Liability Matching Portfolio? Really?

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Leesbro63
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Liability Matching Portfolio? Really?

Post by Leesbro63 » Thu Dec 06, 2012 9:41 am

I have been having a private conversation with a Boglehead friend and thought I'd post this topic.

I keep reading here on Bogleheads that many of the respected advisors posting recommend quitting "the game" once you've "won". That once you have a nest egg that is 25-30 times your annual spending needs, you should go to a "liability matching portfolio"... basically a portfolio of various fixed income products, perhaps including annuities, that will keep your real spending power at least equal to inflation, after taxes.

I never felt comfortable with this and I've finally figured out why. I don't buy it because I don't trust it. Particularly since I am relatively young (53) and won't need the money for 12 years. And the drawdown period will be another planned 30 after that. As much as I "get it" that stocks are risky, it's not at all clear to me that in this scenario going to a "liability matching portfolio" is any less risky over this long term. Perhaps this makes sense if you are more than 70 years old. But to me it seems like putting all your eggs in one basket. Will short/intermediate term fixed income and/or annuities REALLY keep pace with inflation, after taxes? Just as there are odds stocks could crash and not recover for decades, there is the risk that fixed income, especially at today's near-zero rates, could get wiped out by an inflationary spiral, compounded by the higher taxes that the inflated assets would require. Even in a tax-sheltered account (most of my 50plus-times- spending nest egg is taxable), the taxes will hit eventually unless you have a zillion dollars in a Roth (which, we've seen recently, is possible but certainly not common). I don't buy that the odds are good that short term fixed income will keep up with inflation.

So isn't the answer back to the old-time tried and true balanced portfolio (somewhere between 60/40 and 40/60)? I get it that there are no guarantees but there are no guarantees with "liability matching" either for all but "older" wealth holders.

P.S. For holders of large taxable wealth, converting to "liability matching" requires selling stocks and paying 15% of the gain (more in 2013) right off the top. For me that would be about 7-8% since I tax loss harvested in 2009 and my stuff has about doubled. This stacks the deck further against going to "liability matching".

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Ice-9
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Re: Liability Matching Portfolio? Really?

Post by Ice-9 » Thu Dec 06, 2012 10:38 am

One thing I read in William Bernstein's Four Pillars that influenced me on asset allocation was that Benjamin Graham had recommended even the most conservative investor hold at least 25% of their portfolio in equities. (He also suggested even the most aggressive investor should hold no more than 75%.)

I always assumed this to refer to not only investors who are conservative because they are risk averse, but also investors who are conservative because they already have "won the game" and have little need to take risk. Of course, one can argue whether 25% is the right upper and lower limit, but the main point I took away is it's good to always have some equities (and also to always have some less risky assets.) The rest of the portfolio can match liabilities.

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Sbashore
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Re: Liability Matching Portfolio? Really?

Post by Sbashore » Thu Dec 06, 2012 11:05 am

There are a couple of ways of looking at this and I think the position to "quit the game" when you've won, is just one way. I've pretty much won the game, mainly due to my retirement income which is very secure, but I love the game, and the demonstration of theory that is played out every day in my portfolio. That's partly why at age 64 I am at 50/50. That's just me and my individual situation. On the other hand, if I was sitting here in retirement, having won the game, and my current situation was dependent on portfolio income rather than pension income, I'm pretty sure I'd be assessing the risk in my portfolio and calculating what would happen to me and my lifestyle if my portfolio took a big drop. I would probably always be in that 25-75 range for equities, but it would probably be closer to the 25 than the 75.
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Re: Liability Matching Portfolio? Really?

Post by pkcrafter » Thu Dec 06, 2012 11:21 am

Back in the 90's the Wall Street mavens where saying retirement age is not the end of the road, we still have another 30 years to invest, so keep the stock allocations up. Now, we are hearing the opposite. I didn't believe it then and I don't know. However, holding 20-25% stock doesn't carry the risk of an accumulation AA, but it's enough to sustain withdrawals for 30 years. Extremes in investment choices are never good.

Paul
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Re: Liability Matching Portfolio? Really?

Post by garlandwhizzer » Thu Dec 06, 2012 11:57 am

I agree with Leesbro 63 about always, even in retirement, keeping a significant percentage of assets in stocks. Total safety--annuities, bonds in a world where yields are less than inflation, cash which pays nothing--comes at such a high price that I personally don't think it's worth paying for. My goal is to keep my asset base stable, to spend about what the portfolio produces so that the principle value holds steady, and to do that one must take short and intermediate term risk in stocks for expected long term gains. Once your portfolio begins the inevitable but slow decline in value of a conservative glide path, it seems to me that your risk situation actually increases because you never know exactly how much money you may need in the future given the uncertainty of inflation rates, your longevity, your long term care and health care costs, not to mention perhaps your desire to leave money to family or charity on your demise.

Those who are more risk averse may rationally choose otherwise but that's how I see it.

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Re: Liability Matching Portfolio? Really?

Post by 555 » Thu Dec 06, 2012 12:18 pm

Leesbro63 wrote:"(most of my 50plus-times- spending nest egg is taxable)"
This makes the point pretty much moot. You have far in excess of what you need, which means you have a very wide range of options, all of which would work.

Leesbro63
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Re: Liability Matching Portfolio? Really?

Post by Leesbro63 » Thu Dec 06, 2012 1:43 pm

555 wrote:
Leesbro63 wrote:"(most of my 50plus-times- spending nest egg is taxable)"
This makes the point pretty much moot. You have far in excess of what you need, which means you have a very wide range of options, all of which would work.
That's sorta what I'm thinking, but I keep hearing about having won the game and how I should take my chips and go home!

