Hegna's Hotseat

The Research behind Retirement Alpha


ou all know what alpha is. Simply put, alpha is the outperformance of a portfolio that the fund manager brings, knowing what to buy, when to buy, and when to sell. So, where is a 75-year-old couple supposed to get alpha in this market? In this low interest rate environment CDs, stocks, and bonds aren’t providing adequate alpha. The market is too volatile for them to handle. The solution is simple. They need RETIREMENT alpha from the mortality credits that only life insurance and annuities can provide! The Financial Research Corporation (FRC) of Boston published a whitepaper in 2010 called “Income Annuities Improve Portfolio Outcomes in Retirement” that said, “Income annuities offer features others can’t—high cash flow, uncorrelated to market returns; retirement alpha in the form of mortality credits, which only life insurance companies can manufacture; longevity hedging and liquidity features.” Here’s a fact I want you to understand: a portfolio with a lifetime income annuity will outperform the traditional 60/40 portfolio almost all of the time. Don’t take MY word for it; look at the following research, and do the math. For those who don’t believe me, I have a special challenge at the end of this message.

According to Dr. Menahem Yaari, there was no alternative to a lifetime income annuity that could guarantee a more “optimal” solution. You hear me use that word a lot because I’m not saying other strategies are “bad,” they’re just less than what they could be. The reason has everything to do with mortality credits. The risk pool can pay more than a person trying to maximize income on their own. In one of his many articles, Dr. Moshe A. Milevsky wrote that the “do-it-yourself” strategy using a well-diversified portfolio of stocks, bonds, real estate, and the normal investment classes, then withdrawing a fixed amount from principal, dividends, and interest, will likely FAIL if you live too long or continue to withdraw money during an extended bear market. This is exactly why retirees need retirement alpha! Only the mortality credits of a lifetime income annuity can remove longevity risk from retirement planning, but what about the math that proves this?

Many financial planners and brokers use Monte Carlo simulations to show that a stock and bond portfolio can work in retirement. They typically use age 90 as the maximum age for these illustrations. Think about that. Even though most people do not think they will live to age 90, the facts are very different. 33% of men, 44% of women, and 63% of married couples will have at least one of them live beyond age 90! Therefore, if you are married and you set up a financial plan that will last until age 90, that plan will fail 63% of the time! An FRC report emphasized that no other investment vehicle could match the income annuity for providing retirement security. No other investment vehicle was as efficient in creating retirement income from assets. No other investment vehicle could generate more income per dollar of capital. This report found that adding a lifetime income annuity to a diversified portfolio significantly outperforms portfolios without one. And for the brokers who still don’t believe me, just plug age 100 or 105 into your Monte Carlo simulation. Nearly 100% of those simulations FAIL. With the ever-improving medical technology, many experts believe it will not be unusual to have people live to be 125 years of age and even older!

If you don’t believe me by now, I’m offering a whole case of books to anyone who completes this challenge: Take any diversified portfolio (it must have both stocks and bonds), remove some of the bonds, and replace them with a lifetime income annuity. You know what it will do to that portfolio? It will reduce the risk to the portfolio and increase the returns! Here is why: when you add a lifetime income annuity to a portfolio, it functions like an AAA bond with a CCC yield and zero standard deviation or volatility. Try it. See if you can prove me wrong. If this doesn’t outperform the original portfolio, I owe you a case of books. And if you want all the research behind the optimal retirement plan, read my whitepaper called, “Retirement Alpha: How Mortality Credits Improve Retirement Outcomes.”

Happy New Year
-Tom Hegna

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