Saving for retirement is an inexact science. The volatility of economic swings can set back retirement goals, especially when consumers see their portfolios shrink. In addition, economic conditions can increase prices, or even leave you unemployed.
Unfortunately, only about half of the workforce participates in employer-sponsored retirement plans according to a 2008 study published in the Academy of Accounting and Financial Studies Journal. Not surprisingly, working households tend to focus more on day-to-day expenses rather than retirement during a tough economic environment. Luckily, these problems can be avoided or eased, even in a turbulent market environment. Here are seven investment vehicles to help.
1. Fixed Annuities Investors fleeing a volatile stock market should take interest in a fixed annuity. These annuities boomed when the stock market took a beating toward the end of 2000, causing sales in the first quarter of 2001 to surge. Seven years later, they gained popularity during one of the worst recessionary periods ever; sales estimated for fixed annuities were at $107 billion in 2008, up 60% from 2007, according to Beacon Research Fixed Annuity Premium Study. (These contracts provide a guaranteed income stream. Learn how they work and their benefits, check out An Overview Of Annuities.)
An investor may put in a lump sum and lock in a fixed interest rate of 4-10% for a period of time - typically between five and 10 years. Annuities provide either immediate or deferred payments. They can occur for set number of years or until death. The money is tax deferred, and the principal and interest are guaranteed. Generally, the payout has been 5% of the principal each year.
It's important that investors stay attentive to "teaser rates" because once they end, the rate is reset depending on market conditions.
2. Variable Annuities As the market begins to stabilize, investors tend to focus on a different annuity: variable annuities. This investment vehicle allows people to pick from a group of investments, such as mutual funds, stocks and bonds. Investors' rate of return varies as a result. The lump sum of money invested can be moved between investment portfolios inside the annuity to take advantage of a strong stock market or preserve gains.
Keep in mind that with annuities, some withdrawals prior to the age of 59 and half can result in a 10% tax penalty and a surrender fee. Also, once payments are received, interest is taxed. In addition, these annuities aren't guaranteed by government agencies. Whether you choose a fixed or variable annuity, plan for the situation that best fits your needs.
3. Target Date funds Target date funds are geared toward people who have a distinct retirement date in mind. Investors put their money into a diverse mixture of stocks and fixed-income securities. The fund manager automatically shifts away from riskier investments to more conservative investments as the target date approaches.
Assets held in these funds have grown in popularity since these funds emerged in the mid-1990s. This led to their designation as a qualified default investment alternative, which made them very common in 401(k) plans.
However, the funds were hit hard during the 2008 recession. Their unpredictable performance led to significant losses, which varied based upon how the assets were allocated. The average loss for funds with the target date of 2010 was nearly 25%. (These accounts will take charge of your retirement savings, but should you let them? See The Pros And Cons Of Target-Date Funds.)
When it comes to target-date funds, investors aren't always well aware of the risks and differences among the funds. The way the funds are marketed has also become a contentious issue.
Despite the potential volatility of these funds, target date funds are still considered a growth industry and many experts are working to make more, and better, disclosures.
4. TIPs Investors, especially those on fixed incomes, turned to Treasury inflation protected securities, also known as TIPS, to hedge against inflation that may occur upon an economic recovery. The Treasury-issued bonds, with terms of five, 10 or 20 years, protect against rising prices and the future payout rate. TIPS adjust with the Consumer Price Index, which affects both the principal and the interest payments. A fixed interest rate is applied to the principal. As a result, the interest rate payment and principal increase with the rise in the index or with inflation, and fall with deflation or a drop in the index. The amount of principal that investors receive when TIPS mature will depend on whether the adjusted principal or original principal is greater.
Investors will need to consider the timing with this tool. It's often difficult to determine when inflation or deflation will occur. (Learn more in What does deflation mean to investors?)
5. TIPs ETFs TIPS exchange-traded funds (ETFs) are a basket of TIPS bonds compiled into a portfolio. Most TIPS ETFs last between eight and 10 years. PIMCO 1-5 Year U.S. TIPS Index Fund (ARCA:STPZ) offers immediate protection against inflation. Based on historical trends, TIPS with a short maturities have seen a higher correlation with inflation; lower volatility is associated with indexes that follow the entire TIPS maturity spectrum. The products are domestic; however, one can buy into TIPS securities in developed foreign countries and emerging markets. This will expose investors to various currencies and provide some diversification from the dollar.
6. Stable Value Funds Stable value funds are considered safe options when the market is volatile. They have generally made up one-fifth of assets in 401(k) plans.
Money is invested in a high-quality fixed income portfolio that includes U.S. government and agency bonds, corporate bonds and mortgages, and asset backed securities. (Find out how weighted average life guards against prepayment risk in The Risks Of Mortgage-Backed Securities.)
Contracts with banks and insurance companies protect these funds against volatile interest rates. They have a market and a book value unlike some other funds. They are also protected up to the amount of their book value by these "wrap" contracts. Wraps make sure investors receive the fund's book value even if the market value drops.
Caution is needed when selecting these investment vehicles as critics have pointed out that investors are not always aware of what these instruments include or how they are built.
7. Dividend-Paying Stocks Dividends are a steady source of income for investors in good markets, and limit the downside risk during down markets because their incomes (a;though not guaranteed) can remain positive whether price returns are good or bad.
The companies offering them are usually financially sound. Stable and increasing dividends can demonstrate the confidence of managers in their firms' prospects. Investors tend to agree. (Seven words that are music to investors' ears? "The dividend check is in the mail." Check out The Importance Of Dividends.)
Dividend yields were at their highest levels in 2008, and offered higher yields than 10-year Treasury notes. Lowered taxes on dividends made them even more appealing. It's important to review the history of dividend payments from the companies when seeking out these investments.
The Bottom Line An unstable economy may derail retirement goals but investors can get back on track by selecting some conservative approaches. Also, investors should educate themselves about how the investment was structured, its historical performance and the organization offering the investment vehicle. The more you know, the better a decision you can make and that's the best way to keep your retirement savings safe.
Brigitte Yuille has worked in journalism for more than a decade in the areas of radio, online, print and television. Her personal finance articles have been published in newspapers, such as the New Jersey Star-Ledger and the South Florida Business Journal and online at AOL, Bankrate, Inc., MSN and Yahoo. She's also served as an editor for Florida Society of Association trade publications. Ms. Yuille has a Master of Science degree in communication with an emphasis on business journalism from Florida International University.