It’s the income, stupid!

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VictoriaF
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Re: It’s the income, stupid!

Post by VictoriaF » Sun Aug 25, 2013 6:57 am

Another benefit of annuitizing is that as a person's cognitive abilities decline with age, he does not have to make money-management decisions and is less prone to scamming.

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Levett
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Re: It’s the income, stupid!

Post by Levett » Sun Aug 25, 2013 7:18 am

Anyone who can enumerate the following--

"I would say for retirement planning it makes more sense to think in terms of product diversification & allocation. That is, we want to manage retirement living standard risk by hedging, insuring, and diversifying - not just by diversifying.

SS benefit (When to take) hedging
db pension benefit (When to take) hedging
cash balance pension benefit (When to take) hedging
private life annuities (how much & when) hedging
TIPS ladders & I-bonds (how much & how long) insuring
Medigap coverage (how much) insuring
LTCi (how much) insuring
portfolio of diversified risky and safe investment assets (how much risk) diversifying
housing assets (sell & rent, reverse mortgage, sell & buy down, etc.) hedging or insuring

BobK--"


hardly has his "head in the sand."

He's got his head screwed on right.

And I completely agree with Victoria about taking steps in anticipation of cognitive decline. Cognitive decline is a risk that can lay waste to investors and advisors alike.

As a retiree, I have a bias to the near-perpetual nature of institutions--whether it's a law firm, an investment firm, or the U.S. Treasury--rather than depend on my continuing judgment or the judgment of a single advisor who is, himself or herself, subject to the "slings and arrows of outrageous fortune."

Overconfidence is the enemy.

Lev

ndchamp
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Re: It’s the income, stupid!

Post by ndchamp » Sun Aug 25, 2013 8:12 am

Levett wrote:Anyone who can enumerate the following--

"I would say for retirement planning it makes more sense to think in terms of product diversification & allocation. That is, we want to manage retirement living standard risk by hedging, insuring, and diversifying - not just by diversifying.

SS benefit (When to take) hedging
db pension benefit (When to take) hedging
cash balance pension benefit (When to take) hedging
private life annuities (how much & when) hedging
TIPS ladders & I-bonds (how much & how long) insuring
Medigap coverage (how much) insuring
LTCi (how much) insuring
portfolio of diversified risky and safe investment assets (how much risk) diversifying
housing assets (sell & rent, reverse mortgage, sell & buy down, etc.) hedging or insuring

BobK--"


hardly has his "head in the sand."

He's got his head screwed on right.

And I completely agree with Victoria about taking steps in anticipation of cognitive decline. Cognitive decline is a risk that can lay waste to investors and advisors alike.

As a retiree, I have a bias to the near-perpetual nature of institutions--whether it's a law firm, an investment firm, or the U.S. Treasury--rather than depend on my continuing judgment or the judgment of a single advisor who is, himself or herself, subject to the "slings and arrows of outrageous fortune."

Overconfidence is the enemy.

Lev
:beer Well said!

Browser
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Re: It’s the income, stupid!

Post by Browser » Sun Aug 25, 2013 10:34 am

Just to clarify my previous comment. I've heard this type of discussion framed as a "liability matching" vs. "total return" dichotomy. In the LM world, one first secures base income needs in terms of guaranteed income products such as government bonds, annuities, social security, pensions, etc. Most desirable are inflation-adjusted products such as social security, TIPS, I-Bonds, and inflation-adjusted annuities. If one has sufficient resources, the excess can be invested in other products such as stocks. In the TR world, everything is an investment "asset" that is part of one's overall portfolio of assets. However, income-flow assets such as social security, pensions, annuities and bond ladders are typically not considered to be part of one's investment portfolio, per se. In TR, one would attempt to meet incremental income needs in retirement by diversifying across various assets with different risk exposures and by targeting an overall portfolio risk level that is appropriate to one's individual circumstances.

I can't see much difference between the LM model and the TR model; except that the LM model would often steer individuals into allocating their retirement assets heavily toward income-flow products such as annuities and inflation bond ladders; thereby reducing the degree of portfolio diversification they might otherwise maintain via the TR model. My question is whether this is necessarily a good idea, since risk is being concentrated into those risk factors affecting the viability of annuity payments and bond returns. Should, in fact, most individuals have more exposure to a wider range of assets - such as stocks - than might be the case by adopting the LM model?
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Re: It’s the income, stupid!

