A client, a 70-year-old retired individual, has a moderate risk tolerance and wishes to invest a portion of their savings to generate a steady stream of income. They are concerned about interest rate risk and inflation. Which of the following investment options would be MOST suitable to recommend for this client's income objective?
- AA portfolio of dividend-paying utility stocks
- BLong-term zero-coupon bonds
- CA diversified portfolio of high-yield corporate bonds
- DA fixed annuity with an immediate payout option
Show answer & explanationAnswer & explanation
Correct answer: D. A fixed annuity with an immediate payout option
The client is retired, needs steady income, has moderate risk tolerance, and is concerned about interest rate risk and inflation. A fixed annuity with an immediate payout option provides a guaranteed, predictable income stream, addressing the need for steady income and mitigating interest rate risk. While a fixed annuity does not offer inflation protection, it directly addresses the primary need for guaranteed income and stability, which is often prioritized for retirees with moderate risk tolerance. Dividend-paying stocks offer some inflation protection but introduce more market risk than a fixed annuity.
Why the other options are wrong
- A. Dividend-paying utility stocks offer income and some inflation protection but introduce greater market volatility and risk than a fixed annuity, potentially exceeding the client's moderate risk tolerance for their primary income source.
- B. Long-term zero-coupon bonds are highly sensitive to interest rate risk and do not provide a current income stream, making them unsuitable.
- C. High-yield corporate bonds carry significant credit risk and are not suitable for a moderate risk tolerance, despite offering income.
Fixed Immediate Annuity Suitability
A fixed immediate annuity is an insurance contract that converts a lump sum into a guaranteed, predictable stream of income payments starting almost immediately, suitable for retirees seeking stable income with low risk tolerance.
- Provides a guaranteed income stream for a specified period or life.
- Low investment risk as the insurer guarantees payments.
- Does not offer inflation protection; purchasing power may erode.
- Suitable for clients prioritizing income stability over growth or inflation hedge.
Memory trick: Guaranteed income for life, from a fixed annuity's strife.