Are you at or near the point of needing principal protection? Not everyone has the same psychology of investing, but many people start tapping the brakes on their tolerance for risk as they near retirement. While financial markets had some history-making moments in the 2000s, they saw never-before-swings in 2020.
Because of the economic and financial disruptions from the novel coronavirus, and resulting investor fears, the stock market had wild swings happen just in a matter of days. Beforehand, it had taken weeks or months to see such market volatility.
Such uncertainty was tough for retirees and for those who are just on the cusp of retirement. According to Pew Research, 10,000 baby boomers reach age 65 each day. That is a trend that started in 2011, and that Pew expects to go on until 2029.
In other words, this uncharted territory can have a lot at stake. If you are nearing retirement, you may be wondering about your own financial future. Perhaps you are thinking about whether you should have some principal protection for some of your retirement money?
Why Does Principal Protection Matter for Retirement?
One figurehead, Ed Slott is regarded as “America’s IRA expert.” He has been called “the best source for IRA advice,” from IRA rollovers to the tax consequences of different decisions tied to your IRA.
Slott has been a featured speaker in many outlets, including his own PBS television series. In that series, he talks about a few factors that he calls the “Five Silent Retirement Killers”: taxes, risk, saving money, uncertainty, and inactivity.
For Slott, financial risk is enough of a concern to end up in the number-two slot on his list. People have different perspectives, but those of us who are more risk-averse might be worrying about our hard-earned nest eggs.
If you are mindful of your money in this way, you might be unsure of what your finances might look like, both now and for your future.
Everyone’s situation is unique, so the answer for what might make sense for them financially will be different for each person. And no financial decision is ever 100% perfect.
How Important Is Principal Protection to You?
If you are unsure about how you think about your money in terms of risk tolerance and protection of your money, ask yourself these questions below. How do you answer these questions, and what matters most to you financially as you go through them?
- “How do I feel about the money I might have lost?”
- “Could I lose more money?”
- “Do I want to protect my principal?”
- “Do I need to protect my money now so I can be comfortable with retiring later on?”
Don’t Forget About Sequence Risk
As Ed Slott has said at times: “It’s not what you make, but what you keep that matters.” When you are nearing retirement, your timeline for recovery isn’t as lengthy as it was during your career.
One of the bigger risks at this stage is sequence risk. Sequence risk is the probability of someone having financial losses just before or in early retirement. The sequence of negative returns in this timespan can be hard to recover from, especially if you are already drawing on your assets and savings for retirement income.
Just how can those losses add up? A 20% loss would take a 25% rebound to get back to even. Likewise, a 30% drop would take a 43% gain for an account to return to its starting point.
All of this starts with asking yourself a question: As you are getting closer to your retirement years, are you comfortable with the amount of risk in your portfolio? This will be a question with a different answer for everyone.
What About Your Situation?
With risk comes reward. It’s a basic principle in finance: The more risk you take, the more growth potential you will have.
Some will want to continue to carry risk so that they can pursue more aggressive growth opportunities. Others would like a customized balance of risk and principal protection in their portfolio that feels right for them. Then there will always be a segment of people who aren’t interested in having much risk in their portfolios.
Another factor that affects this answer is how much you currently have saved for retirement. That will help provide the amount of income that you will need for a comfortable retirement lifestyle.
But it’s also good to think about capital preservation at this stage. Many financial professionals will say that the sequence of annual returns that you earn – or lose – has the greatest impact in the five to ten years before and after retirement. If you were hit with a big loss, such as many folks were in 2008, then it could take years just to get back to where you were before the crash.
Going Backwards to Move Foward
With a financial professional’s help, do a thorough walkthrough of your current financial strategy, see your progress, and revisit your goals.
They can help you work through these what-ifs and see what solutions, if any, might make sense for you. By working backward in this way, you can see if there are any other steps you can take toward your financial goals.
In this current market environment, volatility is back in style. Many financial strategies will keep some focus on growth. But for those who are concerned about risk, it’s worthwhile to consider how you can protect your principal, too, and see what you can do to not go backward.
One possible solution that you might look at is a fixed index annuity.
How Does a Fixed Index Annuity Work?
Fixed index annuities are a type of annuity that guarantees your principal and pays you interest based on an underlying benchmark index. An example of a common benchmark for many fixed index annuities is the S&P 500 price index.
When this benchmark goes up, your annuity will earn interest that is based on a portion of that growth. When the index goes down, your principal and earned interest are locked in. The annuity simply earns zero percent for that time period.
Since the annuity guarantees your principal, there are only a few ways you can lose money with an indexed annuity.
One way is if you take out money in excess of the free withdrawal amount in a given year. Annuities are a longer-term vehicle for accumulating money, and if your withdrawal charge schedule isn’t done yet, in this case you may have to pay a surrender charge.
But you won’t lose money due to the underlying benchmark going. The other time that you might lose money is if you are paying say an annual rider for a specific annuity benefit, such as a lifetime income rider.
If your annuity earns zero at some point, then the fee could slightly offset the zero-percent credit. Your financial professional can walk you through this possibility and help you find alternative options with no fees if it matters to you. You shouldn’t be afraid to ask about it.
Guaranteed Income Helps Keep Sequence Risk at Bay
Just as other kinds of annuities can do, fixed index annuities can pay guaranteed streams of income that last a lifetime.
In many cases, someone can opt for this without having to give up control of their entire principal in the contract. With annuitization, you receive a guaranteed lifetime income but also give up access to your money in this way.
This can be avoided by choosing an annuity that has an income rider benefit. This type of rider can be turned on and off as needed. When it’s on, it still provides guaranteed lifetime income.
No matter what happens in the stock market, you are contractually guaranteed to receive that lifetime income from the insurance company.
Planning for Your Financial Future
Are you within 10 years of retirement (either before or after)? Then it’s good to take heed of how much market risk that you have in your portfolio.
Does the amount of risk match up with your goals for growth and retirement? Is it fitting for your tolerance of risk at this stage? Or could any adjustments potentially help you reach your goals more in the long run?
These are questions that your financial professional can help you answer. Chances are that your retirement portfolio is one of your largest personal assets.
For many, their house is also a key asset. Most people would never think of leaving their house uninsured. So, might it make sense to insure your retirement portfolio as well? Depending on your goals, a fixed-type annuity may help you do this with its unique guarantees.