Your model to successful individual retirement investment plans

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1 Your model to successful individual retirement investment plans Tim Noonan Managing Director, Capital Markets Insights Russell Investments Presented by:

2 Important Information Please remember that all investments carry some level of risk, including the potential loss of principal invested. They do not typically grow at an even rate of return and may experience negative growth. As with any type of portfolio structuring, attempting to reduce risk and increase return could, at certain times, unintentionally reduce returns. Diversification does not assure a profit and does not protect against loss in declining markets. Nothing contained in this material is intended to constitute legal, tax, securities, or investment advice, nor an opinion regarding the appropriateness of any investment, nor a solicitation of any type. The general information contained in this publication should not be acted upon without obtaining specific legal, tax, and investment advice from a licensed professional. Copyright Russell Investments All rights reserved. This material is proprietary and may not be reproduced, transferred, or distributed in any form without prior written permission from Russell Investments. It is delivered on an as is basis without warranty. Russell Investment Group is a Washington, USA corporation, which operates through subsidiaries worldwide, including Russell Investments, and is a subsidiary of The Northwestern Mutual Life Insurance Company. Russell Financial Services, Inc., member FINRA, part of Russell Investments. Date of first use: October 2011 RFS

3 What are you doing? Bringing about change.

4 What does rich mean? Russell Investment Group does not endorse, promote, review, warrant or assume any liability or responsibility for the accuracy, completeness, or usefulness of any information contained in this product.

5 Change looks like Millions of new conversations Managed and monitored methodically Change can lead to: More successful outcomes Addressing individuals #1 fear Transforming the value of advisory relationships

6 Our challenge is to help investors get through, not just to, retirement. You never retire from investing. -Chicago Investor

7

8 Don t oversimplify retirement. If it really was that simple, investors wouldn t be coming to you for help or losing sleep over it at night. 61% of Boomers say they re more afraid of running out of money than they are of dying. 1 Allianz Life Insurance survey cited in Ignites.com article Boomers Dread Retirement Shortfall: Survey, June 21, 2010.

9 Investing in retirement is different. We need new ways of explaining risk to investors a way of letting them know where they stand.

10 End investor research 1 shows that investors want their retirement strategies to be 1 Personalized 2 Realistic 3 Flexible Source: Maslansky & Luntz research conducted for Russell Investments, 2011.

11 PORTFOLIO VALUE How much money does the investor have? GOALS & TIMING How much will they spend each year? How long does it need to last? Adaptive Investing MARKET FORECASTS What are long-term asset class return expectations?

12 Cost of desired lifetime immediate annuity relative to portfolio value Annuity Purchase Cost or Expected Ending Wealth ($) but there s a good chance it never will You don t want the portfolio to fall below the annuity cost. Time to have a discussion with client Age Annuity Cost Portfolio Balance (good markets) Portfolio Balance (mean return) Portfolio Balance (bad markets) IMPORTANT: This chart is for illustrative purposes only. The projections or other information generated by Russell regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results and are not guarantees of future results. Source: Russell Investments

13 Russell s Adaptive Investing An approach that seeks to maximize retirement lifestyle while minimizing the risk of outliving assets Aims to provide sustainable distributions for life as a way to replace pre-retirement income Designed to serve as an effective annuity deferral strategy, managing longevity risk by setting ending wealth target Russell s estimated future cost to purchase a simulated immediate lifetime annuity There is no guarantee that the stated results will be met.

14 Russell s Adaptive Investing Designed to provide liquidity and control to investors throughout retirement Designed to give investors important information about their risk of running out of money and link this information to their investment strategy Designed to offer good value no incremental cost over comparable income strategies There is no guarantee that the stated results will be met.

15 Expanding the Frontier (with Adaptive Investing Strategies) 70% Surplus (as % of initial wealth) 60% 50% 40% 30% 20% 10% Conditional Adaptive Asset Allocation Investing Static Traditional Asset Allocation Asset Allocation 0% 0% 2% 4% 6% 8% Shortfall Risk (Probability Magnitude of Failure) 65 year-old couple 10 year liquidity horizon 100% survivorship income IMPORTANT: The projections or other information generated by this retirement income analysis regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results and are not guarantees of future results

16 Explaining risk to investors: the funded ratio

17 The key is to connect Assets and Liabilities

18 Funded Ratio = Assets Retirement Liability The current value of assets used to fund retirement Present value of planned retirement spending Note that the Funded Ratio is not a projection. It is a number that can be calculated given a discount rate for the Retirement Liability. This is a point in time measurement and subject to change as market conditions and assumptions change.

19 Funded Ratio Social Security* Future Savings* Estate Goals* Desired Lifestyle Goals* Funded ratio for Estate Goals + Desired Lifestyle Goals + Essential Goals = 85% (Not Feasible) Funded ratio for Essential Goals + Lifestyle Goals = 112% (Feasible) Current Assets Essential Goals* Funded ratio for Essential goals = 230% (Feasible) Assets Goals (Liabilities) *Discounted present values Source: Hypothetical example showing funding status for different goal priority levels.