Post by IlliniDave » Sun Aug 25, 2013 11:07 am

Browser wrote:My question is whether this is necessarily a good idea, since risk is being concentrated into those risk factors affecting the viability of annuity payments and bond returns. Should, in fact, most individuals have more exposure to a wider range of assets - such as stocks - than might be the case by adopting the LM model?
I think it depends on on the relative situation and therefore the specific definition of risk for an individual. I'd say it's different for a person who barely has the true floor covered than for someone targeting an income several times their true floor. A person who is going to barely stay out of the pet food aisle shopping for groceries probably can't afford to fool around with investment assets that would be expected to produce large negative "total returns" from time-to-time. For someone on the other extreme whose goal is to maintain their yacht club membership indefinitely and fly worldwide first-class anytime they're bored while leaving their heirs a sizable estate--their risk is arguably lowered by investing much more aggressively. Most of us, of course, fall somewhere in the middle. I like LM in the sense of covering my floor under all circumstances except governmental/institutional collapse while having freedom to invest the rest to "make money", for myself or for my heirs. I'm still a ways off but that's the leading thought in my planning at present.
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Re: It’s the income, stupid!

Post by bobcat2 » Sun Aug 25, 2013 11:23 am

Browser wrote:Just to clarify my previous comment. I've heard this type of discussion framed as a "liability matching" vs. "total return" dichotomy. In the LM world, one first secures base income needs in terms of guaranteed income products such as government bonds, annuities, social security, pensions, etc. Most desirable are inflation-adjusted products such as social security, TIPS, I-Bonds, and inflation-adjusted annuities. If one has sufficient resources, the excess can be invested in other products such as stocks. In the TR world, everything is an investment "asset" that is part of one's overall portfolio of assets. However, income-flow assets such as social security, pensions, annuities and bond ladders are typically not considered to be part of one's investment portfolio, per se. In TR, one would attempt to meet incremental income needs in retirement by diversifying across various assets with different risk exposures and by targeting an overall portfolio risk level that is appropriate to one's individual circumstances.

I can't see much difference between the LM model and the TR model; except that the LM model would often steer individuals into allocating their retirement assets heavily toward income-flow products such as annuities and inflation bond ladders; thereby reducing the degree of portfolio diversification they might otherwise maintain via the TR model. My question is whether this is necessarily a good idea, since risk is being concentrated into those risk factors affecting the viability of annuity payments and bond returns. Should, in fact, most individuals have more exposure to a wider range of assets - such as stocks - than might be the case by adopting the LM model?
Let me repeat the answer I gave earlier to your previous almost identical question.
I would say for retirement planning it makes more sense to think in terms of product diversification & allocation. That is, we want to manage retirement living standard risk by hedging, insuring, and diversifying - not just by diversifying.

SS benefit (When to take) hedging
db pension benefit (When to take) hedging
cash balance pension benefit (When to take) hedging
private life annuities (how much & at what times) hedging
TIPS ladders & I-bonds (how much & how long) insuring
Medigap coverage (how much) insuring
LTCi (how much) insuring
portfolio of diversified risky and safe investment assets (how much risk) diversifying
housing assets (sell & rent, reverse mortgage, sell & buy down, etc.) hedging or insuring
Many Bogleheads appear fixated in managing risk solely thru diversification and completely ignoring the other two risk transfer methods of hedging and insuring. Diversification is a fine risk management tool, but you cannot diversify away market risk, which means diversification leaves you with considerable risk exposure in the form of market risk. By also hedging and insuring you get greater risk reduction, but unlike diversification hedging offers no upside potential, and there is less upside potential with insuring than there is with diversification. By hedging and insuring you lock in part of your retirement income. With diversification you do not.

BobK
In finance risk is defined as uncertainty that is consequential (nontrivial). | The two main methods of dealing with financial risk are the matching of assets to goals & diversifying.

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Re: It’s the income, stupid!

Post by garlandwhizzer » Sun Aug 25, 2013 11:36 am

I do not find annuities of any type appealing. Nor do I find the current low levels of income from bond holdings appealing. One pays a very high price these days for a guaranteed income stream. I prefer to have a large asset base of stocks and bonds managed by me with a total return approach. This allows better tax treatment (long term capital gains versus ordinary income), has lower costs (cutting out the considerable profit companies derive from annuities, for example), and allows more flexibility in spending including unexpected expenses which might not be covered by an inflexible income stream.