Leesbro63
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Re: Liability Matching Portfolio? Really?

Post by Leesbro63 » Thu Dec 06, 2012 1:44 pm

garlandwhizzer wrote:I agree with Leesbro 63 about always, even in retirement, keeping a significant percentage of assets in stocks. Total safety--annuities, bonds in a world where yields are less than inflation, cash which pays nothing--comes at such a high price that I personally don't think it's worth paying for. My goal is to keep my asset base stable, to spend about what the portfolio produces so that the principle value holds steady, and to do that one must take short and intermediate term risk in stocks for expected long term gains. Once your portfolio begins the inevitable but slow decline in value of a conservative glide path, it seems to me that your risk situation actually increases because you never know exactly how much money you may need in the future given the uncertainty of inflation rates, your longevity, your long term care and health care costs, not to mention perhaps your desire to leave money to family or charity on your demise.

Those who are more risk averse may rationally choose otherwise but that's how I see it.

Garland Whizzer
Well said. Exactly where my head is at!

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Re: Liability Matching Portfolio? Really?

Post by Jerilynn » Thu Dec 06, 2012 11:44 pm

Leesbro63 wrote:I have been having a private conversation with a Boglehead friend and thought I'd post this topic.

I keep reading here on Bogleheads that many of the respected advisors posting recommend quitting "the game" once you've "won".
My goal is to buy controlling interest in News Corp (NWS) and fire all the dead weight. I'm nowhere near winning at this point in time.
Cordially, Jeri . . . 100% all natural asset allocation. (no supernatural methods used)

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nedsaid
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Re: Liability Matching Portfolio? Really?

Post by nedsaid » Fri Dec 07, 2012 12:07 am

How many people can realistically save 25-30 times their spending needs?

Still people need to think about de-risking their portfolio as they get close to retirement. I am intrigued by Prudential Insurance concept of the "Retirement Red Zone" which are the few years just before and just after retirement. A big drop in portfolio value during this time can ruin a retirement. I am not interested in buying their annuity product to solve this problem but I like the concept of protecting your portfolio during those key years.

The Annuity product is an expensive answer as what you are protecting is not the portfolio value itself but an income base from which you are guaranteed a percentage, I think 5 percent for as long as you live even if you exhaust the portfolio. The fees are pretty high. Odds are pretty good that low fee stock and bond indexes in an IRA would outperform the annuity which is weighed down by pretty big fees.

The Buckets of Money strategy from Ray Lucia is a great idea but hard to execute in times of low interest rates. Lucia does some complicated maneuvers to make it work. What had been a simple and easily executable strategy becomes complicated and difficult to execute without an advisor.

Laddering strategies that people used with CDs or individual bonds don't work nearly as well because even 5 and 10 year rates are pretty low.

Quitting the game is pretty easy when interest rates are relatively high. Not so easy today. Most people will have to live with stock market risk even in retirement. No easy answers.
A fool and his money are good for business.

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plannerman
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Re: Liability Matching Portfolio? Really?

Post by plannerman » 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 Rodc » Fri Dec 07, 2012 9:18 am

How many people can realistically save 25-30 times their spending needs?
Pretty much everyone, because at some point they will not be working and one way or another they will be forced to set spending based on how much income they can generate. They may spend too much to start but reality will catch up to them at some point.

That is when they truly discover what is need and what is nice to have. Need is not a lot as many find out.

Also, most people have Social Security. Many live just fine on nothing but Social Security. So if you need $40K per year and get $20K per year from SS, you only need 25 times $20K, or $500K, not $1,000,000. Remember the median family of 4 people or so live on $50K per year, and are paying SS, hopefully saving a little, etc., so while $40K is not a lot, it will be enough for many people. Indeed even less is often enough to get by ok.
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 Browser » Fri Dec 07, 2012 9:39 am

It isn't an Either-Or decision. Consider your existing sources of liability-matching income such as social security, pensions, annuities. If that's enough to meet your basic needs in retirement then go wild with the rest if you want. If it isn't then allocate a portion of your portfolio to TIPS, SPIAs, GLWB riders, etc. until you've matched your basic needs liability spending, and then go wild with the rest. Why have this straw man debate again and again?
We don't know where we are, or where we're going -- but we're making good time.

Leesbro63
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Re: Liability Matching Portfolio? Really?

Post by Leesbro63 » Fri Dec 07, 2012 10:15 am

nedsaid wrote:How many people can realistically save 25-30 times their spending needs?
Most Bogleheads, sooner or later.

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Re: Liability Matching Portfolio? Really?

Post by Leesbro63 » Fri Dec 07, 2012 10:17 am

I am the original poster and I want to thank you all for your answers/input here. Particularly those of you already retired who agree that just as there is the risk of too much equity, there are also risks of too little equity/too much fixed income. You have confirmed my deep seated thinking that over the long term a balanced approach probably has the best risk/reward ratio if you can live on a low withdrawal rate. And that perhaps this "newfangled liability matching" thinking is based on recency and has hidden dangers of it's own (significant risk of failing to beat taxes and inflation by a wide margin).

Thanks for the conversation. Truthfully I thought I was gonna get beat up by you guys!

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LH
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Re: Liability Matching Portfolio? Really?

Post by LH » Fri Dec 07, 2012 10:38 am

the whole liability matching thing is a farce when applied to a single individual over a 30+ year period.

Its great for academic papers, laughable in reality.

Just do a 100 percent TIPS ladder, when young in accumulation, eh? It did not take long for all of that to blow up, unless one is already rich enough it doesn't matter.

