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GE NERATIONS Journal of the American Society on Aging

By Ryan Wilson

Parsing the Financial Landscape for Older Adults: Industries, Products, and Risks
A primer for older adults on investing for and during retirement.

lanning for retirement has become increasservices industry could be more accurately ingly complicated over the last three decades, described as three industriesbanking, securijust as stakes have risen for individual investors. ties, and insurancecompeting to serve the People saving and investing for retirement face investing public, all offering products to help an increasingly complex market with many new people invest. The securities industry includes financial productsand product featuressold brokers who sell securities (stocks, bonds, by a variety of sales professionals. Products sold mutual funds, exchange-traded funds, etc.) and with retirement range from traditional banking investment advisers, who offer investment to insurance to securities. It can be hard enough advice about securities. The insurance industry, for an expert to get the right product mix, let specifically the life insurance industry, sells alone for those who are figuring it out on their insurance products people use to save and invest, own. At the same time, individual investors are such as annuities and other life insurance more responsible for their financial security. products with savings components. TraditionThe fall of traditional defined benefit penally, the banking industry has offered safe sions, especially in the private sector, has coincided with the Mutual funds typically are organized by theme, rise of defined contribution such as company size or industry sector. employee retirement plans, in which the employee bears the investment risk. This article broadly describes savings products like savings accounts and the professionals who sell retirement investcertificates of deposit. ments, the products and services they offer, and The three industries are generally regulated based on the products and services they offer; the varying risks to the individual investor. however, there is some overlap as some market Older adults, like all individual investors, participants sell more than one type of product have a broad range of financial products from which to choose to meet their needs. These or service. Financial sales professionals, someproducts are sold by salespersons with an array times called financial professionals or financial of licenses and registrations. In fact, the financial advisors, have one or more titles, depending on
Copyright 2012 American Society on Aging; all rights reserved. This article may not be duplicated, reprinted or distributed in any form without written permission from the publisher: American Society on Aging, 71 Stevenson St., Suite 1450, San Francisco, CA 94105-2938; e-mail: info@asaging.org. For information about ASAs publications visit www.asaging.org/publications. For information about ASA membership visit www.asaging.org/join.

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Financial Capacity and Competency in an Aging America

the products they are licensed to sell. A financial advisor, which is an industry-adopted term for a financial salesperson, may also be a registered representative of a securities broker. A financial advisor may be a licensed insurance producer (an insurance agent), or the financial advisor may even be an investment adviser or investment adviser representative (thats investment adviser spelled with an e; these financial professionals are regulated under the Investment Advisers Act). The financial advisor may hold more than one of these titles.

The other profession in the securities industry is comprised of investment advisers. These professionals give financial advice about securities and may manage investments of others. Investment advisers are regulated either by the SEC or state securities regulators, depending on the amount of assets they manage. Under the 2010 DoddFrank Act, investment advisers managing less than $100 million are required to register with their home states, and investment advisers managing $100 million or more are required to register with the SEC. Investment advisers typically manage the The Securities Industry: investment accounts of their clients. However, some merely give advice, and the client manages Products and Players The U.S. Securities and Exchange Commission the investments. Generally, investment advisers (SEC) is the primary regulator of the securities charge a fee based on the value of the assets industry, which includes the activities of both managed for that client, but an advice-only securities brokers and investment advisers. investment adviser may charge a per-visit fee. Basically, securities are investments. The term Some investment advisers, especially those who securities includes stocks, bonds, mutual are also brokers, may charge commissions, and funds, and even variable annuities, which have some of these investment advisers may charge a characteristics of securities and insurance. lower asset-under-management feeor the fee There are two professions within the securi- investment advisers charge their clients based ties industry. The first is that of securities broker, on the value of the assets they manage on the someone who conducts trades on behalf of clients behalf. It pays to ask before engaging clients. The sales professionals for brokerages their services. are known as registered representatives, whether they work in-house or independently. Federal Mutual funds securities law requires brokers to join a selfWhen people think of securities, individual regulatory organization (SRO). The SRO regucompany stocks immediately come to mind, but lates the day-to-day activities of brokers and retail (or individual) investors do not often their registered representatives, who are also invest directly in individual company shares. required to register with the SRO. Retail investors typically invest through pooled The primary SRO for the securities industry investments, the most common of which is the is the Financial Industry Regulatory Authority mutual fund. Mutual funds allow investors to (FINRA). The activities regulated by FINRA diversify their investment portfolios by allowing include record-keeping, educational requirethe investor to hold investments in a broader ments, advertising, and recommendations to range of holdings than would otherwise be clients, among others. The FINRAs rules must possible. A mutual fund can be made up of be approved by the SEC and are subject to many individual stocks, bonds, money market comment requirements similar to requirements accounts, or other securitieseven cash. Most of federal agency rules. Brokers and their mutual funds have a mix. representatives are compensated with commisMutual funds typically are organized by sions from trades executed on behalf of clients. theme, such as company size (approximated by
Copyright 2012 American Society on Aging; all rights reserved. This article may not be duplicated, reprinted or distributed in any form without written permission from the publisher: American Society on Aging, 71 Stevenson St., Suite 1450, San Francisco, CA 94105-2938; e-mail: info@asaging.org. For information about ASAs publications visit www.asaging.org/publications. For information about ASA membership visit www.asaging.org/join.

