The Check Is in the Mail

Asset managers are rolling out one-stop funds that turn investors’ savings into a dependable income.

With the first of the 76 million members of the baby boom generation retiring soon (the oldest boomers were born in 1946) and assets earmarked for their retirement having reached almost $18 trillion as of September 30, 2007, mutual fund companies and other asset managers are rolling out some of the first funds designed to transform nest eggs into monthly paychecks. As the eldest boomers retire, fund companies will be facing the first real test of how investors will tap into the assets they’ve accumulated over a lifetime in defined contribution plans, individual retirement accounts and other plans.

David Wray, president of the Profit Sharing/401k Council of America, a research and lobbying group for plan sponsors, says, “People need an efficient way to manage their money over time, and asset managers need to figure out an innovative way for clients to make money even as they start drawing down this huge pool of assets.” Many fund companies are also trying to come up with a viable alternative or supplement to annuities, which give investors a monthly paycheck in exchange for turning over a chunk of their assets to an insurer. Unlike mutual funds, annuities don’t allow investors to withdraw their money all at once if they choose.

After two years of research on income planning, Fidelity Investments recently launched a series of 11 Income Replacement Funds that use a target date corresponding with the expected length of an investor’s retirement. Someone planning to retire in 2012, for instance, and expecting to live an additional 30 years would put their money into Fidelity Income Replacement Fund 2042. Fidelity says the funds have significant exposure to equities to generate income during long retirements. “People didn’t understand how much to spend and underestimated the erosion caused by inflation,” says Jonathan Shelon, co-manager of the funds, of Fidelity’s research findings. “People in their 80s wished they had spent more earlier.”

As a result, Fidelity designed the asset allocation of the funds so that they have the potential to grow to protect against inflation, and they created the target date so investors could be certain their income would last a specified number of years. The funds are designed to return principal, paying retirees a growing percentage of their account as income each year and returning the entire remaining balance in the last year. And unlike with an annuity, investors can cash out completely whenever they want. Shelon says that in fashioning the Income Replacement Funds, Fidelity took pains to make sure the pay-outs in the first years of retirement weren’t too conservative. “People place a higher value on income early in retirement versus later. Why? Because they have a higher chance of being alive to spend it,” Shelon says. The fund’s asset allocation — a mix of stocks, bonds and cash — is designed to rebalance automatically to provide returns consistent with the payment strategy.

Vanguard Group took a different approach with its three Managed Payout Funds, which it launched last month. John Ameriks, head of Vanguard Investment & Consulting Group, says the funds were designed to mimic an endowment in that the principal is not exhausted. Investors can go to Vanguard’s Web site and see how much monthly income would be generated by a given investment amount. “Our research pointed in a different direction: There is a willingness to undertake prudent spending, and there’s little desire to spend assets,” says Ameriks.

Juan Ocampo, president of Trajectory Asset Management, which subadvises the High Watermark Funds for AIG SunAmerica Asset Management Corp., says Trajectory is now designing a fund that incorporates actuarial data to determine payouts on a yearly basis. For example, if an investor reaches 70, it’s very likely he or she will live into their 80s. “Life expectancy evolves as you get older; you can’t set the life expectancy calculation once and forget about it,” he explains.

The Profit Sharing/401k Council’s Wray says: “These funds are in their infancy. There are a lot of smart people working on this problem, and we’re going to see a flood of other approaches soon.”

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