The Myth of Guaranteed Income

With interest rates at such low levels these days, people planning for retirement or currently in retirement are intent on finding the Holy Grail of “guaranteed income” to finance their living expenses.    It brings to mind George Zimmer of Men’s Warehouse fame who used to be on those ubiquitous commercials where he always ended with his signature tag line:  “You’re going to like the way you look- I guarantee it.”

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Very often, I meet with clients to evaluate their income & portfolios and they walk in with the mindset that goes something like this:  “OK – I have my social security, annuity payments and income from “solid” companies.  Since I have so much “guaranteed income”, I should be able to pay for our living expenses if I just take out X% per year.”

I have unfortunate news for those folks.  Much like life itself, with investing there are no guarantees.  Instead, there are only degrees of assurance that can range from almost guaranteed to downright sketchy.   So what are those degrees of assurance?  Below I have a brief spectrum ranging from least risky to most risky.  Importantly, NONE are risk-free.

CDs and / or U.S. Treasuries:  These are bonds issued by banks or the U.S. government.  The reason they are the least risky is two-fold, both related to the U.S. government.  First, CDs are protected up to the limit of FDIC insurance which means the U.S. government insures up to $250,000, subject to limits and restrictions.  Second, U.S. government bonds, despite all the Federal debt, are still the least risky in the world as the Feds own two things that provide investors comfort:  1) a virtual printing press and 2) the most powerful military in the world.  If push came to shove, the Feds can always print interest payments (and some say they are doing that now!)

Cash:  Sure cash “won’t go down” but one thing that is guaranteed with cash is that any inflation will eat away at purchasing power.  So even that coffee can full of cash buried in the backyard is guaranteed to lose value in an inflationary environment, which has been the most common economic scenario in the past.

Social Security:  Similar to U.S. treasuries, social security is a pretty safe bet for those who are already receiving benefits.  However, we all know the government can change the rules at any time so in the future, this benefit could be delayed, taxed at a higher rate or downright cut.

Annuities:  So often people think annuities are “guaranteed” income but they are not.  They are only as good as the insurance company who backs them.  Not only that, salesmen’s illustrations that show “potential income” can be very optimistic and the complexity of these contract makes interpreting them a nightmare- and that’s by design.  Really, the only guarantee with annuities (in my humble opinion) are the commissions charged and the typically high annual fees.

Pensions:  Like annuities, pensions are only as good as the company that backs them up.  While folks who have state obligations (teachers, policemen, etc.) have somewhat more assurance given governments’ obligations to pay, 100% pension state payments, like companies, are only as good as the state’s ability to actually pay them.  Unfortunately, state pensions have been massively over-promised over the years leaving huge, questionable liabilities on state government balance sheets.

Interest on bonds:  Up the scale a bit from pensions, interest payments are also commitments by companies, states or municipalities to pay the coupon on a bond at the stated rate (at par value) at the stated time.  Municipal bonds are usually less risky than corporate bonds (and usually have tax advantages) but every case is different and they are not risk free . Municipalities and companies are very committed to keeping their credit rating solid so they almost always try to pay their debts- until they don’t and they declare bankruptcy (see Detroit, Stockton, CA.).

Cash Dividends on Stocks: Interest on bonds are legally a higher priority than cash dividends on stocks, which are up to the discretion of the board of directors (unless it’s a preferred stock but that’s another story).  Dividend payments really are optional and there is no contractual obligation of the company to pay.  While companies take pride in paying a dividend and are loath to cut it, when the chips are down and cash is tight, dividends can be cut.  So while you might think that utility company’s dividend is “safe”, it is by no means guaranteed.

Your brother-in-law’s latest sports bar idea:  This should require no explanation.  If you think of this “investment” like you would throwing a pile of cash into a roaring campfire, your expectations will be appropriately grounded.

So what’s a quick proxy for judging the risk associated with the income you are expecting?  Very simple- at least for a bond. If it’s a widely traded bond, just look at the current yield.  The farther it is from the accompanying yield on similar dated Treasuries, the riskier it is as judged by “the market”.  If you think you’re finding a “deal” on a corporation’s or a country’s bond, tread very carefully.  There are millions of traders out there who in the aggregate, might disagree with you.

In a nutshell:  no matter how good the sales pitch, no matter how much an investment sounds like a “can’t lose”, no matter how much an advertisement says your gains are “locked in”, always, always, always keep in mind:  there are no guarantees.

To my point, ever wonder what happened to George Zimmer and why we don’t see those commercials anymore?  He was the founder and CEO of Men’s Warehouse so he has 100% guaranteed job security right?  Well, the company went public and shortly after, he was fired by the board of directors in June 2013.

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