Many people are looking for steady, guaranteed income in their retirement years. There are several different vehicles providing guaranteed income. There are many differences between them. Don’t make the mistake most people make. Don’t consider only one vehicle because that’s what your advisor offers. If you’re interested in guaranteed income, consider the several options out there and compare the results under different scenarios. You should look at immediate annuities, variable annuities with guaranteed lifetime withdrawal benefits, fixed index annuities, and longevity insurance coupled with systematic withdrawals or another annuity during the pre-age 85 years.
Here’s an article that does a good job showing how to analyze a choice. It shows how fees and all the restrictions matter. It also shows that despite all the promises and magic some of these products have, you might be better off with something much simpler and less expensive.
A variable annuity lets your client invest in mutual funds and/or exchange traded funds tax-deferred. Not only are the types of investments limited, but your client also is limited as to how much can be invested in stocks.
The guaranteed lifetime withdrawal benefit is a rider the policyholder gets upon buying this tax-deferred annuity. However, average annual expenses for these types of annuities run greater than three percent—more than your client can earn on a bank CD today. Depending on your client’s age, he or she can get as much as five percent or so annual income from the investment for life–no matter how the underlying investment performs. For example, a $100,000 investment might pay your client $5,000 a year from systematic withdrawals. Once the value of the investment hits zero, the insurance kicks in to continue those payments.
That’s what Bill Gross of PIMCO says in his latest monthly essay. He actually says “there will be haircuts,” meaning bond investors will lose part of their principal or have lower returns as a result of several actions. The haircuts could take the form of principal reductions or forgiveness or inflation. They also could be from an artificial ceiling on interest rates that could be earned on bonds. Before financial deregulation, interest rates that could be paid on many types of savings were limited by law. Now, the Fed uses its quantitative easing to keep a ceiling on rates. Either way, savers lose.
Gross reviews the different ways investors could face haircuts, then he gives some advice about how to handle it.
So it seems as if the barber has you cornered, doesn’t it? Sort of like Sweeney Todd! Let’s acknowledge that possibility, along with the observation that all of these haircuts imply lower-than-average future returns for bonds, stocks, and other financial assets. If so, the rather mixed metaphor of “money’s goodness” and “avoiding haircuts” is still the question of our modern investment age. The easiest answer to the question of what to buy is to simply take your ball and go home. If the rules aren’t fair, don’t play. That endgame however, results in a Treasury bill rate of 10 basis points or a negative yield in Germany, France and Northern EU markets. So a bond and equity investor can choose to play with historically high risk to principal or quit the game and earn nothing. PIMCO’s advice is to continue to participate in an obviously central-bank-generated bubble but to gradually reduce risk positions in 2013 and perhaps beyond. While this Outlook has indeed claimed that Treasuries are money good but not “good money,” they are better than the alternative (cash) as long as central banks and dollar reserve countries (China, Japan) continue to participate.
Early in the year I reported to Retirement Watch readers that cash balances were extremely high. Many people and businesses made moves late in 2012 to avoid higher taxes they suspected could take effect in 2013. The moves generated a lot of cash from asset sales, special dividends, and the like. Money market funds and other liquid accounts were only parking places for that money. It needed to go to work elsewhere.
One place money went was the stock market, as shown by the sharp rise in U.S. stock indexes in the first two months of 2013. But the money also is moving into short-term bond funds and similar vehicles, says Sober Look. One impetus for this move is the prospect of new money market fund regulations that requires the value of shares to float instead of being fixed at $1.00. If you’re going to take the risk of a short-term bond fund, why not invest in the real deal and earn a higher yield?
What’s causing this decline? The common explanation has been a major rotation into equities. That certainly explains some of it, but there is more to the story. Some institutional investors are becoming uneasy about the impending money market funds regulation. Not only are investors paid a near zero rate on their money market holdings, they also may be subject to some NAV fluctuations in the near future. Furthermore, the NAV fluctuations may only be applied to funds holding commercial paper and not to those holding just treasury bills or treasury repo.
Brokers of tax-exempt bonds habitually lie or mislead retail investors, said Ric Edelman of Edelman Financial Services. For a long time I’ve warned most individual investors against buying individual tax-exempt bonds. These are thin markets, so you can’t determine the value as readily as you can for major stocks. There are mark-ups that aren’t disclosed and other disadvantages. Edelman spelled out these and other traps in a recent talk to a Securities & Exchange Commission forum.
• Brokers frequently don’t tell retail investors they can negotiate for yield and spreads on muni bonds.
• Brokers also often don’t let a consumer know that a better price may be available from a competitor.
• Sometimes brokers tell a retail investor that the value of the bond is guaranteed, leading the consumer to think he or she can sell the bond at any time for the original purchase price.
“At end of day retail investors are being lied to,” Edelman said.
The Bank of Japan announced a substantial quantitative easing program recently. I thought the announcement didn’t receive enough attention. That’s partly because Japan’s tried a number of programs over the years that haven’t ended its depression. It’s also because several other events occurred the same week. But investors need to take a look at Japan’s policies and consider how they will affect markets.
Bill Gross of PIMCO is one who changed his portfolio based on the program. Previously he was fairly negative about owning treasury bonds. But after Japan’s QE program was announced, he increased his treasury holdings. Gross expect that one effect of Japan’s QE will be increased buyer of U.S. Treasury bonds from Japan’s investors and others. He wanted to get ahead of the rush.
Gross said he had turned positive on Treasury bonds maturing in 10 years because the Bank of Japan’s aggressive monetary stimulus plan would drive Japanese investors to seek higher returns in overseas markets.