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stock capitalization or cap size) or industry sector. For example, some funds invest only in the stock of large-cap, mid-cap, or small-cap companies. Although there is no uniform definition, large-cap stocks are larger firms, usually with a market capitalization value of more than $10 billion. Multiplying a firms per-share stock price by the number of outstanding shares derives market capitalization value. Small-cap companies are more than start-ups but less than larger firms. Although the definition of small-cap varies, it is generally thought to include firms with a market capitalization of somewhere between $300 million and $2 billion. Mid-cap firms fall somewhere in between large-cap and small-cap firms. Funds that specialize in certain sectors of the economy may invest only in the manufacturing sector, the retail sector, or the technology sector. Still other mutual funds invest primarily in foreign companies, and these may even be further parsed by location or firm size. Mutual funds charge fees for investing on behalf of their investors. The fees compensate the mutual fund company for its work in choosing and managing the funds portfolio. Buyers purchase mutual funds from the fund itself or through a broker representing the fund. The mutual fund may charge a fee, called a sales

tion on investing. Index funds are mutual funds whose holdings are tied to a well-known index like the Wilshire 2000 or the S&P 500. Actively managed funds generally charge higher fees than index funds, ostensibly to compensate the fund manager for the additional work in choosing the funds investments. Index funds are not perfect reflections of the index to which they are related. Different mutual fund companies may vary in their holdings of the stocks within the index, which means that fund performance will vary somewhat from the performance of the index. It also means different index funds may vary slightly in their performance. However, because index funds are more alike than actively managed funds, investors may be better able to compare them based primarily on fees.

Bonds and newer funds targeted to retirees Bonds are generally thought to be safer, more stable investments than stocks. They have lower rates of return, but they generally have a lower risk of loss, which will depend on the type of bonds. Just as they can with stocks, retail investors can invest in the bond market through mutual funds, usually called bond funds. Like stock funds, bond funds also vary. Some bond funds specialize in corporate bonds, while others specialize in government bonds. Among those that invest in government bonds, some specialize in U.S. The securities industry has introduced products to Government Treasuries, while others invest primarily in state better meet the needs of the retirement investor. or municipal bonds. The securities industry has introduced charge or load, for purchasing shares in the fund. products to better meet the needs of the retireSome funds may charge a fee, called a deferred ment investor. Life-cycle funds have been on the sales load or redemption fee, when investors market for a while. They have a mixture of stock redeem their shares. Investors should carefully funds, bond funds, money market funds, and review fees in addition to fund performance, as cash. The fund rebalances as the owner ages or even small variations in fees can reduce overall nears retirement. Target-date funds are a newer investment returns. version of a life-cycle fund. These mutual funds Two commonly used groupings of mutual rebalance as the owner nears retirement. As one funds are actively managed funds and index funds. Actively managed funds are mutual funds nears the target date, the fund invests in more conservative investments. But even with targetin which the fund manager has broader discreCopyright 2012 American Society on Aging; all rights reserved. This article may not be duplicated, reprinted or distributed in any form without written permission from the publisher: American Society on Aging, 71 Stevenson St., Suite 1450, San Francisco, CA 94105-2938; e-mail: info@asaging.org. For information about ASAs publications visit www.asaging.org/publications. For information about ASA membership visit www.asaging.org/join.