Now for large groups of people, more relevant, as it can be statistically modeled, but still problematic.

The single person is not going to follow the mean path in reality most likely. On both sides of the equation, the need, and the financial output, both are variable and unpredictable, even with TIPS.

Expose TIPS to high inflation, in an environment where COLAs are talking about being downgraded (relying on money illusion to avoid the visceral reaction to a direct nominal cutback) and lets see what happens. Look at Argentina, what thier government says the inflation rate is currently - its a joke. Read the history of what governments say, and what governments do, including us, in times of stress.

Matching is impossible except in very rough ways, which are equal to rule of thumb, no matter how the math is dressed up.

There are two things

1)Your individual needs over 30 years are unpredictable, except at the rule of thumb level so derided oft times by the "matchers"
2)Any portfolios production and safety over 30 years are unpredictable. TIPS riskless? TIPS have negative yield now, look back 5-10 years ago for models of that. There is some variability. Ladder that with a 3 percent real expectation.

True diversification: Land, Stocks, Bonds. Preferably with geographic diversification if appropriate and agent diversification, is all one can do. Variable to Variable. Life is variable and imperfect. Diversify as best you can.

As a side note: Long term care and Stable value funds. Same deal. There is no money fairy. Its gotta come from somewhere, and if not stocks bonds (which one can invest in oneself with low fees), the so called guarantee now or 20-30 years hence might be dealt with in bankruptcy proceedings of the guarantor.

SPIA now, there is a money fairy of sorts, which is the death of the other people in the pool, the money does comes from somewhere. Also, since its immediate, the risk is less, as principle is being returned immediately.

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Re: Liability Matching Portfolio? Really?

Post by Browser » Fri Dec 07, 2012 11:25 am

I'm glad that LH has figured out the secret for how to make a bunch of money during this era of "financial repression" when the snipe hunt for returns is in full force. And I'm really glad he wasn't my financial advisor when I piled into a TIPS ladder to structure a liability-matching strategy. Let's not forget that you can still make money on your assets no matter how you have labelled them in your portfolio. I've booked more gains on those "liability-matching" TIPS than everything else taken together and they're still going up. LM rules, Baby!
We don't know where we are, or where we're going -- but we're making good time.

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LH
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Re: Liability Matching Portfolio? Really?

Post by LH » Sat Dec 08, 2012 2:26 am

Browser wrote:I'm glad that LH has figured out the secret for how to make a bunch of money during this era of "financial repression" when the snipe hunt for returns is in full force. And I'm really glad he wasn't my financial advisor when I piled into a TIPS ladder to structure a liability-matching strategy. Let's not forget that you can still make money on your assets no matter how you have labelled them in your portfolio. I've booked more gains on those "liability-matching" TIPS than everything else taken together and they're still going up. LM rules, Baby!
?

Perhaps you can clue us in on your secret?

1) First, no claim of having made a bunch of money, you start off with a false claim, if not, please post text where I claim to have made a "bunch of money".... Good luck Browser.

Straw man. No such claim was made. If so post it. Its like me saying, Browser has figured out the secret to being a billionaire, and finding the fountain of youth! Except.... you did not. Minor detail I know Browser. This really denigrates any expectation of a meaningful reply to:

2)So post your TIPS ladder then, I made a post asking for the mythical TIPS ladder, about a 1-2 years ago. A paucity of replies.......

If you have a working TIPS ladder, post it : )

What is your TIPS ladder in reality? So barring 1, at least maybe you can come up with 2?

Would love to see it posted..... I really truly would, no sarcasm, spit it out. was your expectation in making it, rolling it into negative TIPS bonds? Just wondering. But please post it, if not for me, for all the other people, sounds like you have got something truly great going.

Educate us..........

Have a nice day,

LH

http://www.bogleheads.org/forum/viewtop ... 10&t=63039

Hey, I was begging for one previously, got one reply. Really looking forward to seeing yours, actual bonds and such, so we can learn, not just vague description : )

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Re: Liability Matching Portfolio? Really?

Post by YDNAL » Sat Dec 08, 2012 8:52 am

Leesbro63 wrote:I have been having a private conversation with a Boglehead friend and thought I'd post this topic.

I keep reading here on Bogleheads that many of the respected advisors posting recommend quitting "the game" once you've "won". That once you have a nest egg that is 25-30 times your annual spending needs, you should go to a "liability matching portfolio"... basically a portfolio of various fixed income products, perhaps including annuities, that will keep your real spending power at least equal to inflation, after taxes.

I never felt comfortable with this and I've finally figured out why. I don't buy it because I don't trust it. Particularly since I am relatively young (53) and won't need the money for 12 years. And the drawdown period will be another planned 30 after that. As much as I "get it" that stocks are risky, it's not at all clear to me that in this scenario going to a "liability matching portfolio" is any less risky over this long term....
Perhaps you "don't get it" because you haven't saved 50x, 75x, ____ the annual amount needed in retirement to pay bills.
  • We shouldn't fall in the trap to think that a specific strategy is good for everyone... it (whatever strategy) isn't.
  • A 4% withdrawal, for instance, is only as "safe" as what happens in the future - which is of course unknown to all of us.
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Bill Bernstein
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Re: Liability Matching Portfolio? Really?

Post by Bill Bernstein » Sat Dec 08, 2012 1:15 pm

Excellent discussion, and all points well taken.

Certainly, in the real world, it's not difficult to come up with an environment in which a TIPS ladder blows up.

How likely is that? A good question--over a 50-year period, if one looks at the span of human history and financial history, probably about 20-25%. Get used to it; that's as good as it gets, because history can be a cruel mistress.