“This BOJ printing seeps out daily into global markets as Japanese institutions which have sold their Japanese government bonds to the BOJ look for higher yielding replacements,” he told The Wall Street Journal on Tuesday. “Ten-year Treasurys to us look very low-yielding,but to them they yield 125 basis points more,” he added.
Income investors can’t depend on the old, conservative investments. That’s why for several years in Retirement Watch we recommended other investments that pay higher income and have earned capital gains, including master limited partnerships. But be aware that all MLPs aren’t equal, and buying the various MLP mutual funds and ETFs aren’t interchangeable.
This blog post in Barron’s shows just how different the returns from the competing vehicles can be. Some funds use leverage. Some follow an index, and there are several different indexes with very different memberships. A number of new MLPs came to market the last year or two, and some of them are very different from the older MLPs. For example, some have far more commodity exposure than the older MLPs. Others are focused on smaller or different market segments. Know your MLP or fund before investing.
Not all energy Master Limited Partnerships are created equal, and neither are the funds that focus on them.
MLPs are yield-rich investments, which pay out most of their cash flow as tax-deferred distributions. The MLPs that make up the benchmark Alerian MLP Index are yielding 5.5% on average. So far this year, MLPs are up more than 14%, outpacing the S&P 500. Last year, it was quite the opposite, with the group under pressure as the threat of rising taxes loomed. And heavy issuance of new MLP shares didn’t help.
Jeffrey Gundlach, manager of DoubleLine Total Return Bond, made a big move early in 2013. For some time he’s said investors should hold only short duration debt and avoid U.S. Treasury debt. He feared rising interest rates at some point. But early in 2013 there was a little spike in rates, and Gundlach used that as an opportunity to add long-term treasuries to his funds. Gundlach told Reuters he bought some 10-year treasuries because they looked like values after the rate increase.
“They looked cheap at a yield above 2 percent, compared to certain riskier assets, which had gone up in price over the last six months while Treasury prices fell,” he said. “Also, owning 10-year Treasuries at yields above 2 percent provides an offset to credit risk we are taking elsewhere in the portfolio.”
So far, Gundlach’s call is proving correct as 10-year Treasury bond yields dropped below 2 percent to yield 1.87 percent on Monday.
When the Fed started quantitative easing in 2009, many people (but not us at Retirement Watch) thought the monetary expansion would result in higher inflation and interest rates before long. But inflation and long-term rates have stayed low. In a recent speech, Ben Bernanke addressed the issue and offered an explanation. The bottom line is that long-term interest rates stayed low because inflation and inflation expectations are low. Also, something known as the term premium remained low, and largely because inflation is low. The term premium is the amount investors demand for buying long-term bonds instead of short-term bonds.
As long as we are in a deleveraging environment with low credit growth and the potential for sliding into a deflation if the Fed cuts back money growth, long-term rates will remain low. I believe we hit the low rates for this cycle, but there isn’t going to be a sharp jump in rates for a while.
We’ve received some calls this week about rumors that DBLTX is or soon will be closed to new investors. I pointed out some months ago in Retirement Watch that there is a limit to the amount of money Jeffrey Gundlach can manage under his strategy. Since the financial crisis, the number of outstanding mortgages has declined, and 90% or so of new issues are those guaranteed by one of the federal agencies or quasi-federal firms. The huge market of nonagency mortgages that also included the jumbo mortgages on expensive homes has been disappearing. Gundlach said from the beginning that he and his team would consider when to close the fund as it reached $50 billion in assets.
The recent rumors sprang from an interview Gundlach gave to U.S. News in its Jan. 29 issue or web site posting. Gundlach repeated what he’d said before and said it looked like the fund would close in late 2013 or sometime in 2014. So, the fund isn’t closed but it will if money continues to flow in. I expect performance over the next few years will be less than in the past few years because of less capacity in mortgages and because interest rates already are so low.
Looking ahead to 2013, Gundlach says he doesn’t expect much excitement in the mortgage market. “It should be a fairly benign place in 2013,” he says. “Opportunities will be very much in security selection as opposed to beta.” He predicts that the same will hold true for the rest of the bond market. “There’s nothing unique about the lack of interesting developments in the mortgage market. I think that corporate bonds are even less interesting … and emerging markets debt is really getting [to be] fully priced.”
Although Gundlach expects smooth sailing in the short term, he paints a grimmer picture of the bond market in the long term. “The next big move in fixed income will be a negative one. It will either be rising interest rates … or it will be a credit meltdown,” he says.
Most analysts believe that the Fed’s zero interest rate policy is helping banks. It allows the banks to pay close to zero interest on deposits and then invest that money at higher rates. Banks don’t even have to make loans. They can buy treasury bonds and mortgages and pocket the interest rate spread as profit. While the Fed says it has other motives, some analysts believe zero interest rates primarily are a policy to help the banks improve their balance sheets.
But not everyone believes zero interest rates are risk-free for the banks. Federal Reserve Governor Jeremy Stein worries that a bond bubble is forming, and that banks will be hurt badly once the bubble burst. Stein says that contrary to what a lot of people believe, banks own long-term bonds and those bonds will decline in value when rates rise. Stein also has some worries about the high-yield bond market and the individuals investing in it.
Determining how much of a hit banks could take from a drop in bond prices isn’t easy. Banks aren’t required to disclose their bonds holdings. Most give clues, but not in any consistent way. What’s more, higher interest rates would boost banks’ lending profits, offsetting some of the losses in their bond portfolios.
Still, it appears, at least initially, banks stand to lose more from higher rates than they will gain. According to FDIC data, banks earned on average just 3.86% on all their loans and leases. That was the lowest that figure has been since the FDIC began collecting the data back in 1984, but given that 10-year Treasury bonds are yielding around 2%, still high enough to substantiate Stein’s claim that banks are “reaching for yield.”
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