If I fear that I'm becoming senile and incapable of handling my portfolio, or if I become extremely risk averse, then I would consider the annuity path, but fortunately I'm not there yet.

Garland Whizzer

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Re: It’s the income, stupid!

Post by bobcat2 » Sun Aug 25, 2013 11:50 am

garlandwhizzer wrote:I do not find annuities of any type appealing. Nor do I find the current low levels of income from bond holdings appealing. One pays a very high price these days for a guaranteed income stream. I prefer to have a large asset base of stocks and bonds managed by me with a total return approach. This allows better tax treatment (long term capital gains versus ordinary income), has lower costs (cutting out the considerable profit companies derive from annuities, for example), and allows more flexibility in spending including unexpected expenses which might not be covered by an inflexible income stream.

If I fear that I'm becoming senile and incapable of handling my portfolio, or if I become extremely risk averse, then I would consider the annuity path, but fortunately I'm not there yet.

Garland Whizzer
Given the current low real interest rates do you find increasing annuitized income flows by delaying SS benefits and DB pension benefits appealing? Keeping in mind that these two annuitized income streams are based on average LT real interest rates instead of the current low interest rates. This makes delay in both cases very advantageous in this time of low interest rates.

BobK
In finance risk is defined as uncertainty that is consequential (nontrivial). | The two main methods of dealing with financial risk are the matching of assets to goals & diversifying.

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Re: It’s the income, stupid!

Post by LadyGeek » Sun Aug 25, 2013 1:13 pm

I think bobcat2's insight is extremely important, so it's now in the wiki: Matching Strategy

The prior version of the article had already addressed retirement planning, I added bocat2's comments.

This is an important topic. I inserted the article as part of the Bogleheads® Retirement Planning Start-Up Kit, which should have been done a long time ago.

Comments / corrections / updates are welcome.
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Re: It’s the income, stupid!

Post by garlandwhizzer » Sun Aug 25, 2013 4:27 pm

bobcat2 wrote
do you find increasing annuitized income flows by delaying SS benefits and DB pension benefits appealing?
Personally, I do not find either option appealing. I have no defined benefit plan, no retirement plan of any type, only a personal investment account and a self-directed IRA. All the responsibility for my economic future falls on me and that is how I want it. I did not delay taking SS benefits because to delay them meant I would have to sell portions of my portfolio to provide for living expenses in the meantime. The historic rate of return for my portfolio as a whole is in excess of the rate of return of increased SS benefits that I would have gotten by delaying. So I chose specifically not to delay taking SS benefits and that has worked out very well at least up to now. Even though financial markets are sometimes very challenging, I enjoy the stimulation of investing and am not afraid to make decisions on asset allocation and to take full responsibility for myself. I do not recommend my approach for everyone but it has worked for me for more than 2 decades and I am comfortable with it.

Garland Whizzer

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Re: It’s the income, stupid!

Post by SGM » Sun Aug 25, 2013 4:53 pm

I have had no need in the past for any hedging. However, going forward with decreased human capital and increased assets, I am looking towards a partial hedging strategy.

Delay of SS and possibly delaying pensions, as I can live well off of income from investments, is part of the strategy.

Laddered SPIAs may also be useful. I did buy a deferred savings annuity presently increasing at almost 4% yearly. It is through a reputable organization and will likely pay the 4% through the end of the 7th year. I will see what it pays in the 8th year and can take it all out without penalty at that time or annuitize.

I have some real estate payments, some of which contractually goes up 5% yearly. Apartment rentals can go up yearly within prescribed limits.

When you reach retirement, significant early portfolio losses can put the hurt on portfolio longevity. Therefore hedging strategies become important.

I have no need or desire for LTC insurance. I would not qualify for it anyway. I will stubbornly stay out of nursing homes.

Covering most, if not all, of necessary expenses with pensions, SS, annuities, and real estate income will play into my strategy.
"Let us endeavor, so to live, that when we die, even the undertaker will be sorry." Mark Twain

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Re: It’s the income, stupid!

