For much of human history, life—as described by 17th century political philosopher Thomas Hobbes in his book Leviathan—was for most people “nasty, brutish, and short” … whether they were in a state of war or not. Recent generations though—at least in most parts of the developed world—more readily expect to live long, active, and rewarding lives. As people increasingly live not just longer lives, but also more active and healthy lives, the more difficult task these days is to make sure that they also prosper commensurately… so that they do not prematurely exhaust their resources, jeopardize their standard of living, or prevent themselves from achieving other important lifetime goals like leaving personal legacies to family or philanthropy. Indeed, this developing phenomenon has given rise to a new kind of life-planning challenge in recent years called longevity risk.
Longevity risk is particularly troubling for pension funds and life insurance companies, where increasing life expectancy trends among pensioners and policy holders threaten to result in ultimate payout levels much higher than originally estimated. As a result, traditional defined-benefit pension plans and many types of annuities—which guarantee lifetime benefits for their policyholders and thus expose the providers to the greatest levels of longevity risk—are either becoming increasingly rare or more expensive. At the same time, individuals must confront the other side of the longevity risk equation. When coupled with inflation (or purchasing power) risk, longevity risk is typically the main reason why many investors—even those in retirement—may want to consider accepting other forms of more obvious and even more immediate risks like market risk or price volatility when designing and rebalancing their portfolios.
The growing likelihood of being exposed to longevity risk is compounded by the unwelcome circumstance of very low current interest rates and correspondingly low yields on most traditionally desirable safe-haven fixed-income securities. Many fixed-rate investments now offer returns less than the anticipated average long-term rate of inflation, and thus carry the risk of delivering potential negative “real returns” over time. In recognition of this multi-generationally low-yield environment and the parallel need to combat the possibility of outliving one’s asset base, we believe that balanced asset allocation investment programs ought to be considered at all stages of life. Well diversified and balanced portfolios can mitigate not only volatility in the short run but also provide potential capital appreciation and maintenance of purchasing power over time.
Still, some people may simply demand greater assurance behind their planning—or what might be called “longevity insurance”. Buying guaranteed income streams from annuities is one possible way to accomplish this objective—even as a supplement to balanced portfolios. The conundrum is that annuity assets are typically invested in bonds to achieve these ultimate promises, and that means that their payments are disappointingly low right now because of the same low interest rate environment that perplexes regular fixed income investors. As a result, more money must be committed up front to purchase annuities to lock in sufficient or required income, and this raises the inherent cost and difficulty of using annuities; plus, the buyer gives up ownership of the purchase amount in return for the guaranteed income, and generally this trade-off is not desirable—hence our primary focus on balanced portfolios and total return objectives. Nonetheless, we continue to explore various ways to generate income in this era of low yields. In the meantime, we look forward to helping you celebrate a wonderful, rewarding, and long life, and constructing portfolios that have the staying power to allow you to accomplish your goals.
Sources:
https://www.sandhillexperience.com/blogs-1/estate-tax-planning-in-silicon-valley
https://resources.goldman.com/intro/advanced-gift-planning-strategies.html
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