The Added Value of Product Diversification in a Portfolio

When clients reach retirement, advisors play a important role in helping them balance their need for wealth preservation with the new goal of generating income from their savings. While investment diversification remains an important strategy — particularly the process of shifting assets to provide greater stability and income potential — there are additional ways that advisors can help protect clients’ savings and provide greater income certainty.

Here is a look at one of the key challenges advisors and clients face when turning assets into income, along with a potential strategy to help protect assets to meet individuals’ goals.

Timing Matters- How Market Performance Affects Income

Even during retirement, when clients are counting on their assets to provide income, continuing to maintain a diversified portfolio can help provide reasonable growth that allows the client’s purchasing power to keep pace with inflation. And while diversification can help mitigate the effect of market downturns, diversification cannot eliminate all risks. Market performance variation, specifically during the period in which clients are making withdrawals, can affect how much income clients can safely take from their savings — and how long those assets might last.

Consider this hypothetical example: A client with $100,000 saved in a 60% stock/40% bond portfolio needs to make a 4% annual year-end withdrawal for 10 years. Depending on when the client begins making withdrawals, and how the market performs over the next 10 years, the outcome could be very different.

Based on market data from 1998–2017, the 10 years from 2008–2017 would have provided the best outcome — generating $43,506 in income, yet still allowing the portfolio to grow to $131,850 for future income needs. The worst outcome would have come between 1999 and 2008, when the portfolio generated slightly less income but would have declined in value to $79,783 — leaving fewer assets available later in retirement.

Same Investment Mix, Different Outcomes

How the market performs during periods when people make withdrawals from their retirement accounts can lead to very different outcomes. Here are three scenarios for investors with the same diversified investment portfolio, making the same 4% annual withdrawals for 10 years, based on market performance from 1998-2017.

The variability in potential outcomes makes it difficult to plan how much income clients will receive from their investments — and might require advisors to consider additional strategies for generating income in retirement.

Supplementing Assets with Guaranteed Income

During retirement, diversifying the mix of financial products in a retirement plan — including different types of accounts, investment vehicles, insurance products, and annuities — may be equally important as asset diversification within those products. Supplementing an IRA or 401(k), for example, with other financial products can have a large impact on the amount of retirement income received and the sustainability of that income throughout a client’s lifetime.

Advisors can supplement investment diversification with financial product diversification as part of a retirement income plan. Using only one product or category, such as qualified retirement accounts like IRAs and 401(k)s, may not allow clients to maximize their periodic income payments, maintain liquidity for emergencies, satisfy their legacy needs, and sustain payments for a lifetime.

To address these needs, consider the role that additional financial products might play in a retirement plan. Guaranteed sources of income, such as annuities, can help diversify financial products in a client’s retirement plan and add an element of protection. For example, variable annuities with an optional guaranteed lifetime withdrawal benefit offer guaranteed lifetime income and the chance to grow assets on a tax-deferred¹ basis by allocating a portion of the client’s purchase payments into sub-accounts that are invested in a mix of asset classes.

In addition to providing diversification and growth, variable annuities offer some income protection during market downturns. If investments aren’t growing because of suboptimal market performance, the annuity’s income remains flat — a much better outcome than if the asset mix was held outside of an annuity, where income could potentially decline. On the other hand, if investments are growing, income may rise above the previously locked-in rate, allowing the client the benefit of asset growth and direct, positive impact on their income stream.

Products like these help with retirement planning by putting “guardrails” around a portion of clients’ retirement income. Variable annuities allow clients to build capital on a tax-deferred basis, with the chance to generate higher returns through subaccounts that are invested in equities and bonds. While these returns are not guaranteed, adding an income rider can add a level of income protection. Variable annuities also offer some flexibility when it comes to staying diversified and generating potential growth. Advisors can apply traditional diversification strategies within the annuity’s sub-accounts, creating an asset allocation that’s tailored to a client’s specific growth goals and risk tolerance.

Considering product diversification options like this is another way for advisors to fulfill a key role in retirement planning: Helping clients turn their assets into income. This role includes considering the potential impact of market performance on a retirement income plan. Adding forms of guaranteed income to a client’s product mix of IRAs, 401(k)s and other accounts offers additional protection against poor market performance. To see how additional guaranteed income sources can help strengthen a retirement income plan and may help retirement savings last longer, see our conversation guide explaining why clients should consider annuities. While market fluctuations can’t be eliminated, their potential impact can be mitigated to help ensure that the wealth clients accumulate over time will be there to support their income needs in retirement.