Post by Browser » Sun Aug 25, 2013 9:54 pm

Is there really much of a distinction between "wealth" and "income"? Wealth, broadly defined, is the sum total of the present value of one's assets. Some of those "assets" consist of entities producing "known" income flows; e.g., social security, pensions, bond ladders, annuities. Others, such as stocks, bonds not held to maturity, commodity futures, real estate do not produce known income flows. The eventual returns from all these entities are subject to risk factors and none of these returns is guaranteed. Social security is subject to the solvency of government and to government decisions affecting what it will pay. Private pensions are subject to the actions and solvency of private payers. Bond ladders, ditto. Annuities, ditto. Stocks and other non income-generating assets are subject to market risks. Various forms of "insurance", such as LTCI are subject to specific risks involving the solvency of the underwriter and decisions about what and when to pay. I can't see species-class distinctions between these various ways of allocating your total wealth that are sufficient to create a new paradigm for making investment decisions and allocating one's capital. In the the end, it IS all about diversification isn't it? It might be better referred to as product diversification instead of asset diversification but is there anything else new? Things are still just as uncertain as ever for someone with a 20-30 year horizon until retirement. How is framing in terms of an income target really any different from framing in terms of a nestegg target? I'm afraid I just don't get the point of the "It's the Income, stupid" argument. Is there something new and revolutionary here that I didn't know about before?
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Re: It’s the income, stupid!

Post by bobcat2 » Sun Aug 25, 2013 10:27 pm

Is there really much of a distinction between "wealth" and "income"?
You're darn tootin there's a big difference! Again from Merton in the article.
His first premise is that DC needs to be completely redesigned, with the focus on growth in fund values needing to be almost entirely purged from our system. Confusing the need for a pot of money with the need for income can lead to very expensive mistakes he argues.

You cannot say wealth goals are approximate to income goals. Imagine you are a 45 year old and you are going to retire at 65. In returns of income, what is the risk free asset? It is an asset, fully guaranteed, that 20 years from now starts paying you a level income for the rest of your life, corrected for inflation. I created one of those, called a real annuity, and from 2003 to 2012 I ploughed the monthly returns and we saw swings of -17 per cent and +15 per cent, on a risk-free asset. Yet when you measure this asset in terms of income, there’s no risk. So when someone says we can approximate an income goal with a wealth goal, as a practical matter, it doesn’t even come close,” says Merton.

“Or since 2008, suppose someone was lucky enough to have £1m to live off. If they had been very conservative and had bought bank CDs, six or seven years ago they would have told you their income was 4.5 or 5 per cent and they would have got £45,000 to £50,000 a year. Now you say to them, congratulations, I have preserved your £1m. But they say, yes and I am getting £4,000 to £5,000 a year. I can’t live on that,” he adds.
Investment enthusiasts tend to believe that wealth retirement goals and income retirement goals are just two ways of looking at the same thing. Investment enthusiasts are wrong in that belief. Taking into consideration the current level of real interest rates is extremely important when developing an investment strategy, because the higher real interest rates are, then the higher the income stream that can be supported by any particular level of wealth. Because the goal of retirement planning is income in retirement, setting a retirement target of a given level of wealth at retirement is faulty retirement targeting, because the amount of retirement income that wealth will support is conditional, among other things, on the level of real interest rates at retirement age. This is a key reason that the price of a real life annuity at your retirement age, which takes longevity, real interest rates, and inflation expectations into account, is instead a more appropriate target for retirement planning. (Everyone needs to recognize that setting a level of wealth at retirement as the target takes none of these three salient retirement planning factors into account.)

While it is trivially true that all financial instruments carry some risk and nothing is truly "risk-free", it is silly to argue that because of that everything is about equally risky. And no it is definitely not all about diversification. It is about managing risk. Financial risk is typically managed thru three risk transfer methods - hedging, insuring, and diversifying. It is very difficult to effectively manage financial risk in retirement if you are going to throw 2 of the 3 methods out.

These ideas aren't new and revolutionary in finance, but they are apparently new and revolutionary to most investment enthusiasts. To paraphrase Harry S. Truman, "The only new ideas in the world of finance are the old ideas you don't know".

BobK
In finance risk is defined as uncertainty that is consequential (nontrivial). | The two main methods of dealing with financial risk are the matching of assets to goals & diversifying.

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Re: It’s the income, stupid!

