The shock of the financial crisis has left three generations of investors paralyzed, preferring slow-but-steady income to the promise of bigger gains that come with moderate market risk, according to a new poll.
This conservative mindset is part of the Great Recession’s enduring legacy. It holds the potential for millions of Americans to wind up retiring with insufficient nest eggs many years into the future as they opt for sure-fire but low-return investments now—possibly decades before they’ll actually need the money.
Virtually everyone (95%) in the Allianz poll of investors 25-plus with at least $200,000 in liquid assets said they are seeking some form of protection from losses as they save for retirement. Three in four would trade a 10% cap on annual gains for a 10% cap on annual losses. Most (59%) are sick of stock market volatility and more (79%) expect stocks to remain choppy.
This helps explain why $8 trillion sits in money market accounts and other cash equivalents despite historically low yields. It also sheds light on the popularity of fixed income annuities, which offer low rates of return but guaranteed lifetime income. Asked which financial product is more attractive: one with a 4% return that is guaranteed not to lose value or one with an 8% return that has the possibility of losing value, seven in 10 opted for the guaranteed 4% return.
That question appears to have been framed as a choice between a diversified portfolio of stocks and a fixed annuity. The S&P 500 stock index has returned 10% a year since 1926. In the last 10 years, which includes the financial crisis, the index still has returned more 7% a year. It wasn’t smooth sailing by any stretch. The S&P 500 dropped 47% between October 2007 and March 2009.
That kind of loss is what scares folks into cash and safe low-yielding alternatives like a fixed annuity, which if you buy at age 60 and live to around 85 will offer a certain annualized return in the neighborhood of 4%. With such an annuity you can get a higher rate of return if you buy much earlier or live much longer. But it will never return more than around 6%.
Certain but low-return investments like fixed annuities may make sense for folks past 55 and who want to lock up a guaranteed stream of income for life. One common strategy is to combine the monthly income from pension and Social Security benefits, and then augment it with enough income from a fixed annuity to cover basic living expenses. Keep other assets, including some stocks, separate for emergency cash and to offset the impact of inflation over 30 years of retirement.
But annuities and a lot of cash or bonds make little sense for young people that have many years to ride out market blips and collect that long-run average annual return of 8% to 10%. Big market swings are gut wrenching. But if you hold fast and continue to buy during downdrafts the volatility is actually helpful because you buy at lower prices.
The trick is having the courage to avoid panic—and the time to wait for prices to bounce back. Look at it this way: Since 1926 the S&P 500 has never lost money over a 20-year period and it has been up double digits 23 times. The certainty of income from fixed income and annuities comes at a price.