Imagine if you had to replicate—at an individual client level—every mutual fund you purchased by buying individual equities. You couldn’t do it. Not even for the simplest S&P 500 fund. Not because you don’t have the skill, but because there isn’t enough scale at an individual client level. And, it would be a terrible use of your time.
Fortunately, since there are packaged solutions (ETFs and mutual funds) that can give you the range and diversity of investments you need in an inexpensive, efficient way, you don’t need to replicate those strategies. You just buy them rather than build them. Better for your client. Better for you. No-brainer.
Now, instead of trying to replicate a simple S&P 500 mutual fund, let’s consider what it takes to build a retirement income portfolio. What you’re trying to do is replicate an annuity rather than a mutual fund. At an individual client level. A far more complex proposition which, for a long list of reasons, can’t be done. Again, not because you don’t have the skill. It’s simply not possible, at an individual client level, to have a broad enough portfolio of investments to generate the yields and have the diversification of risk that you can buy through an annuity. Nor can you provide a guarantee, or leverage risk pooling and mortality credits to further enhance payout rates. Annuities do all of this very well.
Numerous academic studies demonstrate that annuities are a more efficient means of generating retirement income than traditional portfolios. Studies also show the psychological benefits annuities bring to retirees. But most RIAs have been handicapped in generating retirement paychecks for their clients due to their aversion to annuities. If you examine the process RIAs have to endure to generate retirement paychecks without annuities, well…annuities are a no-brainer.
But instead RIAs try to build income portfolios.
I am struck by the significant executional challenges RIAs face in trying to create retirement paychecks without annuities. Here are just a few of those challenges:
• Trying to find sufficient yield in a low interest rate environment
• Trying to find diversified income sources (dividend yielding equities, bonds, REITs, etc.)
• Managing the risks and varying returns these sources can generate
• Determining the tax implications (qualified accounts, non-qualified accounts, short-term gains, long-term gains, dividends, tax brackets, impacts on Social Security)