Post by LH » Mon Aug 26, 2013 2:56 am

bobcat2 wrote:Investing is boring writes.
Annuities are not somehow immune to this fact. Because annuities are less risky then say a 50/50 bond/equity portfolio, they have a lower expected lifetime return - a lower potential to produce income.
Life annuities are a contingent contract. In this case the contingency is staying alive and the contingent benefit that equities and bonds don't possess is the mortality credit. This gives the annuity a higher annual payout (interest, principal, & mortality credit) than you can get from equities or bonds.

You cannot lower the PV of a liability by taking on more risk. You can lower the PV of a liability by taking out a contingent contract. In this case the liability is the retirement income goal.

In many ways life annuities are the flip side of term life insurance. In that case the contingency is dying. Similarly to life annuities term life insurance provides more bang for the buck than equities or bonds if the contingency is met.

BobK

The most important difference between life insurance and annuities, is that life insurance is more guaranteed.........

One can check the life insurance company for stability. Then when one dies, a lump sum payment can be basically achieved with good certainty. The due diligence timeframe is short, meaningful and achievable.

Ditto fire insurance.

Annuities, one cannot look 10 or 20 or 30 years into the future, and check out the company (countries) expected state in any meaningful sense.

Annuity payments are uncertain. In fact, I would posit ou are not likely to get them fully over 30 years expectationally. Look at detroit, look at defined benefit plans, look at Social security. Failure failure failure.

But hey, Lehman brothers and MF global are great companies with fine reputations that will watch your money.... Oh sorry, I slipped back in time a few years there.......

Also, in terms of trivial, use in preceding post:
While it is trivially true that all financial instruments carry some risk and nothing is truly "risk-free", it is silly to argue that because of that everything is about equally risky

The failure of the annuity of the us to pay out as promised, expectationally saying they will pay only 76 cents on the dollar promised is


not trivial


Detroit is not trivial. Failure of defined benefit plans is not trivial. Hey, I started working in 1986 in high school, I was told I would get my annuity fica payments later in like, when I looked at the FICA hole in my paycheck. Sure.

If the largest financial entity in the wold, cannot swing its annuity, despite money printing, taxing ability, to use the word trivial in terms of expectation risk of a private enity to deliver over a potential40 year time frame is irresponsible in the real world. The risk has shown up already, it's blatantly extant.

To act like some mere contract, with a mere company, means much of anything, 30 to 40 years hence in the future........... Is false.

It's highly uncertain. It's almost a suckers bet, especially forty years out.


I am sure ignoring risk, is fine in academics and theory, assume a frictionless state........ It's ok in sales too.

But the risk with annuities is anything but trivial. One cannot merely contract risk away by magic, those companies are investing in the SAME assets, stocks bonds, to get the return to fulfill the contract!!!!!!!

The market Risk does not go away when you sign the annuity contract.

What does go away, is fees.... Fees to the marketers, fees to the CEO, as well as the same costs to invest in the market that an individual buying vanguard tsm wold get basically.....

It's an added layer of expense, to get at the SAME source of return, stocks bonds, that one can get oneself via vanguard....... Oh, and a private companies promise that everything's gonna be hunky dory.... Guaranteed! For 40 years. Why if stocks bonds don't return, the money will come from...... Come from....come from........

Nowhere!

Because there is no money fairy. You are buying a promise that basically, CANNOT BE KEPT.

That private annuities, that invest in stocks bonds, provided long term diversification of risk, from stocks bonds, is simply false.

LH

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Re: It’s the income, stupid!

Post by SGM » Mon Aug 26, 2013 9:12 am

Certainly there is risk of an insurance company going belly up. There are the state association guarantees up to 100k in my current state of residence. For SPIAs, hopefully the higher rated insurance companies are not taking undo risk. Hopefully those annuitants who die young will pay for those who live longer. :twisted: There is the issue that annuitants tend to have longer life spans than pensioners and that annuity payouts are a little lower. The risk is certainly not negligible. I am not so pessimistic about either the markets or SS. I diversify risks from places like Detroit with national municipal bond funds.

Nothing is risk free. I am comfortable taking risks. Fire away.
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Re: It’s the income, stupid!

Post by Browser » Mon Aug 26, 2013 9:24 am

Bob - I agree with everything that Merton has to say. An income goal trumps a wealth goal. You need to take into consideration real interest rates and all that. The "risk free" asset is an asset producing a guaranteed real lifetime income stream. But the issue is "what should I do differently based on these assumptions" if I'm 40 years old and planning on retiring in 25 years?