The key point is that those are still better odds than with a more aggressive investment strategy; any scenario that vaporizes TIPS does far worse things to stocks and nominal bonds.

In the real world, you can stratify your odds as follows in terms of residual expense savings:

< 10x: Unless both you and your spouse die young and don't have large unexpected expenses, you're sunk.
10-20x: If you're lucky, you just might skate through.
20-30x: You've won the game; most of your money should go into an LMP
>>30x: Doesn't matter much how you divide between a risky portfolio and LMP. You're fine, thank you.

Bill

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Re: Liability Matching Portfolio? Really?

Post by SimpleGift » Sat Dec 08, 2012 1:48 pm

wbern wrote:In the real world, you can stratify your odds as follows in terms of residual expense savings:

< 10x: Unless both you and your spouse die young and don't have large unexpected expenses, you're sunk.
10-20x: If you're lucky, you just might skate through.
20-30x: You've won the game; most of your money should go into an LMP
>>30x: Doesn't matter much how you divide between a risky portfolio and LMP. You're fine, thank you.
Thanks, Bill, this is a very helpful breakdown of which strategy makes the most sense for which retirees.
Cordially, Todd

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Re: Liability Matching Portfolio? Really?

Post by zotty » Sat Dec 08, 2012 2:01 pm

If i wrapped things up to 30x or 50x, I would not do liability matching right now. I would keep maybe 0-20% in stocks and the rest would live in short term bonds. It's a gamble that we are not in a permanent deflationary scenario. If it happens, you've eaten maybe 1-2% a year. at 50x, you can afford it. It's not necessarily a catastrophe. If interest rates do eventually normalize, you'll be rewarded for waiting. Liability matching makes sense when you have a margin of error on you real return. Right now, i don't think there is any margin for error and it's a bad deal.
Nadie Sabe Nada

Bill Bernstein
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Re: Liability Matching Portfolio? Really?

Post by Bill Bernstein » Sat Dec 08, 2012 2:56 pm

Zotty:

You're absolutely right; I make that point clear in "The Ages of the Investor." The LMP right now is more of an ideal than a reality, and short-term reserves are the least worst choice, in my opinion.

In the dark days of late '08-'09, you could have used your cash to build an LMP with cheap TIPS or to buy even cheaper stocks. While both, in retrospect, were a good idea, the latter was the best, especially for the younger investor, since it saw much greater captal appreciation. For the older investor with 20-25x residual expenses saved up, it might have been more reasonable to use at least some of it to lay down some LMP planks.

If you've done things right, you've been rebalancing out of those stocks into short-term fixed income; the downside is you can't buy TIPS at reasonable prices.

If you're patient, you may once again be faced with the choice between cheap TIPS and cheap stocks, or just one of those.

Patience is always a virtue; if you wait long enough, the market in either or both will come to you eventually.

Bill

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Re: Liability Matching Portfolio? Really?

Post by Yipee-Ki-O » Sat Dec 08, 2012 6:08 pm

Rodc wrote:
How many people can realistically save 25-30 times their spending needs?
Pretty much everyone, because at some point they will not be working and one way or another they will be forced to set spending based on how much income they can generate. They may spend too much to start but reality will catch up to them at some point.

That is when they truly discover what is need and what is nice to have. Need is not a lot as many find out.

Also, most people have Social Security. Many live just fine on nothing but Social Security. So if you need $40K per year and get $20K per year from SS, you only need 25 times $20K, or $500K, not $1,000,000. Remember the median family of 4 people or so live on $50K per year, and are paying SS, hopefully saving a little, etc., so while $40K is not a lot, it will be enough for many people. Indeed even less is often enough to get by ok.
Good point, many people overlook the value of Social Security, as this Prudential whitepaper points out:

http://research.prudential.com/document ... omFS&cid=1

The maximum Social Security benefit for higher wage earners (as most Boglheads appear to be) is rather substantial at normal retirement age, even better if one waits until age 70 to begin withdrawals. As Rodc says, once you begin drawing Social Security you're only looking for your portfolio to fund your income needs above what you receive from Social Security.

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Re: Liability Matching Portfolio? Really?

Post by ourbrooks » Sat Dec 08, 2012 8:29 pm

We have a liability matching portfolio that covers 80% of our current living expenses, probably far more than we really need.
The portfolio consists of the following assets:

1. Social Security
2. pension
3. single premium annuity

No TIPS, at least not in our LMP portfolio.

Neither the pension nor the annuity have built-in inflation adjustments. Instead, I will periodically purchase additional SPIAs. I've done some rough calculations based on the historical average inflation rates about how much more we'll need and set aside the money. Interestingly, my calculations are the money can be kept as cash and doesn't have to grow with inflation. That's because SPIAs cost less for a given amount of income the older you get and they do that at faster than the historical rate of inflation. Between ages 70 and 75, the annuity payout would increase by 20% but 3% inflation would only have a 16% effect.

It may not be a problem even if inflation rates are higher than average, because the payout rates of annuities are partially a function of interest rates and higher inflation results in higher interest rates and higher payout rates.

After setting aside the inflation provision, there's still some left. There are lots of possible ways we could use that money, including leaving a surprise bequest, but all of them have the interesting property that they can be deferred for a few years - the high end new car, the move into a high end continuing care community, etc. (Well, maybe not the bequest :happy ) That means that if the money for them is invested in stocks and the market tanks, we could wait for it to recorver before making the expenditures, so it's reasonable to put all of that money into stocks.

