I think this is my favorite section, because I let all the air out of the people who sell the “best” investments or deride “bad investments”:
Reduction of Risk
Understand the fundamental difference between accumulation and retirement
In retirement, risk is a far greater enemy than lack of returns. In accumulation, diversification is your main method of reducing risk. The biggest challenge that you face is losing too much because all your eggs are in one basket. But in retirement, you are looking at inflation risk, interest rate risk, market risk, liquidity risk, longevity risk, sequence of return risk, and more. Balancing between these can be tricky. In retirement, you also don’t have nearly as much earning potential. In accumulation, you have the benefit of dollar cost averaging because you are an “income statement” person. This means that your greatest value is your human capital that allows you to earn an income. Retirement is almost entirely a “balance sheet” game. Your human capital is nearly depleted and has been turned into physical capital. If you lose it, there are very few options for replacing it!
If risk is reduced properly, your plans have a higher chance of working. It has been shown in numerous studies that if you are taking constant withdrawals; a 90/10 portfolio, which will typically have a higher long-run return, has a lower success rate than, say a 70/30 portfolio. But if you take some of that 90/10 portfolio and buy a pension like investment, you could get the same probability of success, but at a higher rate of return. This is not because one investment is better than another; it is simply because the risks have been reduced. And reducing risk does not always mean reducing return!
There are no “bad” products, just bad uses
Different products have different characteristics. You most likely need different products to accomplish your retirement goals. I typically advise to clients to avoid ‘one-trick ponies’. If all I have is a hammer to sell you, all your problems look like nails! There is NO single product that can solve all your retirement goals. And that is the only thing about investments that I can guarantee! Every product has its own strengths and weaknesses. A fixed annuity is great because you can get a fixed, guaranteed income stream which eliminates market risk. But you have to give up your cash so your liquidity risk is very high. Buying mutual funds are a great way to get professional stock and bond management and a diversified portfolio can reduce your inflation risk and interest rate risk. But it exposes you to a great deal of market risk! A variable annuity can be great investment that can compromise between both of these types of products, but it is typically more expensive. Is this extra fee worth it? Maybe, it depends on your situation! A savings account will completely eliminate market risk. But what about inflation or longevity risk? You might not realize it, but judged in terms of inflation risk, a savings account is VERY risky!
You need a mix of all these different products to reduce the risk. You can have money in a savings account, a mutual fund, and a fixed annuity and they will each reduce the risks of the other investments. The old adage it true here, the whole CAN be greater than the sum of its parts!