Liability Matching Portfolio? Really?

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azanon
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Re: Liability Matching Portfolio? Really?

Post by azanon » Mon Jun 23, 2014 11:52 am

market timer wrote:
azanon wrote:So, in summary, my opinion is the most conservative of retirement investors, but still logical, investors implements a best-guess at a MVP of about 30% equities (though more recent guesses have this figure closer to 40%). Going to a full-blow TIPS/CDs/SPIA up to a LMP which will be the entire amount based on what most people actually retire on, is way too conservative. It's illogically conservative.

Asset prices are volatile, but so are liabilities. Where I think LMP differs from MPT is that the former considers the volatility of both assets and liabilities, while the latter just considers the volatility of assets. As a result, what LMP considers a riskless investment, such as an inflation-adjusted SPIA, is perceived as risky by MPT, because the present value fluctuates with interest rates.


I understood what you just said, but I'm still not understanding why it matters. So, Bengen actually based the 4% SWR study on a 60/40 portfolio. So lets say you want to give "volatility" the maximum deference with no regard for return, so you throw out the 60/40 and go for the least volatile (most predictable/steady/consistent) portfolio. If I understood Markowitz's work correctly, that's actually still the ~ 30/70, not the 0/100. The 0/100 is more volatile, and more volatility is bad. I admit I'm not getting it yet, and fear there's nothing to get!?!

Liabilities would be a mutually exclusive variable operating to the beat of its own drum. If anything, liabilities are most likely to be most greatly affected by inflation. So, if that's true, even Dr. Bernstein has suggested that stocks are as good as anything at combating inflation, and I would think, on average, far better at it than even TIPS. Again, sure there's going to be that > 2SD event where stocks actually lose, but then my point is similar to one Larry Swedroe's made, which is why pay such a very high price in a futile attempt to address that last < 5% chance you fail, when you're more likely to die?

Let's just get right down to it. My "simple" grandfather (very kind, simple man, now gone God rest his soul) who knew nothing about investing put all his money in CDs. Surely, someone's not going to tell me after all I've learned, that he was actually doing the right thing?!? Look, I'm as cautious as anyone I know. But I'm drawing the line somewhere!

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Re: Liability Matching Portfolio? Really?

Post by feh » Mon Jun 23, 2014 11:57 am

Somehow I missed this thread during its first incarnation...

Count me in the group that is uncomfortable w/ LMP. I plan on retiring in 2 years (at age 50), and given that I have 40+ years of retirement ahead of me, I am not comfortable with the very conservative approach of LMP. We'll be keeping 50-60% of our portfolio in equities.
Last edited by feh on Mon Jun 23, 2014 2:10 pm, edited 1 time in total.

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Re: Liability Matching Portfolio? Really?

Post by azanon » Mon Jun 23, 2014 1:58 pm

Let me add, I feel this whole LMP is borderline Zvi Bodie kind of thinking. Again, don't get me wrong, I also find him as interesting, knowledgeable, intelligent, (and quite kind) as anyone. But I guess I just have a real issue with a 100% treasury portfolio for any length of time greater than, lets say, 5 years, even if your "human capital" is 0.

And just to throw out another thing I never hear mentioned. Perhaps if your portfolio fails, you won't really be eating "alpo". If you have social security, and better yet, a pension to boot as well, what you might have to do is just "move", and live more like - dare i say - most retirees?!? Forced to guess, I bet there are more retirees on SS alone than any other scenario. When I see them at the checkout line with their SNAP, if they have alpo in the cart, it is usually for the pet dog. MMM isn't eating alpo, and he claims to live on 24K/year. If i work 30 years (and am still married), my SS alone is good for 24K or better!

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Re: Liability Matching Portfolio? Really?

Post by azanon » Mon Jun 23, 2014 2:02 pm

feh wrote:Somehow I missed this thread during it's first incarnation...

Count me in the group that is uncomfortable w/ LMP. I plan on retiring in 2 years (at age 50), and given that I have 40+ years of retirement ahead of me, I am not comfortable with the very conservative approach of LMP. We'll be keeping 50-60% of our portfolio in equities.


And if your withdrawal rate is 4% or less, and you implement some sort of year-to-year adjustment (Such as what Vanguard does for Managed Payout), and it STILL fails, then God help us all. You will most certainly have lots of company.

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Re: Liability Matching Portfolio? Really?

Post by Leesbro63 » Mon Jun 23, 2014 2:13 pm

azanon wrote:
feh wrote:Somehow I missed this thread during it's first incarnation...

Count me in the group that is uncomfortable w/ LMP. I plan on retiring in 2 years (at age 50), and given that I have 40+ years of retirement ahead of me, I am not comfortable with the very conservative approach of LMP. We'll be keeping 50-60% of our portfolio in equities.


And if your withdrawal rate is 4% or less, and you implement some sort of year-to-year adjustment (Such as what Vanguard does for Managed Payout), and it STILL fails, then God help us all. You will most certainly have lots of company.


This is an excellent point. If what's worked since 1926 (or whenever good records became available) won't work going forward (meaning "4% rule"), then only the correct speculators will be OK. Any prudent investor will be badly hurt. That being said, I don't think I'd start with more than a 3% SWR these days, just to be extra safe.

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Re: Liability Matching Portfolio? Really?

Post by feh » Mon Jun 23, 2014 2:19 pm

Leesbro63 wrote:
azanon wrote:
feh wrote:Somehow I missed this thread during it's first incarnation...

Count me in the group that is uncomfortable w/ LMP. I plan on retiring in 2 years (at age 50), and given that I have 40+ years of retirement ahead of me, I am not comfortable with the very conservative approach of LMP. We'll be keeping 50-60% of our portfolio in equities.


And if your withdrawal rate is 4% or less, and you implement some sort of year-to-year adjustment (Such as what Vanguard does for Managed Payout), and it STILL fails, then God help us all. You will most certainly have lots of company.


This is an excellent point. If what's worked since 1926 (or whenever good records became available) won't work going forward (meaning "4% rule"), then only the correct speculators will be OK. Any prudent investor will be badly hurt. That being said, I don't think I'd start with more than a 3% SWR these days, just to be extra safe.


Given our early retirement age (and thus, more years of living on savings), our WR will be somewhere between 2.5 and 3%. We'll also be flexible w/ our withdrawals.

I think there is such a thing as being too conservative.

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Re: Liability Matching Portfolio? Really?

Post by Leesbro63 » Mon Jun 23, 2014 2:23 pm

"The irony is that (especially for early/younger retirees), being too conservative is actually being too risky." -Y. Berra-

(No Yogi Berra didn't say that, but I'll attribute that to him as if he did)

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Re: Liability Matching Portfolio? Really?

Post by siamond » Mon Jun 23, 2014 4:36 pm

Leesbro63 wrote:"The irony is that (especially for early/younger retirees), being too conservative is actually being too risky." -Y. Berra-

(No Yogi Berra didn't say that, but I'll attribute that to him as if he did)

This is probably the best post of the thread. Very funny and... very true.

You can add me to the list of LMP skeptics, not only for the reasons that were listed, but also because:
a) I want to have a decent chance at leaving a solid bequest to my 3 children (and an LMP -without the RP part- is eating the portfolio alive, TIPS ladder or SPIA)
b) I do NOT want to make a bet on longevity - who knows what medicine will bring us 20 to 30 years from now
c) I recently semi-retired in my early 50s - hence hopefully more than 30 years to plan for, and some human capital left in case of severe crisis
d) I do believe (and extensively modeled) that being adaptive in your withdrawals helps solving a lot of issues with a more 'risky' portfolio, and not only avoid the most dire situations, but also take advantage of the more rosy situations, and address some of the deep risk (e.g. inflation).

You know, sometimes, things do go well, and I don't know about you guys, but I'll know what to do if I have more money than the strict liability-matching minimum, thanks to a nice stock run like in the 90s. I'm still eager to take some risk for such reward.