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date funds, there is some variation that can affect returns and the owners retirement safety. Funds may have different ratios of stocks to bonds at any given point. Another point of variation is whether the date is a to date or a through date. In the language of target-date funds, a to date means the fund is designed for maximum safety and to prepare for withdrawal at the funds target date (e.g., 2015). A through date fund means the fund is designed to continue for an additional period, such as five years, from the target date. This information and its implication for risk may not be transparent to the retail investor.

deferred. Variable annuities allow investors growth through market performance, but buyers also bear the risk that their investments will lose money. Variable annuity buyers invest in the securities market through sub-accounts that are similar to mutual funds. The value of the variable annuity as a whole may increase or decrease because it is tied to the market performance of the underlying investments. Fixed deferred annuities can offer a fixed interest-rate return, similar to a bank certificate of deposit. Conversely, their returns can be tied to an index, like the S&P 500, at some nominally fixed rate. These so-called fixed indexed annuities The Life Insurance Industry: (formerly called equity indexed annuities) purport to offer market upside by allowing Products and Players Insurance, including the life insurance industry, purchasers to benefit from market growth is regulated by the states. While some life while promising protection against market insurers make direct sales through online or declines, unlike variable annuities, which may other means, most sales are through insurance decline in value as the value of their investment agents or brokers, collectively called insurance holdings declines. A key concern with all producers. The life insurance industry offers deferred annuities is cost. Many deferred annuities and life insurance. annuities have high fees, and those fees can Annuities include the traditional immediate increase with the addition of features called annuity, which offers an income stream (in the riders, such as a rider allowing the annuity form of fixed monthly payments) and deferred owner to make guaranteed minimum withannuities. Immediate annuities can be for a drawals without annuitizing (usually called a specified period (e.g., twenty years) or for the guaranteed minimum withdrawal benefit). life of the annuitant. Newer life annuities can Life insurance can be a part of ones overall have guaranteed minimum payouts or allow the investment portfolio. Many life insurance annuitant to leave a sum to heirs, but these policies allow the owner, or policyholder, to features carry a cost, in the form of fees, in addi- build up equity in the policy. The insurance tion to the cost of the annuity itself. Immediate benefit allows the policyholder to pass on wealth annuities are not truly investments, but instead without going through probate or paying tax. are income replacements. Deferred annuities, Unlike term life insurance, permanent life on the other hand, are used as investments. insurance builds cash value over time. The cash They offer tax-deferred savings and may be value is different from the policys face amount. converted into an income stream (annuitizing Policyholders can use cash value to make the annuity) at a later date. One drawback is premium payments, purchase additional insurthat deferred annuities have multi-year surren- ance, or even as collateral for a loan from the der periods during which penalties are charged insurer. Such loans must be repaid, or the death for withdrawals. benefit will be reduced. Deferred annuities can be variable or fixed. In Variations of permanent life insurance common parlance they are called either a fixed include whole life, universal life, and variable annuity or a variable annuity, dropping the word life. Term life insurance, on the other hand, only
Copyright 2012 American Society on Aging; all rights reserved. This article may not be duplicated, reprinted or distributed in any form without written permission from the publisher: American Society on Aging, 71 Stevenson St., Suite 1450, San Francisco, CA 94105-2938; e-mail: info@asaging.org. For information about ASAs publications visit www.asaging.org/publications. For information about ASA membership visit www.asaging.org/join.

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A Glossary of Financial Terms