In conclusion:

1. You don't have to use TIPS to construct an LMP; if you're old enough, SPIAs will do just fine and most of us don't win the game until the final innings.
2. If you like investing in stocks and you have achieving the perfect slice and dice is on your bucket list, then the LMP approach helps to set clear boundaries about where you can afford to take the risk.

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Re: Liability Matching Portfolio? Really?

Post by joe8d » Sat Dec 08, 2012 11:34 pm

Rodc wrote:
How many people can realistically save 25-30 times their spending needs?
Pretty much everyone, because at some point they will not be working and one way or another they will be forced to set spending based on how much income they can generate. They may spend too much to start but reality will catch up to them at some point.

That is when they truly discover what is need and what is nice to have. Need is not a lot as many find out.

Also, most people have Social Security. Many live just fine on nothing but Social Security. So if you need $40K per year and get $20K per year from SS, you only need 25 times $20K, or $500K, not $1,000,000. Remember the median family of 4 people or so live on $50K per year, and are paying SS, hopefully saving a little, etc., so while $40K is not a lot, it will be enough for many people. Indeed even less is often enough to get by ok.
Exactly.I'm 70,retired 8 years and have found my SS and private sector pension more than covers my expenses.I have not had to tap my portfolio and ,in fact,have added to it by putting all my P/T job earnings into my IRA.
All the Best, | Joe

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LH
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Re: Liability Matching Portfolio? Really?

Post by LH » Sun Dec 09, 2012 1:28 am

Well, for a 43 year old investor, using Social Security as part of a liability matching portfolio is likely more problematic than using TIPS.....

I mean TIPS, sure, the cpi-u is not only malleable, the TIPS CPI-U can be changed outright to another unspecified inflation index. "best interest" or something if I recollect.... So TIPS is problematic.

Already though, SS they are stating only funds for about 76 percent of the promise. Which is a simple (expectant) default.

So.......

The biggest financial entity in the world, with the biggest army, cannot swing it....... Pay SS money diligently in...... and..... maybe get 76 percent out, projected at the moment.

How do I LMP that? 24 percent of my matching funds just vaporize like MF global segregated accounts.

There is no LMP for a 40 year old. There is no financial entity big enough. I think we can all agree? If not, tell me how much SS I will collect 20+ years hence, and tell me what age I will collect it, and tell me what they will tax it.

Hey, I love LMP, I wanna LMP. just answer the questions in a way thats gonna expectantly hold for 20 plus years?!?!?!?!? You cannot. Its simply not doable. Its a myth.

Now the expectation is to kick the can, such that todays seniors "escape" (to try not to be morbid) with no downgrades..... Maybe that can occur. But I think we borrow 46 cent of every dollar spent now.... Sounds problematic. Imagine a single US household doing that, even one which has printed IOU's which people have accepted for a hundred years? other households heads might start to turn, maybe the russian, chinese, and arabic neighbors might start to look hard at the paper eh?

How many US in 1929 dreamed of the great depression, or greek pensioners in 2003 dreamed of now? Not many. You know what, I posit it would have been considered laughable, to even bring it up on average, no one would believe it.

Variable needs, variable financial payout = diversification.

You cant really get better than rule of thumb metrics in a complex chaotic system where not only the rules of the system change, the "particles" in the system are aware, and actively make decisions in response to the perceived system...... (Especially for a single individual, in that system).

Model that LTCM.

Then drop down to private pensions, with small entities with no army, no taxing power...... Then examine recent history. Even state pension, I think 3 trillion liability, 1 trillion assets....... So..... the 1 trillion, while doing payouts that likely consume more than is coming in, is gonna TRIPLE...

There is no LMP, real world. Real world, LMP entities and LMP concepts are tools, in a broader diversification toolbox.

Its an ok framework. but one has to be really really really careful, to parse out the reality, from the academic inapplicability at real world level like "riskless" et al. There is a fundamental conflation between perfectly acceptable academic think kept in academic papers, and real world application. Academic "riskless asset" Real world no such thing. Thats just the most obvious, but on down the line, it permeates.

So one can say, yeah do an LMP in response to a question, list out criteria and such, while later, say, well, there really is no LMP. Because one is perfectly acceptable top of the line academic answer, and the other accepts reality. Its just usually not specified, and even when it is, as a human its awfully easy to slip back and forth between idealized academics and real world workability.

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Re: Liability Matching Portfolio? Really?

Post by YDNAL » Sun Dec 09, 2012 6:49 am

LH wrote:Well, for a 43 year old investor, using Social Security as part of a liability matching portfolio is likely more problematic than using TIPS.....

So one can say, yeah do an LMP in response to a question, list out criteria and such, while later, say, well, there really is no LMP. Because one is perfectly acceptable top of the line academic answer, and the other accepts reality. Its just usually not specified, and even when it is, as a human its awfully easy to slip back and forth between idealized academics and real world workability.
LH,

All good points in your (otherwise) lengthy post, so I quoted the first sentence and last paragraph.

You are, though, putting it out of context. There is no viable reason that I see for a 43yo to have a "retirement" portfolio to match liabilities - that is, unless you are ready to retire (separate and distinct issue). As you already mentioned, for a 43yo "retirement" income streams are sketchy (at best) and so are expenses, adjusted for inflation. Now, move ahead 20 years and you are 63yo with a clearer (though not 100% clear) picture. What do you do then?
Landy | Be yourself, everyone else is already taken -- Oscar Wilde

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Re: Liability Matching Portfolio? Really?

Post by 1210sda » Sun Dec 09, 2012 10:10 am

wbern wrote: In the real world, you can stratify your odds as follows in terms of residual expense savings:

< 10x: Unless both you and your spouse die young and don't have large unexpected expenses, you're sunk.
10-20x: If you're lucky, you just might skate through.
20-30x: You've won the game; most of your money should go into an LMP
>>30x: Doesn't matter much how you divide between a risky portfolio and LMP. You're fine, thank you.