Now, if you don't have a) as a goal, I can understand the LMP approach if you're 70+, notably with the SPIA approach to take care of point b). And to be fair to Dr Bernstein, he always positioned LMP as a tool for 'regular' retirees (e.g. 65+ with a 30-years lifespan). And then, even if I'm not entirely convinced, I can see the logic of it. And I might see it even better when I get older and more conservative.

What I am trying to say is that we all have our own circumstances and goals. The LMP approach is not *THE* magic bullet. It's just a tool that could be used in *some* situations. And there are other approaches, which are equally valid. And hey, it's good to agitate our aging grey cells to think hard about it! :wink:

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Re: Liability Matching Portfolio? Really?

Post by market timer » Mon Jun 23, 2014 9:31 pm

azanon wrote:Liabilities would be a mutually exclusive variable operating to the beat of its own drum.

This is the key point: The volatility of liabilities is correlated with the volatility of certain types of assets. In particular, as real interest rates decline, the present value of your future liabilities increases. This is identical to what happens to TIPS.

If anything, liabilities are most likely to be most greatly affected by inflation.

Inflation reflects the current price of commodities, but it is inflation expectations that determine the present value. If inflation expectations increase, holding nominal interest rates constant, that means real interest rates fell and the present value of liabilities will go up. However, if inflation expectations increase at the same rate as nominal interest rates, then there is actually no change in the present value of liabilities.

So, if that's true, even Dr. Bernstein has suggested that stocks are as good as anything at combating inflation, and I would think, on average, far better at it than even TIPS.

Ignoring tax consequences, there is no better investment for matching a typical basket of consumption liabilities than TIPS of the same duration as the liability. In other words, if you would like $30K in today's buying power 10 years from now, the least risky way to meet this liability is a 10-year TIPS (ideally zero coupon). If you object on the basis of after-tax returns, there are ways to hedge this tax liability by creating an inflation break-even (long TIPS short nominal Treasuries).

Let's just get right down to it. My "simple" grandfather (very kind, simple man, now gone God rest his soul) who knew nothing about investing put all his money in CDs. Surely, someone's not going to tell me after all I've learned, that he was actually doing the right thing?!? Look, I'm as cautious as anyone I know. But I'm drawing the line somewhere!

Nobody recommending LMP suggests 100% CDs; rather, a TIPS ladder (or COLA SPIA) is the typical recommendation for meeting necessary retirement spending. I'd also note that a owning a house goes a long way towards hedging the future cost of shelter, and should be viewed more favorably by LMP than MPT.

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Re: Liability Matching Portfolio? Really?

Post by #Cruncher » Mon Jun 23, 2014 10:32 pm

azanon in this post wrote:I have an admitted basic understanding of some of Markowitz's work on minimum variance portfolios (MVP), but one of the take-home "cliff-notes" guides I remember from this was that, for a long term investor ..., 100% bonds/cash equivalents is ALWAYS wrong. Rephrased, 100% TIPS (up to a LMP amount?) is also, ALWAYS WRONG. Reprhased, there is a certain amount of equities (30% is the number I hear most often), where you both increase return AND reduce risk, … (two underlines added)
A 30% stocks : 70% TIPS portfolio might indeed be less volatile than 100% TIPS, but that doesn't make it less risky as a Liability Matching Portfolio (LMP). This is because -- with a couple of minor qualifications * -- if the proper ladder of TIPS is held in an IRA (Roth or Traditional), it is certain to provide the necessary funds after taxes to meet the projected liabilities in today's dollars regardless of changes in the Consumer Price Index (CPI). And if something is certain to produce a desired result, by definition it is the least risky way of doing so. That it might be more volatile (than the 30:70 mix) along the way is irrelevant.

But if the TIPS are held in a taxable account, there is no such guarantee. The after-tax real return of TIPS will decrease, the higher the increase in the CPI. In this case, maybe a 30:70 stocks:TIPS portfolio would be less risky for an LMP. I don't know.

* Qualifications:
  • If the 100% TIPS portfolio is held in a Traditional IRA instead of a Roth IRA, there is risk that one's Federal income tax rate could be higher than planned. For example, if one needs $30,000 per year after taxes and one expects the tax rate to be 25% at time of withdrawal, one needs $40,000 of principal and coupons each year before taxes. As long as the tax rate is 25%, one is still guaranteed to have $30,000 after taxes in today's dollars regardless of the change in the CPI. But this won't be so if the tax rate is higher.
  • Currently there are no TIPS maturing in 2030, 2031, and 2033 - 2039. (See WSJ TIPS Quotes.) So one has to accept some reinvestment risk and / or interest rate risk in building a TIPS ladder to cover these years.

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Re: Liability Matching Portfolio? Really?

Post by IlliniDave » Tue Jun 24, 2014 5:07 am

I don't know about the "quit once you've won" mantra, but I'll dedicate some portion of my assets to US Gov't bonds and cash to ensure a minimum sustenance once I stop working. Beyond that, I don't plan on quitting the game, and the rest of my money will be invested for potential growth. For myself, I see capital preservation and investing as different beasts. The purpose of the latter is to increase wealth (at some amount of risk). The purpose of the former is to come as close to eliminating risk as possible. To me that distinction is enough to feel that someone who retreats to all cash and short/intermediate treasuries is no longer investing per se.

I don't have an issue with bucketing. So another way of looking at my own plan down the road is to say I'll pull a bucket out of my investment assets sized to ensure I'll never starve. The rest will stay invested very similarly to how I invest now. The net result is similar to a substantial shift in AA towards bonds, but I won't consider rebalancing from the liability-matching bucket into fallen equities.

Fortunately my personality is not too brittle to accommodate adjusting my lifestyle expenses if need be.
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Re: Liability Matching Portfolio? Really?

Post by azanon » Tue Jun 24, 2014 7:32 am

#Cruncher wrote:
azanon in this post wrote:I have an admitted basic understanding of some of Markowitz's work on minimum variance portfolios (MVP), but one of the take-home "cliff-notes" guides I remember from this was that, for a long term investor ..., 100% bonds/cash equivalents is ALWAYS wrong. Rephrased, 100% TIPS (up to a LMP amount?) is also, ALWAYS WRONG. Reprhased, there is a certain amount of equities (30% is the number I hear most often), where you both increase return AND reduce risk, … (two underlines added)
A 30% stocks : 70% TIPS portfolio might indeed be less volatile than 100% TIPS, but that doesn't make it less risky as a Liability Matching Portfolio (LMP). This is because -- with a couple of minor qualifications * -- if the proper ladder of TIPS is held in an IRA (Roth or Traditional), it is certain to provide the necessary funds after taxes to meet the projected liabilities in today's dollars regardless of changes in the Consumer Price Index (CPI). And if something is certain to produce a desired result, by definition it is the least risky way of doing so. That it might be more volatile (than the 30:70 mix) along the way is irrelevant.


Here's the thing though. I bet you could take that 30/70 portfolio instead of the laddered TIPS, withdraw exactly the same amount (no more) as you would with the full TIPS ladder, and the likelihood than the 30/70 couldn't at least keep pace with the 100% guaranteed TIPS ladder is going to be well under 5% (e.g. well under 2 SD), and I bet 1-2%, if modeled. Again, (global) stocks are absolutely outstanding at combatting long-term inflation, and if you're using a 30/70 with a rebalancing strategy, it will not only keep up, I think it will trounce the all TIPS, and then if you live past the end of your ladder, i bet there's still a sizeable chuck left if you kept the strict/low withdrawal rate.

