The life-cycle approach ("floor" plus upside approach) is the general economics approach to financial planning including retirement planning. The older approach (called mean/variance or "probabilistic") is based on risk-return tradeoffs along the efficient frontier and is a special case of the life-cycle approach. In that special case the floor goal is either non-existent or very low, and the aspirational goal is soft. (I would like to have this much or more, but perhaps not realizing that the “or more” reduces the chances of meeting the goal.)500Kaiser wrote:I have (some) very basic questions.
After reading the wiki and some of the articles, my interpretation is that a "floor" plus upside approach, say 10 - 15 years of TIPS in a non rolling ladder used to spend as income, and a coventional portfolio with the intent to extend the ladder at some point in future is not a pure lifecycle finance approach since part of this strategy is relying on a probabalistic approach. Is this interpretation accurate? How unpure is it?
There is no pure life-cycle approach. You pick two goals. One goal is what you want. The other goal is a lower conservative goal that typically you want to hit with very high probability. You are serious when you set or reset the goals and you employ investment strategies that are explicitly targeted to meet the goals. If you want to hit the lower goal with near certainty, you are going to have to hedge or insure, not diversify, the risk of reaching that goal. That means you need a matching strategy to reach that conservative goal both before and during retirement .
As a practical matter I think in early retirement it’s prudent to have both annuitized income and a TIPS ladder. You get the mortality credit from the annuity and you get more flexibility in the income stream from the TIPS. I would suggest building the TIPS ladder from retirement to no later than your life expectancy year. Either at retirement purchase a longevity annuity that begins when the ladder ends, or wait to buy an annuity when the ladder ends to replace the laddered income. In the second case you may never need the annuity.(H)ow does one figure out how far out to take the floor if self annuitized via TIPS? Isn't there always going to be some uncertainty that I can live past the end of the ladder?
Financial engineers can replicate the characteristics a bond ladder with bond funds precisely. We at home, doing this on our own and taking only bond duration into account, will only loosely match the bond ladder characteristics. This becomes more problematic if adjustments aren’t made as frequently as monthly or at least semi-monthly. So I agree that DIY bond fund duration matching to a ladder is only a loose approximation of the ladder’s characteristics.A bit off topic, but I have never been able to get comfortable with the idea that I can substitute a mix of different duration TIPS bond funds and say a MM fund to replace a non rolling TIPS ladder. I guess maybe if someone had ever worked through an example of this, mathematically, I would be interested to know about it and try and understand it. I have looked before, but most of the threads here get into a clarification around bond funds and bond ladders and the difference of non rolling and rolling ladders. Occassionally, this mixing thing gets thrown out, and I don't disbelieve it, but before I would consider utilizing it for a floor, I would want to be 100% clear on how it would work, like I am with a non rolling TIPS ladder.
BobK