20 Using the funded ratio with investors Provides an objective measure of where they stand now If the retirement liability is properly specified, an investor with FR=1 can implement a very low risk investment strategy that will likely fund retirement FR>1 means there is a surplus that can be invested for growth in the portfolio with limited risk in terms of funding retirement FR<1 means there is a funding deficit

21 Using the funded ratio with investors Provides an objective measure of how their investment strategy is performing FR can be monitored over time, and should be monitored regularly because it will change A steady or increasing FR over time indicates their investment strategy is doing well in terms of providing retirement cash flows and managing the risk of running out of money (but remember that it is not a guarantee of future results) A declining FR indicates their strategy is not working as planned FRs approaching or falling below 1 indicates increasing risk of running out of money In this situation a change in strategy or a reduction in retirement spending goals may be called for

22 The funded ratio and Adaptive Investing The funded ratio can be incorporated into Adaptive Investing Makes Adaptive Investing easier to implement and explain A single asset allocation schedule works for investors of all ages differences in age and withdrawal rates are normalized by the FR Links Adaptive Investing risk metrics to the funded ratio Each value of the funded ratio is linked to the probability of running out of money and the magnitude of the possible shortfall

23 Using the funded ratio turns this 80% Asset Allocation, Age 65 Allocation to Growth Assets 70% 60% 50% 40% 30% 20% 10% 0% 2.0% 2.5% 3.0% 3.5% 4.0% 4.5% 5.0% 5.5% 6.0% 6.5% 7.0% 7.5% 8.0% Withdrawal Rate Age 65 The % figures in the table show the optimal equity allocation as determined by the model in a portfolio for an age and withdrawal rate. The remainder, if applicable, is allocated to fixed income. IMPORTANT: The projections or other information generated by this analysis regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results and are not guarantees of future results.

24 Into this 80% Asset Allocation, Age 65 Allocation to Growth Assets 70% 60% 50% 40% 30% 20% 10% 0% Funded Ratio Age 65 The % figures in the table show the optimal equity allocation as determined by the model in a portfolio for an age and withdrawal rate. The remainder, if applicable, is allocated to fixed income. IMPORTANT: The projections or other information generated by this analysis regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results and are not guarantees of future results.

25 What about other ages? To a very close approximation, this relationship between the funded ratio and the asset allocation is the same for all ages 80% Allocation to Growth Assets 70% 60% 50% 40% 30% 20% 10% 0% Funded Ratio Age 65 Age 70 Age 75 The % figures in the table show the optimal equity allocation as determined by the model in a portfolio for an age and withdrawal rate. The remainder, if applicable, is allocated to fixed income. IMPORTANT: The projections or other information generated by this analysis regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results and are not guarantees of future results.

26 flexible tactical

27 27 The winds and waves are always on the side of the ablest navigators. Edward Gibbon, Decline and Fall of the Roman Empire

28 Appendix

29 Methodology To construct various charts within the presentation we used Monte Carlo simulation, a statistical process in which a broad range of hypothetical economic scenarios is evaluated over time randomly generated scenarios per year are used. These simulations are designed to reflect the forecasted volatility of investment markets and other economic variables such as interest rates. The Monte Carlo simulated data (Scenarios) are created using asset class return assumptions described below. The scenarios model investment performance for a set of asset classes (i.e. stocks, bonds, cash etc.), the level of interest rates, and the rate of inflation to estimate how each might affect the portfolio balance over time. This analysis was conducted using hypothetical estimates of market conditions described in the table below with certain numerical models applied to that information. This analysis is not meant to serve as a direct prediction regarding the future performance of retirement assets or the income and capital gains that they might produce. Similarly, they are in no way intended to predict or guarantee future investment performance of any sort. It is likely that actual returns will vary considerably from these assumptions, even for a number of years. References to future returns for either asset allocation strategies or asset classes are not promises or even estimates of actual returns a client portfolio may achieve. The assumptions do not take fees into consideration and all returns are assumed gross of fees. Asset classes are broad general categories which may or may not correspond well to specific products. Asset class assumptions are subject to change without notice. The simulation process uses the following assumptions: We examine the performance of a variety of portfolios while distributions are being deducted from them. Our purpose is to determine the wealth generated under the different investment portfolios and combinations of them. We also model the cost of an annuity by using the generic formula for actuarial net present value. Equity, bond and cash returns are modeled assuming a well-diversified portfolio of underlying investments. All withdrawals are considered to be pre-tax without regard to the investors tax situation. Any taxes owed (if any) are assumed to be paid out of the withdrawals and/or any Income from Other Sources that is entered. The time horizon is 20 years. After 20 years we measure whether they have enough money to purchase a joint annuity for a male and female couple. Annuity cost is calculated using standard actuarial net present value (NPV) calculations. It is a probability weighted NPV, where the probability is determined from mortality tables (Society of Actuaries, U.S. Basic Individual Annuitant 2000 Table). The cost of the future value of the annuity (age 85) is calculated using a hypothetical AA Grade yield curve created by Russell. Details of the assumptions are available upon request. The analysis is not meant to predict the results of any actual investment, results may vary with use and over time, other investments may have characteristics similar or superior to those being analyzed.

30 Methodology continued In stage 1 the simulation process models the non inflation adjusted withdrawals from the portfolio. Then at the end of stage 1 (after 20 years) it models the cost to purchase an immediate life annuity providing non inflation adjusted income over the second stage. The Probability of Success measure is based on the percentage of scenarios for which the portfolio value at the end of first stage is greater than or equal to the estimated second stage annuitization cost. The magnitude of shortfall measure is the average difference between the cost of the annuity and the portfolio value for those scenarios where the portfolio value was less than the annuity cost. This number is expressed as a percent of the initial portfolio value. The use of this methodology is not a recommendation for annuitization at any particular time, but rather simply a means for measuring the likelihood of sustainability of a spending plan. Source of actuarial tables: Society of Actuaries, U.S. Basic Individual Annuitant 2000 Table.

31 Asset class assumptions The asset allocations modeled in this presentation rely on the following broad asset assumptions: Equity Fixed Income Cash Interest Rate Expected return 7.9% 4.9% 3.6% 4.3% Standard deviation of returns 16.4% 5.3% 6.5% 2.7% Correlations The returns and volatility information are for illustration only, and are not intended to reflect the return of any actual investment.

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