And I want to point out another thing here. Could there not be possibly a worse time to implement any sort of strategy that would have one lock in long-term interest rates. I mean, come-on, what are 30yr TIPS paying on the interest rate component - a paltry 1.6%? Good lord. Even in you set aside the numerous studies that say duration generally isn't rewarded, one can't take the ostrige approach and ignore what today's rates are. And as a somewhat similar issue, who in the world would want to lock in today's rates with a SPIA? Ok, sure, I don't know which direction rates are headed anymore than anyone else, but I DO know today's rates are very low relative to history. IMO, they're so low, that I think whether working or retired, your bonds/cash equivalents are all short duration. To use an analogy here, I think of myself being in a store, and the clerk says "I'll give you 1.6% interest on a 30yr TIPS", then without so much as firing one neuron I say, hell no! And no, I haven't forgotten there's an inflation component to TIPS, but still, there's the fixed portion as well, and it reeks today.

So here's where I end up. I say if you're REALLY conservative, you go with a ~ 30/70, with the 70 being TBills/Tbonds (or some combination), and the 30 being a globally diversified portfolio of equities, and a ~ 3% SWR (with a year-to-year adjuster based on actual market conditions). And if you're a more moderate investor, something inbetween 50/50 to 60/40 doing the same thing, but start with 4% SWR, again adjusting year-to-year based on actual market outcome. And I see little danger in starting with a potentially slightly elevated SWR, if you decide beforehand that you'll lower it if market conditions warrant.

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Re: Liability Matching Portfolio? Really?

Post by Rodc » Tue Jun 24, 2014 8:26 am

Leesbro63 wrote:
azanon wrote:
feh wrote:Somehow I missed this thread during it's first incarnation...

Count me in the group that is uncomfortable w/ LMP. I plan on retiring in 2 years (at age 50), and given that I have 40+ years of retirement ahead of me, I am not comfortable with the very conservative approach of LMP. We'll be keeping 50-60% of our portfolio in equities.


And if your withdrawal rate is 4% or less, and you implement some sort of year-to-year adjustment (Such as what Vanguard does for Managed Payout), and it STILL fails, then God help us all. You will most certainly have lots of company.


This is an excellent point. If what's worked since 1926 (or whenever good records became available) won't work going forward (meaning "4% rule"), then only the correct speculators will be OK. Any prudent investor will be badly hurt. That being said, I don't think I'd start with more than a 3% SWR these days, just to be extra safe.


FWIW: the 4% rule has not been completely reliable from 1926 onward; it failed on occasion.

That said, I think for a planning number, with the understanding that one might have to economize during times of poor returns, is pretty good. But as an ironclad rule it makes no sense.


********************

I agree with those who caution about going whole hog into LMP land, especially for those looking at hopefully a long retirement. It is unclear we really have a full enough set of LMP assets to really pull off the safety that is envisioned. That said, I think there are some very important ideas in the LMP arena, and while going in 100% is not warrented, going in 0% is probably not idea either.
We live a world with knowledge of the future markets has less than one significant figure. And people will still and always demand answers to three significant digits.

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Re: Liability Matching Portfolio? Really?

Post by Bustoff » Tue Jun 24, 2014 9:09 am

As I understand this you have the LMP and RP.
Lets say you have basic expenses that that run at 40K per year. Thus, a sixty-year-old would need a 30 year LMP that amounts to 1.2M allocated to SPIA's or TIPS simply for the LMP side.
Is that the basic idea?
Last edited by Bustoff on Tue Jun 24, 2014 12:54 pm, edited 1 time in total.

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Re: Liability Matching Portfolio? Really?

Post by dbr » Tue Jun 24, 2014 9:22 am

Bustoff wrote:As I understand this you have the LMP and RP.
Lets say you have basic expenses that that run at 40K per year. Thus, a sixty-year-old would need a 30 year LMP that amount to 1.2M allocated to SPIA's or TIPS simply for the LMP side.
Is that the basic idea?


My understanding is that he would have enough money that has been used to buy inflation indexed SPIA's and/or a ladder of TIPS that would provide 40K real for thirty years.

Of course the math is not that simple. For example, at age 60, let's assume an inflation indexed SPIA pays out 4.2% (an invented number). In that case to buy 40K real would cost $952,381, so that would be the size of the "LMP," which however is not a portfolio at all but an annuity and does not last thirty years but rather for the investors lifetime. In this scheme the guaranteed withdrawal rate is 4.2% lifetime.

On the other hand, if one can find a way to actually buy 30 TIPS maturing in each of the next 30 years, then one would have the 40K per year if each of those TIPS had a present value due on maturity of 40K. The actual cost to buy that face value could be more or less than 40K depending on whether the available bonds were at a premium or a discount. In addition to that the bonds would pay an actual coupon, so we could fuss over whether or not we should be using the coupon as part of the 40K income. These are all quibbles as the answer in this case would be close enough to the 1.2MM. There is, or course, the question of what happens at the end of thirty years. Also, note as an aside, that in this scheme the guaranteed withdrawal rate is 3.33% for 30 years and 0% thereafter.

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Re: Liability Matching Portfolio? Really?

Post by Greg4boat » Tue Jun 24, 2014 11:31 am

Bustoff wrote:As I understand this you have the LMP and RP. Lets say you have basic expenses that that run at 40K per year. Thus, a sixty-year-old would need a 30 year LMP that amount to 1.2M allocated to SPIA's or TIPS simply for the LMP side. Is that the basic idea?


Bustoff: That is how I implemented the Bernstein framework and roughly the way I calculated the amount needed. The liability matching component of my portfolio is intended to cover expenses not covered by SS and my pension. My expenses include discretionary spending like vacations. So, as much as one can, I believe I have defined a very comfortable retirement for my wife and I with minimum adjustment to our lifestyle. Since I am out of the accumulation phase, ensuring an income source for these residual expenses by forgoing risk / the possibility of growth is OK with me. The performance of the risk component of my portfolio will simply put icing on the cake - we will take more or longer vacations and leave something to our heirs.
I will also add that many retirees who advocated "staying the course" before 2008, and sold during the financial crisis, learned this is easier said than done. When you are in retirement, have no or limited ability to make money, are faced with huge losses, don't know when the market will stop dropping or how quickly it will recover, and you have a limited time horizon for it to recover, then the pressure to contain your loss and preserve your assets will be significant.

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Re: Liability Matching Portfolio? Really?

Post by Bustoff » Tue Jun 24, 2014 1:25 pm

Greg4boat wrote:
Bustoff wrote:As I understand this you have the LMP and RP. Lets say you have basic expenses that that run at 40K per year. Thus, a sixty-year-old would need a 30 year LMP that amount to 1.2M allocated to SPIA's or TIPS simply for the LMP side. Is that the basic idea?


Bustoff: That is how I implemented the Bernstein framework and roughly the way I calculated the amount needed. The liability matching component of my portfolio is intended to cover expenses not covered by SS and my pension. My expenses include discretionary spending like vacations. So, as much as one can, I believe I have defined a very comfortable retirement for my wife and I with minimum adjustment to our lifestyle. Since I am out of the accumulation phase, ensuring an income source for these residual expenses by forgoing risk / the possibility of growth is OK with me. The performance of the risk component of my portfolio will simply put icing on the cake - we will take more or longer vacations and leave something to our heirs.
I will also add that many retirees who advocated "staying the course" before 2008, and sold during the financial crisis, learned this is easier said than done. When you are in retirement, have no or limited ability to make money, are faced with huge losses, don't know when the market will stop dropping or how quickly it will recover, and you have a limited time horizon for it to recover, then the pressure to contain your loss and preserve your assets will be significant.

I agree. Except I don't like the idea of using SPIA's or TIPS's.
Didn't you fund your LMP with Target Retirement ? I thought that was an intriguing approach.

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Re: Liability Matching Portfolio? Really?

Post by garlandwhizzer » Tue Jun 24, 2014 1:29 pm

I really enjoyed Dr. Bernstein's new book, but there is one point he makes that on which I strongly disagree. LMPs may be attractive for very risk averse investors but I am not one and I don't think it necessary for everyone to have a LMP. I have won the game and I choose to keep playing.