First, Merton's risk-free asset exists only in an imaginary world. What is this mystical "real annuity" that he says he created? Why does he think his capital is any safer in whatever that consists of than in other types of investment assets? Second, should I be investing all my savings during the next 25 years in what I believe to be the risk-free or real annuity asset, or an approximation? That is Bodie's view -- one should invest everything in TIPS or I-Bonds until enough has been accumulated to generate a floor annual income (assuming you actually know what that will be when you are retired).

It all boils down to an asset allocation decision in the last analysis. You can't escape from the reality that whatever you invest in, you are doing so based on assumptions and you are assuming risks of various sorts. How can this be avoided by adopting the "income, stupid" paradigm. I'm afraid it's the same old hag in a new kimono. The only difference I can see that makes a difference is that the goal of creating and investing in a synthetic "real annuity" portfolio is going to have you putting your savings mostly into such things as TIPS and I-Bonds during your working career. Not everybody thinks that would be a good idea, and it leaves you with undiversified portfolio risks.

Yes, it's important to look ahead to how you are going to generate dependable income when you retire, and everyone should do that sooner rather than later. Should I work longer and delay social security? Should I purchase life annuities? Should I rely on taking "safe" withdrawals from a total return investment portfolio? Should I purchase LTCI when I'm 50? But these are decumulation issues and not accumulation issues. Apples and oranges. I just don't get what I should do differently during the accumulation phase - perhaps I can be enlightened.
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Re: It’s the income, stupid!

Post by bertilak » Mon Aug 26, 2013 10:49 am

Browser wrote:But these are decumulation issues and not accumulation issues. Apples and oranges. I just don't get what I should do differently during the accumulation phase - perhaps I can be enlightened.
I asked essentially the same question above. Here is bobcat's reply http://www.bogleheads.org/forum/viewtop ... 8#p1783271.

I don't think that means to do things sequentially. You can be funding the safe investments at the same time as the risky investments. Planning is needed to see that both targets are met at the age of retirement.

I have seen it mentioned elsewhere that getting quotes on SPIAs, even with no intention of buying one, can give some insight into target amounts needed for risky investments to achieve income above the safe floor income to reach an aspirational income level. (I think I have that right -- would appreciate any corrections.)

In general, I think it helps to think in terms of income as that is what is needed.

Any legacy is above and beyond needed/desired income. It has also been pointed out that by taking advantage of SPIA mortality credits (higher income), there can be, in the long run, a larger legacy even after paying for the SPIA since there will be less spend-down of the invested assets over time.
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Re: It’s the income, stupid!

Post by Browser » Mon Aug 26, 2013 11:37 am

Thanks. That's getting to the practical implementation aspect that I'm most interested in. Milevsky authored a book titled "Pensionize Your Nestegg" that addresses various ways to turn your accumulated wealth into DB-like retirement income. The basic questions are "how" to pensionize by allocating assets to the kinds of financial products that are appropriate, "when" to start pensionizing, and "how much" of your total wealth to pensionize. Unfortunately, for most people their employer retirement plans don't offer appropriate alternatives for pensionizing. They are stuck with traditional investment assets such as stock and bond funds. They have little choice other than to follow the total return + diversification approach until they reach retirement. I'm not so sure that isn't the best way to go anyhow. A total return portfolio that is based on tolerable risk (portfolio volatility) is still the default option. We can do our best to lay the groundwork for "pensionizing" our nestegg at retirement; for example, by considering LTCI, SS distribution date, etc. Nothing really earth-shattering here is there? Perhaps in the future, employer retirement plans and tax legislation will expand opportunities for individuals to try to create DB-like investment portfolios during accumulation and discussions like this will have some relevance.
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Re: It’s the income, stupid!

Post by bobcat2 » Mon Aug 26, 2013 12:44 pm

Browser wrote:Perhaps in the future, employer retirement plans and tax legislation will expand opportunities for individuals to try to create DB-like investment portfolios during accumulation and discussions like this will have some relevance.
Here's a link to a short paper on DC managed retirement plans. From the intro -
The DC industry has been shifting its efforts to a more outcome-oriented approach, in which workers are asked to create retirement plans with the assistance of online tools and other resources which help to determine the retirement nest egg they need. By and large, however, retirement planning in 401(k) plans continue to focus on accumulation while side-stepping the difficult questions of how much is actually needed to meet a retiree’s nondiscretionary and discretionary needs and how to create a sustainable “paycheck” to meet these needs. Participants are urged to maximize their deferrals and to diversify their portfolios to achieve their savings goals based on their risk tolerance. Beyond that, they are left on their own to determine what those actual goals are, and more importantly, how to deploy that nest egg upon retiring.

