Fidelity and Vanguard Creating Investments to Compete With Annuities

Fidelity and Vanguard, monsters in the world of mutual funds, are busy creating new products catering to the vast number of baby-boomers approaching retirement. These products are designed to compete with annuities, insurance products with guaranteed income, but are investments products so they offer no guarantees. Like target retirement funds, the asset allocation of these funds of funds changes over time, but they are managed more actively.

Fidelity’s strategy is to create “Income Replacement Funds.” While target retirement funds are organized by the projected retirement date, the Income Replacement Funds are designed to liquidate in a particular year. There will be a fund for every other year between 2016 and 2042. Between the times of investment and liquidation, the fund will provide a monthly cash payment based on investment gains and possibly a portion of the principal.

On the other hand, Vanguard will be offering three different portfolios: Growth Focus, Distribution, and Growth and Distribution (a combination). The purpose of the Growth Focus portfolio is to maintain your principal while investing aggressively. The Distribution portfolio is designed to maximize your monthly payments while preserving the principal as much as possible. The Growth and Distribution portfolio falls somewhere in the middle of the other two.

In this way, with no end date, the Vanguard funds will operate more like a university endowment.

…[U]nlike annuities, these funds let you keep your money. After the $25,000 initial investment, you can buy additional shares or sell them without penalty, a big advantage if you need to pay for an unexpected expense.

The $25,000 investment sounds steep, but these funds are for retirees who may be changing their perspective at retirement. They will have the funds from their 401(k) and IRAs which will be tapped to help pay for expenses once retirement is in full swing.

I have not yet seen any information about projected fees to cover the operation and management of these funds.

Turning savings into income, Eugenia Levenson, Fortune Magazine, June 18, 2008.

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Tagged as: 401(k), annuities, Investing, ira, Retirement

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Kyle

I can't seem to find a link right this moment, but I've read before the ER of the Vanguard funds will be in the 0.5-0.6% range. The reason it's so high (for Vanguard) is because dividends paid out on short positions by the market neutral portion of the portfolio must be included in the ER per SEC rules even though the fund will usually recover those costs in normal circumstances. Can't find a link to where I read that for the life of me, though. I think it was on morningstar.

Andrew

It's certainly a boon to be able to pass on the principal to heirs, which doesn't usually happen when you annuitize, but many annuities are beginning to either offer guaranteed income features that don't require annuitization or allow for a preservation of principal to be left to a beneficiary.

Most people purchase annuities for guaranteed income to insure they won't run out of money due to longevity or poor market results. Really, I don't see this appealing to the same crowd. With your money still very much in the market you have a significant comparative upside but you stand to lose your nest egg as well, which is what most annuity investors are trying to avoid.

Where this could fit pretty well is with investors searching for a middle ground between annuities and traditional funds. The more risk averse will stick with guarantees.

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