My main reservations about LMPs are twofold. First their safety comes at a very high price. TIPs yield essentially nothing but also have duration risk to principal in case you have an emergency and need cash in excess of your LMP projections and have to liquidate your TIPS to provide for expenses at some point before maturity. SPIAs that are inflation adjusted are also extremely expensive. You have to up front accept a 30 year inflation adjusted investment return of essentially zero when you sign up. Additionally, neither of these is flexible in terms of payout. If you have unexpected expenses 10 or 20 years down the road or an emergency that requires more money than your LMP is paying out, you are stuck, locked up in an inflexible payment schedule. I don't think I am capable of accurately defining what my need for retirement income is going to be 20 or 30 years down the road. I am not sure that I can accurately define now what my income needs will be 20 or 30 years from now. I personally have a higher degree of certainty that 20 or 30 years down the road, putting all that LMP money into a well thought out asset allocation plan with considerable equity exposure in index funds will provide greater returns with more flexibility through the years. Perhaps I am Pollyanna but that's how I see it.

In our time average lifespan has increased dramatically. What if your 30 year LMP runs out and you're still alive? Your SPIA continues but your TIPS ladder is gone unless you have continued to buy TIPS along the way. Again you're stuck unless you have kept on investing in TIPS during retirement. And investing with what, since you've already paid a fortune for your modest inflation-adjusted income stream. If you have adequate assets that you can do a LMP plus a considerable equity investment and you are risk averse, I see its appeal. But if you don't have considerable assets invested in equities in addition to those considerable funds required for a LMP, its inflexibly locks you in to whatever figure you estimated your future needs would be, a judgement like all judgements made by humans, that may in time prove to be in error.

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Re: Liability Matching Portfolio? Really?

Post by Greg4boat » Tue Jun 24, 2014 2:39 pm

Bustoff wrote:I agree. Except I don't like the idea of using SPIA's or TIPS's.Didn't you fund your LMP with Target Retirement ? I thought that was an intriguing approach


Hi Bustoff: I didn't use TIPS because the bulk of my assets are in a taxable account. I agree with you regarding SPIAs too unless much later in life when mortality credits are working for me. The liability component is in PenFed CDs (3%) and limited term bond. The risk component uses one of the target retirement income funds.

garlandwhizzer wrote:But if you don't have considerable assets invested in equities in addition to those considerable funds required for a LMP, its inflexibly locks you in to whatever figure you estimated your future needs would be, a judgement like all judgements made by humans, that may in time prove to be in error


I have a little different view. The LMP does come with a price - and the benefit - that we have a very high probability we will not have to significantly adjust our lifestyle over retirement. We don't know the price for the benefit. When using a non liability matching approach, its return and sustainability are significantly impacted by the sequence of returns; I personally don't want to worry about that since I don't have to. If my liability component is exhausted, which is a very low probability in my mind (estimated expenses on the high side, maintain LTC and supplemental Medicare insurance, and delaying Social Security until 70), then I can reduce / eliminate discretionary spending and / or convert some of the risk component of my portfolio into a SPIA with significant mortality credits.

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Re: Liability Matching Portfolio? Really?

Post by #Cruncher » Tue Jun 24, 2014 8:36 pm

dbr in this post wrote:... then one would have the 40K per year if each of those TIPS had a present value due on maturity of 40K.
Allow me to be picky about your wording, dbr. I believe the term current inflation-adjusted principal would be clearer. The term present value implies discounting future cash flows by the yield-to-maturity, which is something else entirely.

dbr wrote:In addition to that the bonds would pay an actual coupon, so we could fuss over whether or not we should be using the coupon as part of the 40K income.
The coupons on currently outstanding TIPS may seem small, but they add up to a significant amount. For example, in the 30-year 2015-2044 example on my TIPS ladder builder, 45% of the $30,000 in 2015 is collected from coupon interest payments and only 55% from the principal of a TIPS maturing that year. By the way, the inclusion of coupons as part of the annual withdrawal means that such a bond ladder has no coupon reinvestment risk.

garlandwhizzer in this post wrote:TIPs ... also have duration risk to principal in case you have an emergency and need cash in excess of your LMP projections and have to liquidate your TIPS to provide for expenses at some point before maturity.
Good point, Garland. But remember that with a ladder of TIPS, one will have the whole range of maturities to choose from for liquidation. If interest rates are low, one can liquidate longer maturities and possibly not lose any principal at all. If interest rates are high, one can liquidate the TIPS closer to maturity, minimizing the loss of principal.

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Re: Liability Matching Portfolio? Really?

Post by dbr » Wed Jun 25, 2014 8:43 am

Thanks I figured there would be some refinements to be added. It was just to point out that the arithmetic has to be done with some exactness if the investor really wants to be sure what he is getting.

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Re: Liability Matching Portfolio? Really?

Post by garlandwhizzer » Wed Jun 25, 2014 4:47 pm

#Cruncher wrote:
Good point, Garland. But remember that with a ladder of TIPS, one will have the whole range of maturities to choose from for liquidation. If interest rates are low, one can liquidate longer maturities and possibly not lose any principal at all. If interest rates are high, one can liquidate the TIPS closer to maturity, minimizing the loss of principal.


Good point, #Cruncher. Principal loss can be minimized by selective sale in a TIPS ladder in case extra money is needed. That premature sale from your LMP, however, means that you'll run out of LMP income a bit before you anticipated. In my opinion this is why if you choose to go the LMP path it is desirable to keep some equity exposure apart from the LMP in case your income needs change at some point.

Garland Whizzer

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Re: Liability Matching Portfolio? Really?

Post by Lieutenant.Columbo » Sat Jul 30, 2016 3:42 pm

plannerman wrote:I have adopted a semi-liability matching investment strategy. I have the next 10-years of cash needs in laddered TIPs. Most of the rest of my portfolio is in equity funds. My target asset allocation is 58% equities and 42% fixed income.

When the equity market is up and my asset allocation is over-weighted in equities, I buy another TIP on the end of the ladder. So rather than a semi-liability matching strategy, what I really have a dynamic, semi-liability matching strategy.

When the equity market is down, I go to the golf course knowing that whatever happens to the market for the next few years, my cash flow needs are secure.

While this strategy is not for everyone, it works for me.

plannerman
I believe I can learn from your example. I am not in retirement yet. I'd like to ask to a few questions:

1. why not using a TIPS Funds instead of a TIPS ladder?

2. in order to get 10-years of cash needs covered with TIPS, did you actually invest your yearly expenses times 10? is that how it works?

3. why would your strategy Not be for everyone? it seems very well thought out and it seems to make sense? what am I missing?

4. how has your plan done and or changed since you posted that reply?

thank you
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Re: Liability Matching Portfolio? Really?

Post by dbr » Sat Jul 30, 2016 3:45 pm

JLMA Good for you. I see you are following up on your questions. These guys are real experts.

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Re: Liability Matching Portfolio? Really?

Post by Lieutenant.Columbo » Sat Jul 30, 2016 3:49 pm

dbr wrote:JLMA Good for you. I see you are following up on your questions. These guys are real experts.
thank you for pointing me in the right direction; I would have never guessed the TIPS ladder and LMP are the terms I needed to search

actually what plannerman said he does sounds (to a non expert like myself) like a reasonable and very good plan
Last edited by Lieutenant.Columbo on Wed Jul 12, 2017 8:37 pm, edited 1 time in total.
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Re: Liability Matching Portfolio? Really?

Post by Kevin M » Sun Jul 31, 2016 12:35 pm

JLMA wrote:1. why not using a TIPS Funs instead of a TIPS ladder?

The idea with a TIPS ladder is that you have a bond maturing each year to cover that year's residual living expenses. A fund does not mature, so you can't use it in exactly this way.

However, there are strong proponents of using a longer-term and shorter-term TIPS fund along with cash to create an inflation-hedged, fixed-income portfolio that is duration-matched to your liabilities. One such proponent is forum member BobK (aka bobcat2). You can find discussions of this with a search something like this:

bobk tips fund duration matched site:bogleheads.org

JLMA wrote:3. why would your strategy Not be for everyone? it seems very well thought out and it seems to make sense? what am I missing?

