Adjusting income strategy against a volatile interest environment
by Kurt AuletaMr. Auleta is Head of Western Sales for Security Benefit. Visit www.securitybenefit.com.
With yet another rate increase from the Federal Reserve, financial advisors and their clients are considering additional product options for their portfolio mix to make the most of today’s rising rates. It is also a great time to revisit long-term retirement planning goals.
A key question: what are you doing to protect client assets? Once a client’s tolerance for risk has been established, advisors can turn to positioning their portfolios for what many anticipate as a volatile second half of the year.
Today’s Current Market Conditions
In short, the market has corrected, aligning with past drawdowns and may drop closer to where the market stood pre-COVID, in 2019. Labor market difficulties and supply chain disruptions remain challenges, along with strong or robust price increases and fuel surcharges.
Overall, rising interest rates, general inflation, the Russian invasion of Ukraine, disruptions from COVID-19 cases (especially in the Northeast), profits, and the risk of recession were the primary concerns in the economy. Expectations of future growth have diminished, and some concern over a possible recession is evident as a faster slowing of the economy than the Fed expects could be a trigger for an economic downturn.
Anticipating market setbacks and seeking opportunities amid heightened volatility
So, what does this mean for those considering shifting their longer-term strategies to make the most of it? Structured products designed to weather the storm with principal floors could be a great option.
Although today’s economic conditions are far different from past events leading to rate increases, the retirement products that can make a difference in this environment have become more sophisticated in nature. Some have been designed to accommodate interest rate changes, which can help stabilize a portfolio, earn interest in a variety of ways, and can even act as bond alternatives.
Floating Rate Options
The annuity industry has experienced a lot of change in the past decade with providers building innovative features into traditional annuity products.
To take advantage of changes in interest rates, for example, a floating rate annuity could be a good complement to an existing retirement strategy. Automatic credited rate adjustments based on the movement in interest rates allows clients to lock in a competitive rate now, without locking them out of potential rate increases in the future. This has the potential to earn more, while protecting assets from market loss. On top of these benefits, the interest earned is tax deferred.
Floating rate options also offer the potential to re-balance out of fixed rate savings while maintaining a portfolio’s growth potential. They can help clients bridge the gap between locking in a fixed rate or investing in longer-term Treasury bonds, all without typical bond market risk.
They can also be used to replace part of the bond portion of a portfolio. Bond funds can create multiple issues for advisors: constant market value adjustments are exacerbated by rising rates (and therefore falling prices for many bonds), the multiple bond tranches drive up costs, and manager bias can impact performance. With a floating rate annuity, advisors replace these funds with a non-correlated, tax-deferred vehicle that protects principal and credits interest, all while taking advantage of rising rates.
Advisors may also consider a split ticket—leveraging a traditional MYGA (multi-year guaranteed annuity) along with a floating rate vehicle—one product offers a guaranteed rate for a period of years while the other offers upside if rates rise.
Another Way To Tap The Equity Market
Certainly, for long-term retirement planning, clients should be in stocks and bonds and other investments, to help grow their retirement assets over time. But clients also need to understand market dynamics. The concept that inflation was transitory clearly was wrong. While inflation can temporarily increase profits (through prices rising), if it continues to climb, it can choke off spending, so there is no longer a catalyst for growth, and it decreases liquidity and buying power.
Managing debt loads also becomes more difficult in this environment. Another concern will be how quickly the Fed sells off its massive bond holdings, or “quantitative tightening,” and how that will impact the markets. The Fed’s holdings had reached $8.5 trillion or 35% of GDP earlier this year—shrinking this will add pressure to the credit markets by reducing demand for assets the Fed holds and increasing rates.
With ongoing inflation, notable layoffs, and more, market volatility has grown, and the perception that a recession is in the offing has become persistent. The Wall Street Journal noted that Fed Chairman Jerome Powell has said the central bank wants to see clear evidence that price pressures are diminishing before slowing or suspending rate increases. This could elevate the risk of recession.
The S&P 500® 10-year P/E Ratio stands at 29.3 (July 8, 2022), or 46% above its market average of 19.6 which indicates it is overvalued. To get back to average, the S&P 500® would have to fall to 2200. So, what is fair value? Markets could continue the downward trend until the Fed believes inflation is under control. With recession a distinct possibility, advisors need to consider ways to protect client assets. While a recession may allow the economy to reset itself, it won’t be without more pain along the way.
Bundled products like fixed index annuities (FIAs) offer a way to for advisors to deliver “protected equity” solutions for accumulation and protection. If a client is invested in the market, they experience 100% of the gains, as well as 100% of the downturns. In an FIA, they are never invested in the market; instead, an FIA offers guaranteed protection from all market loss, and interest credits based on part of the performance of an underlying financial index like the S&P 500®. FIAs often offer higher interest potential than many bonds, without the same market value-related downside risk.
Of course, one size doesn’t fit all. Annuities should be considered based on customer need and have wide application. Going back to the split ticket concept, advisors could consider a combination of an FIA and a floating rate annuity. With both stocks and bonds on a downward trend, this split allocation would give a portfolio fixed interest exposure that will rise with rates, and the upside potential of stocks when the markets make a comeback— all with no downside risk, and any interest credits earned along the way are locked in.
Redefining The Portfolio Mix In A Rising Rate Environment
Adjusting client portfolios in a fast-moving, volatile market can be tricky. It often involves balancing their ambitions while pushing for longer-term strategies using diversified options like protected equities, fixed income alternatives, and products like floating rate annuities which seek to make the most of rising rates.
Financial advisors and their clients must redefine the portfolio mix in this economic environment. We continue to face a variety of headwinds like the ongoing inflation, rising rates, and market volatility. The real challenge is turning those headwinds into tailwinds.
Financial advisors should continue to assess their clients’ goals amid the market flux and establish objectives around allocating funds for the long term. Younger clients, who stay the course, will likely reap benefits in the long-term as markets recover. Those with their retirement closer to the horizon may want to shift sights to protect their asset base.
In either case, utilizing options that allow for flexibility like FIAs, floating rate annuities, or split tickets, may help insulate clients from market madness, achieve better long-term results, and position them for a more secure retirement.
About Security Benefit
Security Benefit Corporation (“Security Benefit”), through its subsidiary Security Benefit Life Insurance Company (SBL), a Kansas-based insurance company that has been in business for 130 years, is a leader in the U.S. retirement market. Security Benefit together with its affiliates offers products in a full range of retirement markets and wealth segments for employers and individuals and held $46.9 billion in assets under management as of December 31, 2021. Security Benefit, an Eldridge business, continues its mission of helping Americans To and Through Retirement®. Learn more at www.securitybenefit.com and follow us on LinkedIn, Facebook or Twitter.