To address this dilemma, the market is slowly evolving towards meeting individualized participant retirement needs. Enter DC managed account solutions, which most commonly use a technology platform to professionally manage a participant’s account on a discretionary basis. Managed accounts in DC plans are likely to lead the way in linking the accumulation portion of retirement to a retirement income solution. Managed accounts will not be the only solution to help participants achieve their desired retirement income outcomes, but they have the necessary investment and retirement planning elements to deliver customized retirement solutions by leveraging technology. ...

In 2011, based on extensive academic and practical research, Dimensional Fund Advisors launched its Managed DC program, which offered plan sponsors and participants a new framework from which to prepare for retirement. Traditional retirement planning and investment styles are focused on wealth accumulation based on a mean-variance optimization approach as the primary investment strategy to maximize a worker’s nest egg. DFA believes that a lifecycle-based approach that can deliver a personal pension to participants is a more effective approach to retirement planning.

Rather than focusing on a total-return nest egg goal, DFA focuses on attaining a baseline income goal needed to cover non-discretionary expenses and a secondary goal for discretionary goals. Once the non-discretionary goals are achieved, those assets are managed with an immunization strategy similar to a defined benefit plan with an asset-liability matching methodology. Participants are granted greater flexibility in their ability to ratchet risk levels up or down with regards to their discretionary asset bucket once their non-discretionary income needs are met.
Link to article - http://www.dfaus.com/pdf/IgnitesManaged ... EPRINT.pdf

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Re: It’s the income, stupid!

Post by Valuethinker » Mon Aug 26, 2013 3:42 pm

Bobk

Just wanted to say what a fantastic thread this is, full of rich history and insight.

Sincerely

Valuethinker

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Re: It’s the income, stupid!

Post by Beagler » Mon Aug 26, 2013 5:47 pm

bobcat2 wrote:
The DC industry has been shifting its efforts to a more outcome-oriented approach, in which workers are asked to create retirement plans with the assistance of online tools and other resources which help to determine the retirement nest egg they need.....
Link to article - http://www.dfaus.com/pdf/IgnitesManaged ... EPRINT.pdf

BobK
From the article: "In all fairness, there are a number of concerns regarding relatively low managed account adoption due to program fees and the level of customization that can be attained with limited participant inputs."
Hmmm, let's hear more about those fees.
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Re: It’s the income, stupid!

Post by Browser » Mon Aug 26, 2013 7:22 pm

I see from the article that DFA and Financial Engines are both offering their versions of synthetic DB managed investment strategies. What I don't see is what is inside the black box. I'm sorry but this troubles me because it reminds me too much of the current magic solution - Target Retirement Date funds. In my view, these things represent a spectacular triumph of marketing hype over substance. "Hey, give your money to us and we have the technical expertise to manage it in such a way that you'll glide to a smooth landing at retirement with just the right-sized portfolio, and live happily ever after!" Just how do I know what will happen when I turn my money over to DFA and FE to manage in such a way that I'll end up with just the right amount of real income flow to get me safely through the shoals of my retirement? Here comes the next "big thing" for us hapless retirement savers. I can see it now. The very idea that an individual can create anything remotely resembling a DB pension strains credulity. DB pensions worked because they represented pooled investment and mortality risk. You can only approximate that as an individual via public and private annuitization (social security and private insurance annuities). The way most people should plan to replace DB pensions is simply by investing as astutely as possible in a total return framework and then simply annuitizing one's nestegg at retirement (or at least enough to meet basic spending needs, in addition to their social security "annuity". OR, you can trust DFA and Financial Engines to do it for you and take their cut.
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Re: It’s the income, stupid!

Post by Oicuryy » Mon Aug 26, 2013 8:16 pm

Permit me to quote myself from an earlier thread.
Oicuryy wrote:Here is some more info on Dimensional Managed DC.