The more standard LMP TIPS ladder would cover more like 25 years of residual living expenses (RLE) rather than 10. The standard ladder should cover RLE for your expected lifetime.

Some of us are not using TIPS ladders because the yields are so low. For example, I use CDs with mild early withdrawal penalties instead, since I'm betting that 2%-3% nominal will beat -0.24%-0.6% real (Daily Treasury Real Yield Curve Rates), at least over the next few years. The early withdrawal option provides a pretty decent inflation hedge, since nominal interest rates tend to track inflation, so being able to do an early withdrawal and reinvest at a higher rates (paying a small penalty) should help with unexpected inflation.

Kevin
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Re: Liability Matching Portfolio? Really?

Post by Dandy » Sun Jul 31, 2016 2:55 pm

I don't think the Dr.Bernstein idea was targeted to a 53 year old retiree. It would seem to be more geared to retirees of a more typical age.

I found his suggestion a game changer (not to over due the analogy). I like the bottom up approach to determine my retirement allocation i.e. first determine how much "safe" fixed income do I need to fund my retirement for 20-25 years. I modified that to be to age 90. I had plenty of TIRA assets so moving some assets into CDs, short term bond funds was no problem and no tax issues. I did not incur taxable transactions either. I did use taxable dividends and gains to fund Ltd Term Muni bond fund. Not every one can do this with as little penalty as I did. I ended up with a 42/58 allocation. For people to feel comfortable I feel the "risk" portfolio needs to be at least 1/2 the size of the "safe" portfolio. I hate selling investments that incur capital gains tax but I saw a lot of people hold on to their company stock while it went from 120 to about 8 because they didn't want to incur cap gains while they were earning a good salary/bonus. Many also lost their job to boot.

The benefit to me is having a "safe" portfolio that probably fully funds my retirement and a nice sized "risk" portfolio for growth. It virtually eliminated any equity market concerns and I sleep well and so does my non investment oriented spouse. In 18 months I will begin taking RMDs. If the "risk" portfolio does well I might take some or all of my expense needs from that portfolio but If we get a bad sequence of equity returns I will use my "safe" assets.

CDs, and short term bonds generally keep up with moderate inflation on a bit of a lag. I believe Dr. Bernstein recommends things like TIPs ladder and short term treasuries which should do well with inflation and as a offset to significant equity declines.

There is no retirement portfolio allocation and withdrawal strategy that is likely to be great over many decades. Every year or so you need to check your expenses, health and portfolio and make adjustments. You may find that later in retirement this approach suits you better.

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Re: Liability Matching Portfolio? Really?

Post by Lieutenant.Columbo » Fri Dec 16, 2016 9:05 pm

larryswedroe wrote:...Payout Annuities can certainly help especially after mid 70s due to the mortality credits
There are periods when bonds due poorly but stocks do well so you want to hold at least some equity, say 20-30% and that is what I recommend to HNW investors who've won the game, and then use high tilt portfolio to keep expected returns up while minimizing the tail risks.

As Bill notes unfortunately with TIPS yields so low the sustainable withdrawal rate is lower, and shows why IMO one should load up on TIPS and go real long with them when the real yields are high, locking them in and not taking an index type approach. Now I would not lock in long TIPS...
Larry,
I wonder how/if your opinion on the Limited Liability Portfolio has changed since your post above from December 2012.
Would you please update us on how you see LLP now?
Thank you
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Re: Liability Matching Portfolio? Really?

Post by dbr » Thu Jul 13, 2017 8:46 am

Lieutenant.Columbo wrote:
larryswedroe wrote:...Payout Annuities can certainly help especially after mid 70s due to the mortality credits
There are periods when bonds due poorly but stocks do well so you want to hold at least some equity, say 20-30% and that is what I recommend to HNW investors who've won the game, and then use high tilt portfolio to keep expected returns up while minimizing the tail risks.

As Bill notes unfortunately with TIPS yields so low the sustainable withdrawal rate is lower, and shows why IMO one should load up on TIPS and go real long with them when the real yields are high, locking them in and not taking an index type approach. Now I would not lock in long TIPS...
Larry,
I wonder how/if your opinion on the Limited Liability Portfolio has changed since your post above from December 2012.
Would you please update us on how you see LLP now?
Thank you
Larry has announced he doesn't post here anymore. You could try a PM or contact him through a link in his blog page if you find one. The question is a good one.

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Re: Liability Matching Portfolio? Really?

Post by Lieutenant.Columbo » Thu Jul 13, 2017 8:33 pm

dbr wrote:
Lieutenant.Columbo wrote:
larryswedroe wrote:...Payout Annuities can certainly help especially after mid 70s due to the mortality credits
There are periods when bonds due poorly but stocks do well so you want to hold at least some equity, say 20-30% and that is what I recommend to HNW investors who've won the game, and then use high tilt portfolio to keep expected returns up while minimizing the tail risks.

As Bill notes unfortunately with TIPS yields so low the sustainable withdrawal rate is lower, and shows why IMO one should load up on TIPS and go real long with them when the real yields are high, locking them in and not taking an index type approach. Now I would not lock in long TIPS...
Larry,
I wonder how/if your opinion on the Limited Liability Portfolio has changed since your post above from December 2012.
Would you please update us on how you see LLP now?
Thank you
Larry has announced he doesn't post here anymore. You could try a PM or contact him through a link in his blog page if you find one. The question is a good one.
Just now...
larryswedroe wrote:Nothing different now with TIPS yields so low. Personally have sold all my CDs and have invested them in LENDX and SRRIX for tax advantaged space while using munis for taxable> Now if real yields ever go back to 2%+ then I would prefer TIPS. In other words, valuations matter
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Re: Liability Matching Portfolio? Really?

Post by sharukh » Mon Nov 20, 2017 5:33 pm

Hi plannerman,

I like this approach. I am planning to do similar thing.

Do you include the TIPS ladder amount as part of fixed income when you calculate the target asset allocation.
Or the target asset allocation is aside from the TIPS ladder bucket.

Now that this post is relatively old. Have you made any changes to the plan that you mentioned below.

Thanks.
plannerman wrote:
Fri Dec 07, 2012 9:03 am
I have been retired for 14 years, am 69 years old, and have probably won the game, but am not ready to quit yet—for several reasons.
1) I can’t be sure I have won because I don’t know what the future holds.
2) I share your concern about the risks associated with say a 30-year liability matching portfolio
3) I worked hard for what we have and scrimped and saved for 40+ years and I’m not willing to give up the upside of a equity heavy portfolio for less volatility
4) Like Sbashore above, I still like playing the game

While I’m not particularly risk adverse, I don’t want to do anything stupid. So I have adopted a semi-liability matching investment strategy. I have the next 10-years of cash needs in laddered TIPs. Most of the rest of my portfolio is in equity funds. My target asset allocation is 58% equities and 42% fixed income.

When the equity market is up and my asset allocation is over-weighted in equities, I buy another TIP on the end of the ladder. So rather than a semi-liability matching strategy, what I really have a dynamic, semi-liability matching strategy.

When the equity market is down, I go to the golf course knowing that whatever happens to the market for the next few years, my cash flow needs are secure.

While this strategy is not for everyone, it works for me.

plannerman

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Re: Liability Matching Portfolio? Really?

Post by NPT » Mon Nov 20, 2017 5:50 pm

There is no such thing as a more or less "safe" asset in the longer term. Thus, the perception that it is possible to "quit the game" is a dangerous illusion.

The only choice one has is how much to allocate to various types of risk. I believe it is a good idea to diversify in this sense.

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Re: Liability Matching Portfolio? Really?

Post by FIREchief » Tue Nov 21, 2017 12:54 am

NPT wrote:
Mon Nov 20, 2017 5:50 pm
There is no such thing as a more or less "safe" asset in the longer term. Thus, the perception that it is possible to "quit the game" is a dangerous illusion.
TIPS?
I am not a lawyer, accountant or financial advisor. Any advice or suggestions that I may provide shall be considered for entertainment purposes only.