Bill
Bill, is this intuitive, or have you done research on this?

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Re: Liability Matching Portfolio? Really?

Post by market timer » Sun Dec 09, 2012 10:54 am

Owning a paid-off house (with low property taxes) and receiving Social Security and Medicare should cover the basics in retirement: food, shelter, clothing, health care. Any necessities above this should probably be met with long duration TIPS. For luxury purchases (travel, gifts, etc.), riskier assets can be used, since these expenses can be cut if risk shows up.

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Re: Liability Matching Portfolio? Really?

Post by steadyeddy » Sun Dec 09, 2012 12:59 pm

I think it's a mistake to believe exchanging equity for debt is akin to "taking money off the table." Your capital is still subject to investment risk, longevity risk, and the inflation risk you've identified. If your goal is to stop playing the game, I think SPIA's offer the best opportunity to truly transfer these risks to another party in exchange for credit risk, which you can minimize through diversification.

I'm not sure if I'll be keen to move to a liability matching strategy once I've accumulated "enough," but if I do, I'll execute it with several SPIA's purchased from well capitalized insurers.
Last edited by steadyeddy on Sun Dec 09, 2012 1:15 pm, edited 1 time in total.

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Re: Liability Matching Portfolio? Really?

Post by dbr » Sun Dec 09, 2012 1:04 pm

steadyeddy wrote:I think it's a mistake to believe exchanging equity for debt is akin to "taking money off the table." Your capital is still subject to investment risk, longevity risk, and the inflation risk you've identified. If your goal is to stop playing the game, I think SPIA's offer the best opportunity to truly transfer these risks to another party in exchange for credit risk, which you can minimize through diversification.
I think this is a very perceptive and also very traditional point of view.

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Re: Liability Matching Portfolio? Really?

Post by Rodc » Sun Dec 09, 2012 2:15 pm

Already though, SS they are stating only funds for about 76 percent of the promise. Which is a simple (expectant) default.
That is my current expectation. I expect low income people will get closer to 100%, as I expect my 76% to come from being means tested (implicitly or explicitly. Implicit is already happening due to retirees with good incomes having their SS taxed). I don't see how that changes the basic idea that having (some) SS reduces income need in retirement.

Life comes with no guarantees, ever. Expecting a lock solid liability matching scheme of a 43 year old to implement going forward for 50+ years is simply a straw-man. Just as "4% rule" set and never revisited at age 43 is foolish.

Other than around age 50 starting to put together something of a TIPS ladder to go with my and wife's (expected) pension, and my SS, I'm not too putting a lot of effort into liability matching, though I may well annuitize some savings in retirement which is another liability matching method.

I plan to stay diversified by using some liability matching ideas (some I control like annuitizing and TIPS ladder, and some like SS and pension I do not control) and some basic portfolio of investments ideas.

And I do not expect any of this to provide any sort of guaranteed never every could have a problem income stream.
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 wshang » Sun Dec 09, 2012 2:19 pm

1210sda wrote:
wbern wrote:>>30x: Doesn't matter much how you divide between a risky portfolio and LMP. You're fine, thank you.Bill
Bill, is this intuitive, or have you done research on this?
WBern, as someone who has written about historical economics and stability, certainly those who were ">>30x" in the terminal states of their government states faced ruin. Even at this level, how can one be guaranteed to be "fine"? Certainly, there must be a defensive stance or measures individuals in this financial state should adopt to insulate themselves from ruin other than bland reassurances? Care to elaborate?

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Re: Liability Matching Portfolio? Really?

Post by Leesbro63 » Sun Dec 09, 2012 2:22 pm

steadyeddy wrote:I think it's a mistake to believe exchanging equity for debt is akin to "taking money off the table."
+1 I am the original poster and this much better (than I said it) states the premise of my post! Thank you, Steadyeddy! :D

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Re: Liability Matching Portfolio? Really?

Post by SimpleGift » Sun Dec 09, 2012 3:34 pm

1210sda wrote:
wbern wrote: In the real world, you can stratify your odds as follows in terms of residual expense savings:

< 10x: Unless both you and your spouse die young and don't have large unexpected expenses, you're sunk.
10-20x: If you're lucky, you just might skate through.
20-30x: You've won the game; most of your money should go into an LMP
>>30x: Doesn't matter much how you divide between a risky portfolio and LMP. You're fine, thank you.
Bill, is this intuitive, or have you done research on this?
Not wbern, but there's a good quantitative treatment of this concept of calculating a multiplier of one's residual expenses in Jim Otar's book, Unveiling the Retirement Myth. See Chapter 41 (lots of charts and graphs), where Otar breaks down the various multiples into zones of safety — red, gray and green. Very clear, useful guidelines about when to annuitize, when not to worry, etc. Highly recommended.
Cordially, Todd

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Re: Liability Matching Portfolio? Really?

Post by Bill Bernstein » Sun Dec 09, 2012 4:41 pm

Hi All:

I treat this quantitatively in all 3 of my finance books, and particularly in the last e-book, "The Ages of the Investor."

When I wrote Ages, an inflation-adjusted joint survivor SPIA bought at age 65 yielded 4%; that's where the 25x comes from. (Now it's closer to 3.3%/30x, but I didn't want to be too morbid in my post.)

The other part is to look at how survivable a 100% stock portfolio is. My "outer limits" scenario is a permanent 50% fall in real dividends--that is, to 1% of current prices, for a safe all-stock multiple of 100x. Between those two extremes--all SPIA/TIPS ladde and all stocksr, you weight those numbers.