Annuity: An annuity is an insurance contract in which the buyer pays a premium to the insurance company in exchange for a stream of payouts. There are different types of annuities, as follows: eferred Annuity: A deferred annuity allows its owner to save, tax-deferred, until payouts begin. The period D of time before the annuity owner starts receiving payouts is called the accumulation phase. With many deferred annuities, owners can invest additional money in the annuity. Most deferred annuities charge fees, called a surrender charge, if the owner wants to access the money prior to the period allowed under the annuity contract. ixed Annuity: A fixed annuity earns a fixed rate of interest for a set amount of time, frequently one to five F years. After this period, the interest rate may be adjusted. mmediate Annuity: An immediate annuity is an annuity in which the payments begin to the annuitant I within one year after the premium is paid. ndex Annuity: An index annuity earns interest based on a formula that is tied to an equities index such as I the S&P 500. The index and the formula may be different from other index annuities. ariable Annuity: A variable annuity puts its owners money in the equities markets through sub-accounts. V Because variable annuities are considered securities under federal securities law, the insurance company must issue a prospectus similar to the ones issued by mutual funds. Bond: A bond is a security representing a debt at a fixed interest rate and can be traded. Bonds may be issued by corporations, municipal or state governments, the U.S. government, or other governmental entities such as water or school districts. Broker: An individual or firm that, usually for a commission or a fee, executes trades (buy or sell orders) for an investor. Broker-Dealer: An individual or firm that executes trades both on behalf of other investors (as a broker) and on its own behalf (as a dealer). Insurance Producer: Formerly known as insurance agent or broker, this individual or firm is authorized to sell, solicit, or negotiate insurance. Insurance producers are usually paid by commission. Investment Adviser: This individual or firm makes investment recommendations or conducts securities transactions on behalf of clients. Investment advisers are paid through fees, either based on the assets under the advisers management, or another arrangement. Mutual Fund: A mutual fund is an investment vehicle made up of a pool of funds from many investors to invest in securities. Mutual funds are operated by money managers. The funds investment portfolio is structured to meet the objectives stated in its prospectus. Permanent Life Insurance: Permanent insurance builds up cash value over time. The cash value is different from the face value of the policy. The cash value can be used to cover premium payments, to purchase additional life insurance, or as collateral for a loan against the policy. The cash surrender value represents what the insurer would pay for the policy if the policyholder decides to cancelor surrenderthe policy. The cash value can also be converted into an annuity. Types of permanent life insurance include whole (or ordinary) life insurance, universal (or adjustable) life insurance, and variable life insurance. Registered Representative: A registered representative is an individual who works on behalf of a stockbroker. The relationship between the registered representative and the broker may be an employment or agency relationship. Security: A security is an instrument that evidences ownership (a stock), a debt (a bond), or rights to ownership (derivatives). A security derives its value through the work of others, and it can be traded. Stock: A stock is a security signifying ownership in a corporation. Stock owners have a claim on the corporations assets and earnings. Corporations may have more than one class of stock, representing different ownership rights. Term Life Insurance: Term life insurance pays a death benefit if the covered individual dies during the period covered under the contract. The premiums may either be constant or may increase over time.

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Copyright 2012 American Society on Aging; all rights reserved. This article may not be duplicated, reprinted or distributed in any form without written permission from the publisher: American Society on Aging, 71 Stevenson St., Suite 1450, San Francisco, CA 94105-2938; e-mail: info@asaging.org. For information about ASAs publications visit www.asaging.org/publications. For information about ASA membership visit www.asaging.org/join.