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Re: Liability Matching Portfolio? Really?

Post by Caduceus » Tue Nov 21, 2017 4:08 am

I don't think that's what a liability matching strategy usually means. Liability matching does not mean that if an investor has drawdown needs of 4%, then he invests in bonds giving real yields of 4%. This portfolio is not liability matched because his drawdown needs are going to stay fixed at 4%, but the real return of any bond portfolio, being dynamic, might exceed or underperform 4% with interest rate changes.

Liability matching makes more sense for institutions or investors who have both assets and liabilities that respond to interest rate changes. Pensions, for instance, might employ liability matching strategies because their assets and liabilities move in the same direction in response to interest rates. When interest rates go up, the value of the assets fall, but the value of the liabilities fall as well. When interest rates fall, both the value of the assets and liabilities go up. So, that's liability matching, and it's a dynamic process requiring constant adjustment of the portfolio.

Ordinary investors, unlike institutions, aren't usually subject to interest rate exposures on both the lending and investing side.

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Re: Liability Matching Portfolio? Really?

Post by Leesbro63 » Tue Nov 21, 2017 7:02 am

FIREchief wrote:
Tue Nov 21, 2017 12:54 am
NPT wrote:
Mon Nov 20, 2017 5:50 pm
There is no such thing as a more or less "safe" asset in the longer term. Thus, the perception that it is possible to "quit the game" is a dangerous illusion.
TIPS?
Not for high income/high net worth investors with large taxable accounts. If we ever get the rip-roaring inflation that TIPS are bought to protect against, that investor will become a victim of taxflation. Nominal, but not real gains on TIPS become subject to real income tax. Income tax brackets currently rise with inflation, so that does mitigate the problem somewhat. But not completely.

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Re: Liability Matching Portfolio? Really?

Post by TheTimeLord » Tue Nov 21, 2017 7:39 am

NPT wrote:
Mon Nov 20, 2017 5:50 pm
There is no such thing as a more or less "safe" asset in the longer term. Thus, the perception that it is possible to "quit the game" is a dangerous illusion.

The only choice one has is how much to allocate to various types of risk. I believe it is a good idea to diversify in this sense.
There are always edge cases that will derail any plan but the cost of protecting against them usually has a serious adverse effect of the results you would achieve if things proceed within the normal range of expectations. People just need to decide if they are going to try to protect against everything and receive poorer results for the expected cases or if they just want to optimize for the expect and deal with the edge best they can when it happens. I personally take the later case because in my opinion no matter oh well you prepare for some of the edge cases you will still be stuck in a world in a terrible state. Plus I will likely be old and nearly defenseless by then and likely an easy target.
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Re: Liability Matching Portfolio? Really?

Post by grok87 » Tue Nov 21, 2017 7:46 am

Leesbro63 wrote:
Tue Nov 21, 2017 7:02 am
FIREchief wrote:
Tue Nov 21, 2017 12:54 am
NPT wrote:
Mon Nov 20, 2017 5:50 pm
There is no such thing as a more or less "safe" asset in the longer term. Thus, the perception that it is possible to "quit the game" is a dangerous illusion.
TIPS?
Not for high income/high net worth investors with large taxable accounts. If we ever get the rip-roaring inflation that TIPS are bought to protect against, that investor will become a victim of taxflation. Nominal, but not real gains on TIPS become subject to real income tax. Income tax brackets currently rise with inflation, so that does mitigate the problem somewhat. But not completely.
It's definitely an issue. Some things That would help but that i am pessimistic will ever happen:

1) raise the annual limit on ibonds

2) mips: municipal inflation protected securities- there was some small issuance a while ago but currently no market

3) allowing tips funds in variable annuities- some weird rule prevents this apparently

In the meantime 529s are a possibility...

Cheers
Grok
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Re: Liability Matching Portfolio? Really?

Post by plannerman » Tue Nov 21, 2017 8:34 am

sharukh wrote:
Mon Nov 20, 2017 5:33 pm
Hi plannerman,

I like this approach. I am planning to do similar thing.

Do you include the TIPS ladder amount as part of fixed income when you calculate the target asset allocation.
Or the target asset allocation is aside from the TIPS ladder bucket.

Now that this post is relatively old. Have you made any changes to the plan that you mentioned below.

Thanks.
plannerman wrote:
Fri Dec 07, 2012 9:03 am
I have been retired for 14 years, am 69 years old, and have probably won the game, but am not ready to quit yet—for several reasons.
1) I can’t be sure I have won because I don’t know what the future holds.
2) I share your concern about the risks associated with say a 30-year liability matching portfolio
3) I worked hard for what we have and scrimped and saved for 40+ years and I’m not willing to give up the upside of a equity heavy portfolio for less volatility
4) Like Sbashore above, I still like playing the game

While I’m not particularly risk adverse, I don’t want to do anything stupid. So I have adopted a semi-liability matching investment strategy. I have the next 10-years of cash needs in laddered TIPs. Most of the rest of my portfolio is in equity funds. My target asset allocation is 58% equities and 42% fixed income.

When the equity market is up and my asset allocation is over-weighted in equities, I buy another TIP on the end of the ladder. So rather than a semi-liability matching strategy, what I really have a dynamic, semi-liability matching strategy.

When the equity market is down, I go to the golf course knowing that whatever happens to the market for the next few years, my cash flow needs are secure.

While this strategy is not for everyone, it works for me.

plannerman
To answer your questions:

Yes, I include the TIPs ladder in fixed income when looking at our overall asset allocation.

No, no significant changes in the strategy. However, my wife and I are now 74 years old. Our TIPs ladder takes us to age 84. I'm now pretty sure we have won the game and are now investing for the next generation. Therefore, I am letting the equity portion of our portfolio drift upward with the market.

A couple of other comments. 1) We have since moved to a Continuing Care Retirement Community and the required cash flow from our portfolio has increased. Consequently, I have been "fine tuning" the individual rungs on our TIPs ladder as well as continuing to add to the end of the ladder. 2) I did struggle a little when confronted with buying TIPs with a negative nominal yield to maturity a few years ago. But, since the primary purpose of owning TIPs in the first place is to deliver known real cash flow--rather than "investment return", I bit the bullet and did it.

plannerman

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Re: Liability Matching Portfolio? Really?

Post by NPT » Tue Nov 21, 2017 11:06 am

FIREchief wrote:
Tue Nov 21, 2017 12:54 am
NPT wrote:
Mon Nov 20, 2017 5:50 pm
There is no such thing as a more or less "safe" asset in the longer term. Thus, the perception that it is possible to "quit the game" is a dangerous illusion.
TIPS?
I would not disagree if someone described TIPS as relatively safe, but I do not consider them completely safe. Some of the potential risks I could think of off the top of my head:

The inflation adjustment could prove to be problematic even without intentional wrongdoing:
- if one's personal inflation rate is higher than average, one would need assets to grow faster than official inflation figures by a comfortable margin,
- the taxation of nominal yields could greatly reduce inflation protection in taxable accounts,
- economic circumstances could change in entirely unexpected ways that would necessitate updating the methodology of the inflation adjustment, but that may not happen,
- nobody knows how inflation adjustment would work in a hyperinflation scenario (seems unlikely in the U.S., but it is hardly impossible).
TIPS are a relatively small market, therefore:
- they could have liquidity problems,
- they could be discontinued.
The U.S. government could partially default in a number of ways (none of these is an apocalyptic scenario):
- due to technical errors (it happened in 1979, could happen again),
- due to political problems (remember 2013?),
- it could decide to restructure its debt, which seems unlikely today, but could happen if times are really hard (abandoning the gold standard could be considered such a case),
- it could compromise the calculation of the inflation adjustment.
TIPS are bonds and could lose value if interest rates rise more than inflation over an extended period of time.