Sure, when you exchange stocks for TIPS/SPIA, you exchange one kind of risk for another. But it's tendentious to argue that the risk of the former might be somehow less than the risk of the latter.

Finally, when I said "fine," I should have qualified it as "fine as you can be." In a catastrophic scenario, you're better off with canned goods, ammo, and Krugerrands. But in most normal curcumstances, you're a lot worse off with that portfolio. Is it unreasonable to hold a little of that portfolio? Probably, but to the extent you hold it you're probably decreasing your survival chances in a more normal, and more likely, historical sample.

Bill

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Re: Liability Matching Portfolio? Really?

Post by 1210sda » Sun Dec 09, 2012 5:21 pm

Thanks for the reminder, Simplegift.

I went back and checked out Otar's book.

For those that want to check this out also, the section is "Calculating your Zone--A Simpler Method" on page 450.

Otar's tells us to compare our Client Asset Multiplier (CAM) to the Sustainable Asset Multiplier. (CAM = Retirement Assets divided by Required Income) (SAM = The minimum portfolio value required to generate $1 of income, indexed to CPI each year)

Otar's SAM's are: For age 55, "33"; For age 65, "27"; For age 75, "21".

If your CAM is greater than the SAM, you are in the "green zone" and have abundant savings. A SAM of 27 for age 65 works out to 3.7 withdrawal rate. (1/27th = 3.703)

Thanks Dr. Bill for the additional info. (He posted before I got a chance to finish this post)
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Re: Liability Matching Portfolio? Really?

Post by Browser » Sun Dec 09, 2012 5:58 pm

wbern wrote:Hi All:

I treat this quantitatively in all 3 of my finance books, and particularly in the last e-book, "The Ages of the Investor."

When I wrote Ages, an inflation-adjusted joint survivor SPIA bought at age 65 yielded 4%; that's where the 25x comes from. (Now it's closer to 3.3%/30x, but I didn't want to be too morbid in my post.)

The other part is to look at how survivable a 100% stock portfolio is. My "outer limits" scenario is a permanent 50% fall in real dividends--that is, to 1% of current prices, for a safe all-stock multiple of 100x. Between those two extremes--all SPIA/TIPS ladde and all stocksr, you weight those numbers.

Sure, when you exchange stocks for TIPS/SPIA, you exchange one kind of risk for another. But it's tendentious to argue that the risk of the former might be somehow less than the risk of the latter.

Finally, when I said "fine," I should have qualified it as "fine as you can be." In a catastrophic scenario, you're better off with canned goods, ammo, and Krugerrands. But in most normal curcumstances, you're a lot worse off with that portfolio. Is it unreasonable to hold a little of that portfolio? Probably, but to the extent you hold it you're probably decreasing your survival chances in a more normal, and more likely, historical sample.

Bill
Dr. Bill. If we're closer to 30x now for a 65-year old how would you modify that for a 70-year old, etc?
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Re: Liability Matching Portfolio? Really?

Post by wshang » Sun Dec 09, 2012 6:23 pm

1210sda wrote:Otar's SAM's are: For age 55, "33"; For age 65, "27"; For age 75, "21".
So, if I were to understand this correctly . . .
Age 55, SWR = 3.3%
Age 65, SWR = 3.7%
Age 75, SWR = 4.75%

Wm Bernstein appears to be implying even more conservative a ratio. Seems at least with each passing decade, or year, one can "live it up" a little bit more, by increasing their SWR, (RIGHT???!)

Having "won the game" I set my SWR 2.5% at age 51, which from the extrapolation here, seems perhaps a little too conservative. Personally, there is no reason to take on an iota more risk than necessary to enjoy life at this point. Preservation of capital is especially important since I no longer wish to expend my human capital. :sharebeer

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Re: Liability Matching Portfolio? Really?

Post by Bill Bernstein » Sun Dec 09, 2012 7:04 pm

Yes, at the moment we're at 30x, not 25x.

But that's mainly a result of today's repressive Fed stance; I don't expect that to be permanent. Looking on the bright side, for example, if we get another financial crisis with 3% TIPS rates, a 5% payout lasts 31 years, meaning we're back at 20x.

And, yep, with each successive decade that nothing horrible happens to your portfolio, you can "live it up" a little more. It might not be unreasonable, for example, to increase your SWR estimate by at least 0.1% each year above 65.

Bill

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Re: Liability Matching Portfolio? Really?

Post by Browser » Sun Dec 09, 2012 8:20 pm

wbern wrote:Yes, at the moment we're at 30x, not 25x.

But that's mainly a result of today's repressive Fed stance; I don't expect that to be permanent. Looking on the bright side, for example, if we get another financial crisis with 3% TIPS rates, a 5% payout lasts 31 years, meaning we're back at 20x.

And, yep, with each successive decade that nothing horrible happens to your portfolio, you can "live it up" a little more. It might not be unreasonable, for example, to increase your SWR estimate by at least 0.1% each year above 65.

Bill
What about the idea of trying to spend more upfront and decrease as one ages? I don't expect to be "living it up" too far into geezerhood. I'd rather do that while I can still understand what that means.
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Re: Liability Matching Portfolio? Really?

Post by LH » Mon Dec 10, 2012 1:16 am

YDNAL wrote:
LH wrote:Well, for a 43 year old investor, using Social Security as part of a liability matching portfolio is likely more problematic than using TIPS.....

