelly was awarded Advisor of the Year by Weisner Publications, publisher of Boomer Magazine and Senior Market Advisor Magazine.

Kelly is an author and has many publications, including the top-selling Kindle book on college planning, “College Planning Made Easy.” Kelly has done business in San Diego and Riverside for the past 20 years and currently resides in Temecula, California. To contact Kelly, email him at, visit online at, or call (951) 676-6301.


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