Bigger picture concerns: The creditworthiness of the U.S. government, or that of potential successor governments that assume U.S. obligations, will inevitably go to zero at some point (although perhaps only a very long time from now). People usually imagine such scenarios to be cataclysmic events, when it makes no difference what assets you own because nothing will save you. But that is only one of the ways it could happen, and there are other possibilities. TIPS or other U.S. treasury securities could start to deteriorate long before financial markets collapse, in which case one will be happy not to have put all eggs in one basket.

Finally, the low expected real return of TIPS leaves a very small margin of error, which is a risk in itself. It is a problem:
- if our understanding of the behavior of TIPS is ever so slightly incorrect (there could be many more potential issues I did not even think of),
- if one's expectation of one's own financial needs proves to be even slightly incorrect.
How certain can one be of the accuracy of such estimates? Maybe it is only because of my ignorance, but in my opinion, not very.

None of the above is meant to suggest that TIPS are to be avoided or that they are particularly risky or that there is any big problem with the creditworthiness of the U.S. government. But it is one thing to claim that TIPS are low risk under certain assumptions, and it is an entirely different thing to consider them "safe" in some absolute sense.

If someone is so wealthy that they can both (1) invest a significant amount in assets usually considered risky and also (2) build a liability matching portfolio of whatever assets they presume to be safe, then labeling the "safe" portion liability matching is barely more than a play on words: In that case the LMP is really just one component of a larger portfolio, and as such it may be useful. But I would not bet the farm on just TIPS or on any sort of LMP.

For a 90-year-old, none of this is of huge concern, because these risks are unlikely to materialize very quickly from today's starting point. But a 65-year-old who is about to retire could easily end up living to be 100 (regardless of their estimated longevity), and that is a very long time, during which a lot can happen.

On a more philosophical note, the theory of safe assets seems to violate the law of no free lunches... :happy

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Re: Liability Matching Portfolio? Really?

Post by garlandwhizzer » Tue Nov 21, 2017 12:10 pm

NPT wrote:
On a more philosophical note, the theory of safe assets seems to violate the law of no free lunches...
1+

There is risk in any asset, some much greater than others. One major risk of a 100% TIPS LMP is that you cannot accurately estimate what your necessary living costs are going to be in real terms 20 or 30 years from now. The future often has a way of surprising us with things like Alzheimer's disease care, lawsuits, divorces, remarriages, accidents, greater life expectancy than foreseen requiring expensive long term care, stroke or other medical causes that require 24 hour around the clock nursing care for years, etc., etc.. The idea that you can accurately determine your financial needs a decade or two in advance is laughable in my opinion. I will always have some significant equity exposure that allows for long term growth of asset base in order to meet unexpected future financial needs. Personally I don't think I'll ever have less than 40% equity, currently a bit more than 60% and I"m 70 years old. I have been slowly de-risking my equity-heavy portfolio for years, increasing bonds and decreasing stocks, but there are considerable risks IMO with putting all portfolio eggs in the fixed income market. Being stuck with a fixed income when the unexpected occurs, requiring more income than anticipated is a major concern. If you have many millions in assets and not too long to live, 100% TIPS works, but that's not most of us.

Garland Whizzer

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Re: Liability Matching Portfolio? Really?

Post by FIREchief » Tue Nov 21, 2017 3:35 pm

Leesbro63 wrote:
Tue Nov 21, 2017 7:02 am
FIREchief wrote:
Tue Nov 21, 2017 12:54 am
NPT wrote:
Mon Nov 20, 2017 5:50 pm
There is no such thing as a more or less "safe" asset in the longer term. Thus, the perception that it is possible to "quit the game" is a dangerous illusion.
TIPS?
Not for high income/high net worth investors with large taxable accounts. If we ever get the rip-roaring inflation that TIPS are bought to protect against, that investor will become a victim of taxflation. Nominal, but not real gains on TIPS become subject to real income tax. Income tax brackets currently rise with inflation, so that does mitigate the problem somewhat. But not completely.
Maybe I should have said "TIPS in a Roth."
I am not a lawyer, accountant or financial advisor. Any advice or suggestions that I may provide shall be considered for entertainment purposes only.

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Re: Liability Matching Portfolio? Really?

Post by siamond » Tue Nov 21, 2017 4:56 pm

garlandwhizzer wrote:
Tue Nov 21, 2017 12:10 pm
There is risk in any asset, some much greater than others. One major risk of a 100% TIPS LMP is that you cannot accurately estimate what your necessary living costs are going to be in real terms 20 or 30 years from now. The future often has a way of surprising us with things like Alzheimer's disease care, lawsuits, divorces, remarriages, accidents, greater life expectancy than foreseen requiring expensive long term care, stroke or other medical causes that require 24 hour around the clock nursing care for years, etc., etc.. The idea that you can accurately determine your financial needs a decade or two in advance is laughable in my opinion. I will always have some significant equity exposure that allows for long term growth of asset base in order to meet unexpected future financial needs. Personally I don't think I'll ever have less than 40% equity, currently a bit more than 60% and I"m 70 years old. I have been slowly de-risking my equity-heavy portfolio for years, increasing bonds and decreasing stocks, but there are considerable risks IMO with putting all portfolio eggs in the fixed income market. Being stuck with a fixed income when the unexpected occurs, requiring more income than anticipated is a major concern. If you have many millions in assets and not too long to live, 100% TIPS works, but that's not most of us.
That is a post that should be read and re-read by many people on this forum. Lots of wisdom in there.

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Leesbro63
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Re: Liability Matching Portfolio? Really?

Post by Leesbro63 » Tue Nov 21, 2017 5:28 pm

siamond wrote:
Tue Nov 21, 2017 4:56 pm
garlandwhizzer wrote:
Tue Nov 21, 2017 12:10 pm
There is risk in any asset, some much greater than others. One major risk of a 100% TIPS LMP is that you cannot accurately estimate what your necessary living costs are going to be in real terms 20 or 30 years from now. The future often has a way of surprising us with things like Alzheimer's disease care, lawsuits, divorces, remarriages, accidents, greater life expectancy than foreseen requiring expensive long term care, stroke or other medical causes that require 24 hour around the clock nursing care for years, etc., etc.. The idea that you can accurately determine your financial needs a decade or two in advance is laughable in my opinion. I will always have some significant equity exposure that allows for long term growth of asset base in order to meet unexpected future financial needs. Personally I don't think I'll ever have less than 40% equity, currently a bit more than 60% and I"m 70 years old. I have been slowly de-risking my equity-heavy portfolio for years, increasing bonds and decreasing stocks, but there are considerable risks IMO with putting all portfolio eggs in the fixed income market. Being stuck with a fixed income when the unexpected occurs, requiring more income than anticipated is a major concern. If you have many millions in assets and not too long to live, 100% TIPS works, but that's not most of us.
That is a post that should be read and re-read by many people on this forum. Lots of wisdom in there.
+1. I concluded a few years ago that I (age 57) will try to stay about 50/50 for the rest of my life.

sharukh
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Re: Liability Matching Portfolio? Really?

Post by sharukh » Wed Nov 22, 2017 8:57 am

Thanks very much plannerman for taking time to write back.
plannerman wrote:
Tue Nov 21, 2017 8:34 am
sharukh wrote:
Mon Nov 20, 2017 5:33 pm
Hi plannerman,

I like this approach. I am planning to do similar thing.

Do you include the TIPS ladder amount as part of fixed income when you calculate the target asset allocation.
Or the target asset allocation is aside from the TIPS ladder bucket.

Now that this post is relatively old. Have you made any changes to the plan that you mentioned below.