So one can say, yeah do an LMP in response to a question, list out criteria and such, while later, say, well, there really is no LMP. Because one is perfectly acceptable top of the line academic answer, and the other accepts reality. Its just usually not specified, and even when it is, as a human its awfully easy to slip back and forth between idealized academics and real world workability.
LH,

All good points in your (otherwise) lengthy post, so I quoted the first sentence and last paragraph.

You are, though, putting it out of context. There is no viable reason that I see for a 43yo to have a "retirement" portfolio to match liabilities - that is, unless you are ready to retire (separate and distinct issue). As you already mentioned, for a 43yo "retirement" income streams are sketchy (at best) and so are expenses, adjusted for inflation. Now, move ahead 20 years and you are 63yo with a clearer (though not 100% clear) picture. What do you do then?
Depends on:

1) what I have
2) what SS will pay, if much of anything
3)what medicare pays
4) Current state of country, 1933 like, current greek like, or no?

Basically a 60/40 split, with plus minus SPIA, SWR 4 percent rule of thumb.

Life is rule of thumb 20 years hence. there is no LMP really. 1)there is no defined need 2)there is no defined ability to pay. Its just two highly variable sides, especially for a single individual.

I mean, if you were a greek with a pension in 2005, where the heck is the lmp there? Yeah, it is about 100 pecent clear now where they are.

20 years is a long time borrowing 46 cent on the dollar spent. I am not very clear currently on current retirees 10-20 years hence. Its as easy now to say it will be fine as it was in 1929, so no worries though : )

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Re: Liability Matching Portfolio? Really?

Post by larryswedroe » Wed Dec 12, 2012 3:57 pm

Thought I would just add these points
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

Hope that is helpful

Larry

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Re: Liability Matching Portfolio? Really?

Post by Browser » Wed Dec 12, 2012 4:15 pm

larryswedroe wrote:Thought I would just add these points
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

Hope that is helpful

Larry
Larry - I followed your advice and did load up on TIPS when real yields were high back in 2008. But, loading up is one thing. But what should one do if (as now) the "loading up" has paid off and one is sitting on the load of TIPS with some nice cap gains, but now with really low real rates?
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Re: Liability Matching Portfolio? Really?

Post by larryswedroe » Wed Dec 12, 2012 6:35 pm

Browser
the right way to look at it is that you now own them at the current yield, so the question is would you buy them at this level? If not then my view is I would sell them
The problem is that there really are no good alternatives at the moment, only lesser among "evils"
Wish I had good answer for you. But at least you took the advice at the time.

Best wishes
Larry

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Re: Liability Matching Portfolio? Really?

Post by Bustoff » Fri Feb 15, 2013 11:58 am

wbern wrote: In the real world, you can stratify your odds as follows in terms of residual expense savings:

< 10x: Unless both you and your spouse die young and don't have large unexpected expenses, you're sunk.
10-20x: If you're lucky, you just might skate through.
20-30x: You've won the game; most of your money should go into an LMP
>>30x: Doesn't matter much how you divide between a risky portfolio and LMP. You're fine, thank you.
Bill
Can anyone explain what these numbers reference (10x, 20-30x, etc.) ?
Thanks

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Re: Liability Matching Portfolio? Really?

Post by fidelio » Sat Feb 16, 2013 3:30 am

multiples of annual spenddown.

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Re: Liability Matching Portfolio? Really?

Post by azanon » Mon Jun 23, 2014 9:53 am

Bumping because the LMP came up again in Bill's latest book so I was thinking about it again.

Ok, so here's the thing. I don't get this concept of LMP at all. 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 (say 5-10 years or more), 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, so any portion of equities below that amount would make Spock roll in his grave were he dead.

The concept of LMP in Dr. Bernstein's books seems to be intertwined with this investment that is allegedly the equivalent of (paraphrasing) sitting at a table with a hand of cards and a pile of chips, or this "investment" seems to be strangely be associated with gambling as if the two have something to do with each other. Of course this investment here is namely stocks, (or other equities). So we are to deduce that Dr. Bernstein seems them either as being one in the same since the analogy continues to resurface in multiple books, or that they're at least distance cousins. Further, Dr. Bernstein actually wrote a short book ("Deep Risk") outlining and acknowledging how a diversified portfolio of stocks was one of the best things you can own to be able to defend against deep risk. So what gives? You can believe one, or the other, but not both. Why? Because if it is a portfolio/withdrawal plan that you're setting up to withstand a 25+ year period, then you already know up front you're dealing with a "long-term" scenario, the scenario where stocks not only excel, but outright trounce any alternative (see SFTLR if you want data instead of just an opinion). Again, depending on which book you're reading, Dr. Bernstein agrees!

There was also some study that seems to have slipped my mind what is was, but basically it said you're really starting to be/act silly (act illogical) when you're taking drastic measures (e.g. a 100% portfolio of TIPS or a SPIA) to protect against a less likely risk, when you are more likely to, say, die early. To use an exaggerated analogy, it is like being OCD about changing the oil every 3K miles on your modern car, when you're riding on tires with 0.5/32rd of an inch of tread.

The whole 4% SWR study which admittedly is based on a 60/40 portfolio (not a 30/70), is designed to protect you against the worst case scenario, not the average scenario. And FWIW's, there are still highly respected individuals who are experts in this field (e.g. Michael Kitces) and groups (Vanguard) who still support the 4% SWR starting point which would logically mandate a portfolio that would include equities. And FWIW, Mr. Kitces just told me last week on twitter that he believes a properly structured portfolio using a 4% SWR can still survive a 2 standard deviation event.

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.

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Re: Liability Matching Portfolio? Really?

Post by market timer » Mon Jun 23, 2014 10:08 am

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.

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