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now confidently call the CFPB with complaints. No additional license is required for a bank employee who assists a customer in the purchase of a traditional bank certificate of deposit or other traditional banking product like a savings account. Banks also traditionally offer loans. The reverse mortgage is a loan available to consumers ages 62 and older who own their homes. The reverse mortgage borrower repays the loan when the borrower sells the house or no longer lives in the house, either because the borrower moves or dies. Most reverse mortgages are Home The Banking Industry: Products and Players Equity Conversion Mortgages guaranteed by the Federal Housing Administration (FHA) and Bank regulation can be confusing to those must meet specified criteria. A reverse mortgage unfamiliar with it. Banks can be chartered by can be an appropriate financial decision for older the federal government or by a state. Federally homeowners who lack other funds to finance chartered banks are regulated by the Office of the Comptroller of the Currency. State-chartered their retirement, but the decision and options can be quite complex. Even though the FHA banks are regulated by their state banking requires pre-loan counseling, the stakes are huge for potential The decision of whom to consult for investment problems, including losing a advice is the most crucial one investors can make home to foreclosure. The GrammLeachBliley especially if they dont question that advice. Act of 1999 ended prohibitions supervisor, but they also have a federal regulator. that acted as walls between banks and other State-chartered banks that are part of the Federal financial services firms. That Act allowed banks to offer securities, investment advice, and Reserve System are subject to its regulation. Bank holding companies are also regulated by insurance products in their branches. Bank the Federal Reserve. The Federal Deposit employees who sell securities, insurance, or Insurance Corporation also regulates both investment advice must have the appropriate state-chartered and federally chartered banks. license. The bank and its employees are subject State banking supervisors generally have to regulation by banking, insurance, and securities regulators. authority to enforce state consumer protection laws over banks under their regulation, but they are generally preempted from enforcing those Weighing the Risks and laws against federally chartered banksand Preventing Consumer Confusion banks chartered in other states. The 2010 With so many products being marketed by so DoddFrank Wall Street Reform and Consumer many companies, it is little wonder that consumProtection Act consolidated federal consumer ers, particularly older consumers, can become protection for banking products and services confused. For many investors, the decision of under the authority of the Consumer Financial whom to consult for advice on how to invest is Protection Bureau (CFPB), whereas consumer the most crucial one they make, especially if they protection authority was formerly spread over follow the advice theyre given without indepenseven different federal agencies. Consumers can dently verifying it. Investors turn to experts covers a specified term, such as a certain age or a specified date. Some life insurersand a limited number of stand-alone insurers (those that are not life insurance companies)offer long-termcare insurance, which pays the expenses of long-term care when an individual suffers physical or mental incapacity. Some life insurance policies offer the option of an accelerated death benefit, in which the policyholder receives part of the policys death benefit to help with long-term-care expenses.
Copyright 2012 American Society on Aging; all rights reserved. This article may not be duplicated, reprinted or distributed in any form without written permission from the publisher: American Society on Aging, 71 Stevenson St., Suite 1450, San Francisco, CA 94105-2938; e-mail: info@asaging.org. For information about ASAs publications visit www.asaging.org/publications. For information about ASA membership visit www.asaging.org/join.

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because they lack the expertise to independently check the advice they are given. Because of this, the duty of care that financial advisors owe their clients is important. When brokers and their representatives make recommendations to clients, the recommendation must be suitable to meet the clients investment needs. In most states, life insurance agents have a similar duty when selling annuities; however, insurance agents selling life insurance itself have a duty to make suitable recommendations in only a few states. Investment advisers have a fiduciary duty to act in the best interest of their clients. When bank employees act as securities brokers, insurance agents, or investment advisers, they are held to the same duty of care as other licensees providing these services. In contrast, there is no duty of care for selling traditional banking products. The difference between the suitability standard and the fiduciary duty is slight. Selling investors bad investments or outright fraud is not permitted under either standard. However, a fiduciary duty can make a difference that is perceptible over time. A fiduciary must continually recommend the best investment for the client, not merely one that is good enough, over the course of the relationship with the investor. Sometimes this can mean lower returns in exchange for greater safety. In other instances, a fiduciarys duty to disclose conflicts may promote better client decision-making. Most risks an investor faces can be grouped under the category of outliving ones retirement savings. Other risks, such as market downturns,

inflation, or even an insufficiently diversified portfolio, are ways in which the investor fails to have enough means to live comfortably during retirement. Many of the products and product features discussed earlier in this article were developed to address one or more of these risks, but each answer to one issue raises others. The basic life annuity provides lifetime income, but the owner no longer has access to the money with which the annuity was purchased. A rider can be purchased guaranteeing the annuitant will get at least the amount paid for the annuity, but at a cost that reduces the amount of monthly income. Guaranteed living benefit riders in variable annuities address market risk by allowing the investor to retain the right to make withdrawals of a guaranteed amount without annuitizing, but again, there is a cost associated with this benefit, just as there is with all benefits. Fund diversification and automatic fund rebalancing help investors mitigate market risk of downturns and overexposure to single stocks or single classes of stocks, but there are fees and costs associated with these benefits as well. Ultimately, there is no one right answer for all investors. People must do their homework and choose financial advisors wisely. As reflected in the articles that follow, the older investor faces particular challenges related to cognitive and other changes associated with aging that can affect the quality and outcomes of their financial decisions and choices. Ryan Wilson, J.D., is a strategic policy advisor with the AARP Public Policy Institute in Washington, D.C.

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Copyright 2012 American Society on Aging; all rights reserved. This article may not be duplicated, reprinted or distributed in any form without written permission from the publisher: American Society on Aging, 71 Stevenson St., Suite 1450, San Francisco, CA 94105-2938; e-mail: info@asaging.org. For information about ASAs publications visit www.asaging.org/publications. For information about ASA membership visit www.asaging.org/join.

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