Thanks.
plannerman wrote:
Fri Dec 07, 2012 9:03 am
I have been retired for 14 years, am 69 years old, and have probably won the game, but am not ready to quit yet—for several reasons.
1) I can’t be sure I have won because I don’t know what the future holds.
2) I share your concern about the risks associated with say a 30-year liability matching portfolio
3) I worked hard for what we have and scrimped and saved for 40+ years and I’m not willing to give up the upside of a equity heavy portfolio for less volatility
4) Like Sbashore above, I still like playing the game

While I’m not particularly risk adverse, I don’t want to do anything stupid. So I have adopted a semi-liability matching investment strategy. I have the next 10-years of cash needs in laddered TIPs. Most of the rest of my portfolio is in equity funds. My target asset allocation is 58% equities and 42% fixed income.

When the equity market is up and my asset allocation is over-weighted in equities, I buy another TIP on the end of the ladder. So rather than a semi-liability matching strategy, what I really have a dynamic, semi-liability matching strategy.

When the equity market is down, I go to the golf course knowing that whatever happens to the market for the next few years, my cash flow needs are secure.

While this strategy is not for everyone, it works for me.

plannerman
To answer your questions:

Yes, I include the TIPs ladder in fixed income when looking at our overall asset allocation.

No, no significant changes in the strategy. However, my wife and I are now 74 years old. Our TIPs ladder takes us to age 84. I'm now pretty sure we have won the game and are now investing for the next generation. Therefore, I am letting the equity portion of our portfolio drift upward with the market.

A couple of other comments. 1) We have since moved to a Continuing Care Retirement Community and the required cash flow from our portfolio has increased. Consequently, I have been "fine tuning" the individual rungs on our TIPs ladder as well as continuing to add to the end of the ladder. 2) I did struggle a little when confronted with buying TIPs with a negative nominal yield to maturity a few years ago. But, since the primary purpose of owning TIPs in the first place is to deliver known real cash flow--rather than "investment return", I bit the bullet and did it.

plannerman

randomguy
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Re: Liability Matching Portfolio? Really?

Post by randomguy » Wed Nov 22, 2017 10:19 am

NPT wrote:
Tue Nov 21, 2017 11:06 am

On a more philosophical note, the theory of safe assets seems to violate the law of no free lunches... :happy

Safe assets aren't a free lunch. They are an incredibly expensive one 95% of the time and cheap the other 5%. Take the 65 year old who plans for 30 years. With TIPS they have to hold ~30 years of expenses (assuming taxes eat up most of the gains). The 4%er holding a 50/50 portfolio only needs 25. The TIP person is broke at 95. The 50/50 person likely has 2x as much as they started with. Does that mean safe assets are a poor choice? Depends on your ability to handle the 5% chance that things go real bad.

As you said as the time frames shrink, LMP type portfolios make more and more sense. Setting one up for a 50 year retirement requites a huge excess of money. Setting one up for a 10 year retirement (i.e. you are 95) is pretty easy. In between you need to decide what your risk tolerance is.

In the end you will never know if you won or lost the game until you are dead (and even then you might have obligations you wanted to cover that last well past your death. Say a disable child or funding grand kids colleges).

NPT
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Re: Liability Matching Portfolio? Really?

Post by NPT » Wed Nov 22, 2017 3:14 pm

garlandwhizzer wrote:
Tue Nov 21, 2017 12:10 pm
There is risk in any asset, some much greater than others. One major risk of a 100% TIPS LMP is that you cannot accurately estimate what your necessary living costs are going to be in real terms 20 or 30 years from now. [...]
That is probably the biggest risk in any kind of LMP.

dbr
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Re: Liability Matching Portfolio? Really?

Post by dbr » Wed Nov 22, 2017 3:56 pm

NPT wrote:
Wed Nov 22, 2017 3:14 pm
garlandwhizzer wrote:
Tue Nov 21, 2017 12:10 pm
There is risk in any asset, some much greater than others. One major risk of a 100% TIPS LMP is that you cannot accurately estimate what your necessary living costs are going to be in real terms 20 or 30 years from now. [...]
That is probably the biggest risk in any kind of LMP.
It is exactly the reason you don't annuitize everything in an indexed SPIA. I don't know if I am just imagining it but I had the idea insurance companies are not allowed to annuitize more than half the original assets of an investor. A subtlety regarding inflation is that CPI may not be accurate for personal trend in increasing or decreasing expenditures.

NPT
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Re: Liability Matching Portfolio? Really?

Post by NPT » Wed Nov 22, 2017 4:04 pm

randomguy wrote:
Wed Nov 22, 2017 10:19 am
NPT wrote:
Tue Nov 21, 2017 11:06 am

On a more philosophical note, the theory of safe assets seems to violate the law of no free lunches... :happy

Safe assets aren't a free lunch. They are an incredibly expensive one 95% of the time and cheap the other 5%. [...]
If one pays only a finite premium, then it is reasonable to expect only a finite increase in safety. In other words, the so-called "safe assets" can really only be relatively safer, but not safe. If it were possible to obtain absolute or near infinite safety for only a finite premium, that would be a free lunch.

I do not mean to split hairs. The point I am trying to make is that even the safest assets have very real and possibly hard-to-estimate risks. Discussions about liability matching portfolios make me think that it is very easy not to fully appreciate the risks in safer assets or in strategies that rely heavily on safer assets.

randomguy wrote:
Wed Nov 22, 2017 10:19 am
In the end you will never know if you won or lost the game until you are dead [...]
I very much agree.

NPT
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Re: Liability Matching Portfolio? Really?

Post by NPT » Wed Nov 22, 2017 5:44 pm

NPT wrote:
Wed Nov 22, 2017 4:04 pm
[...] safer assets [...]
Even the word "safer" is a gross simplification here because it is only meaningful in the context of some particular definition of safety, and there are multiple conflicting but perfectly reasonable definitions. Instead of labeling assets safer or riskier, it would be more correct and much less misleading to talk about assets with different risk profiles.

Risk is not a simple real number (nor does it have a single obvious mapping to a linearly ordered set). Attempting to compare two quantities of risk is meaningless in a mathematical sense. This might sound a bit abstract but it has very real implications, and thinking of risk along these lines can help understand a complex reality better. For example, it makes it easier accept that neither stocks, nor bonds are universally safer than the other, they are just very different. And this is what comes to my mind when I read in Warren Buffett's 2014 letter to shareholders that it is "dead wrong" to equate volatility with risk.

Viewing risk this way makes one much less confident about various assumptions, not to mention specific calculations or predictions. And that is a good thing in my opinion. :happy

dbr
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Re: Liability Matching Portfolio? Really?

Post by dbr » Wed Nov 22, 2017 8:07 pm

NPT wrote:
Wed Nov 22, 2017 5:44 pm
NPT wrote:
Wed Nov 22, 2017 4:04 pm
[...] safer assets [...]
Even the word "safer" is a gross simplification here because it is only meaningful in the context of some particular definition of safety, and there are multiple conflicting but perfectly reasonable definitions. Instead of labeling assets safer or riskier, it would be more correct and much less misleading to talk about assets with different risk profiles.

Risk is not a simple real number (nor does it have a single obvious mapping to a linearly ordered set). Attempting to compare two quantities of risk is meaningless in a mathematical sense. This might sound a bit abstract but it has very real implications, and thinking of risk along these lines can help understand a complex reality better. For example, it makes it easier accept that neither stocks, nor bonds are universally safer than the other, they are just very different. And this is what comes to my mind when I read in Warren Buffett's 2014 letter to shareholders that it is "dead wrong" to equate volatility with risk.

Viewing risk this way makes one much less confident about various assumptions, not to mention specific calculations or predictions. And that is a good thing in my opinion. :happy
The above is well said. A lot of conversations on this forum become difficult because there has not been a clear understanding of what safety or risk is intended to mean in the mind of one poster or another. Some posters do that because they don't know and others because they just aren't being specific.

A quibble is that in financial conversations volatility is equated with risk because that is a customary definition or perhaps a term of the art. Such an equating does not mean that people doing it are ignorant of all the considerations. What it does mean is that in a financial conversation if someone wants the word not to have the conventional meaning then they have to say so.

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