Few subjects generate endless obsessions among financial professionals to the degree that volatility does.
I’ve always been amazed at how many of us equate volatility with sharp drops in equity prices, not sharp increases. There is a technical term for that—semi-variance. I always thought volatility should be defined by the magnitude of the move, up or down. But what do I know?
One thing many advisors know is that there is a bigger volatility problem for many clients—income volatility. For clients who work, it’s an issue as employers have increasingly turned to different forms of variable compensation like stock options, bonuses and deferred comp.
For retirees, the problem is far more serious. This subject was addressed by economist Allison Schrager at last month’s Investments & Wealth Institute meeting for investment advisors.
What is the bigger risk for clients: wealth or income? Retirees need income, but it takes wealth to generate income streams so the two financial yardsticks are interrelated.
Traditionally, bonds were the vehicle of choice for investors seeking income while looking to control risk and reduce volatility. But at times in the post-financial crisis world, age-old principles have been stood on their head.
Investors have wound up purchasing stocks for income and bonds for capital appreciation, whether or not that’s what they intended to do. As of mid-February, 60% of stocks in the S&P 500 yielded more than the 10-year Treasury.
The author of An Economist Walks Into A Brothel, Schrager noted that what is risk-free to one person is not risk-free to another. Risk aversion varies from person to person and can change sharply during an individual’s lifetime.
Three-month Treasury bills were traditionally defined as the risk-free investment, the foundation upon which modern finance was built. But few ever expected them to sport such paltry yields for so long a time period. Safety today, Schrager noted, is very expensive.
Abroad, the trade-offs are even worse. Schrager observed that in Switzerland some retirees are willing to accept a return of minus 0.5% to avoid a stock market crash.
In this month’s issue, we take a look at how four advisors are working with clients to address the income challenge. You’ll find it intriguing.
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