The appeal of having a lifetime annuity

Q: How should single-payment, immediate annuities be considered in a retiree's portfolio? Should they replace a large share of cash and short-term bonds?

A: Lifetime annuities, in which you exchange your principal for a guaranteed monthly income for life, should be considered as fixed-income investments in your portfolio of financial resources. Because the monthly income is considered to be both interest and return of principal, the monthly payments are likely to be higher than any yield you could find in the fixed-income markets.

This does not mean they should replace fixed-income investments altogether. A life annuity offers monthly payments. It does not offer liquidity. You can't sell your lifetime annuity to raise cash the way you can redeem a CD, sell a Treasury note or write a check on a money-market fund. As a consequence, it would be unwise to have a portfolio that was 50 percent stocks, 50 percent lifetime annuity.

A better strategy would have a portfolio that holds equities, short-term fixed-income and annuities.

Q: My wife and I have been using a fee-based financial planning group. It charges about 0.75 percent annually on the total portfolio of tax-deferred and taxable accounts. If we plan to take out no more than 4 percent of our portfolio annually, would you adjust that down to 3.25 percent to allow for the management fee? Or is it reasonable to assume that its management gains me at least an additional 0.75 percent, and stay with 4 percent of my portfolio?

A: Your annual withdrawal rate should include three items: what your financial planning firm charges, the annual expenses of any underlying investment such as a mutual fund and the money you intend to withdraw for your personal use. All three withdrawals come from the return your money is earning.

Money management is a service. If we have someone else do it, we should expect to pay for the service.

The question is, how much should we pay? Money management may or may not add return to your portfolio. While some money managers earn their keep and add value equal to or exceeding their fees and expenses, decades of research shows that most don't.

Over the 15 years ending Dec. 31, 2005, for instance, the average return of all large-blend domestic equity-mutual funds trailed the S&P 500 index by 87 basis points, indicating that their average annual expenses of 1.19 percent weren't completely recouped through wise decisions.

Funds in the same group with annual expense ratios of at least 2 percent a year trailed the S&P 500 index by 2.47 percent a year, a loss that was actually greater than their average expense ratio of 2.24 percent.

Questions about personal finance and investments may be sent to Scott Burns at The Dallas Morning News, P.O. Box 655237, Dallas, TX 75265; by fax at 214-977-8776; or by e-mail at scott@scottburns.com. Questions of general interest will be answered in future columns.