Brochure filed with SEC form ADV Part 2A
http://www.adviserinfo.sec.gov/Iapd/Con ... _ID=135819
Dimensional Managed DC is a managed account program which determines an asset allocation of a Participant’s specific retirement plan account, based upon input received from or on behalf of a Participant, with the goal of giving the Participant in the Plan some degree of estimated probability regarding the Participant’s ability at retirement to have sufficient assets in the Participant’s account to purchase a stream of inflation-protected retirement income for life.
Article by Wade Pfau
http://advisorperspectives.com/newslett ... ension.pdf
The income that the Dimensional Managed DC® targets depends on current wealth and projected future savings within the managed account, and on the prices of hypothetical inflation-adjusted deferred annuity units. Projections for annuity prices depend on interest rates, the inflation outlook and mortality statistics. Their prices can be quite volatile, and nothing is guaranteed with respect to what will actually be on the market when the desired retirement date arrives.
Ron
http://www.bogleheads.org/forum/viewtop ... 2#p1523872

You can use the Income Solutions link on Vanguard's site to get current prices for inflation-linked immediate annuities. But you will need a time machine to get future prices for the day you retire.

Merton hints that he has such a time machine. If your employer hires DFA to manage your DC plan he will use his time machine to get the price of an inflation-linked annuity on your retirement date. For no additional charge he will also find out how much you need to contribute and what to invest in so that you will accumulate enough to buy that annuity. DFA will even manage the investments for you. Such a deal.

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Money is fungible | Abbreviations and Acronyms

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Re: It’s the income, stupid!

Post by bobcat2 » Mon Aug 26, 2013 9:05 pm

What a very competent financial engineer like Merton can do is price a delayed annuity that starts paying out in your projected retirement year. Just because no one currently sells such a product doesn't mean the fair market price can't be discovered. For example, if no one sold standard life annuities we could still find fair market value of the product.

What I think they do is beginning about 20 years from your target retirement year is they match TIPS maturing in the participant's targeted retirement year to the current price of a delayed real annuity that begins payouts in the retirement year and update the process every year between now and retirement. This is to meet your retirement floor income goal. (Although I suspect the updating is done more frequently than annually.) Note that in the retirement year the delayed life annuity converges into being a standard real life annuity and the participant should have enough safe maturing TIPS to purchase the annuity. In this way the participant is kept on track to meeting his retirement floor real income goal very safely thru the last 20 years or so of his employment. This would be difficult (to say the least) for most individuals to pull off on their own in their 401ks, but fairly straightforward for the folks at DFA.

They have been doing this for the employees at a few large firms in Europe for several years now and it appears to be working well as far as I know.

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Re: It’s the income, stupid!

Post by 555 » Mon Aug 26, 2013 10:04 pm

Money is fungible. Income and assets are basically the same thing.

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Re: It’s the income, stupid!

Post by bertilak » Mon Aug 26, 2013 10:37 pm

555 wrote:Money is fungible. Income and assets are basically the same thing.
But an annuity gives you access to more assets -- assets from those who die before you do.

Also, an annuity is an insurance product. You trade cash (assets) for longevity insurance, just as homeowners trade cash for fire insurance. Sometimes it is better not to self-insure.

An individual can diversify across assets. An annuity company can diversify across investors just like a homeowners insurance company can diversify across homeowners. Not everyone's house will burn down and not every investor will live past the actuarial tables.
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Re: It’s the income, stupid!

Post by bobcat2 » Mon Aug 26, 2013 10:51 pm

Is there really much of a distinction between wealth (assets) and income?

555 replies.
Money is fungible. Income and assets are basically the same thing.
Bob Merton replies.
Confusing the need for a pot of money with the need for income can lead to very expensive mistakes.“You cannot say wealth goals are approximate to income goals. Imagine you are a 45 year old and you are going to retire at 65. In returns of income, what is the risk free asset? It is an asset, fully guaranteed, that 20 years from now starts paying you a level income for the rest of your life, corrected for inflation. I created one of those, called a real annuity, and from 2003 to 2012 I ploughed the monthly returns and we saw swings of -17 per cent and +15 per cent, on a risk-free asset. Yet when you measure this asset in terms of income, there’s no risk. So when someone says we can approximate an income goal with a wealth goal, as a practical matter, it doesn’t even come close,” says Merton.

“Or since 2008, suppose someone was lucky enough to have £1m to live off. If they had been very conservative and had bought bank CDs, six or seven years ago they would have told you their income was 4.5 or 5 per cent and they would have got £45,000 to £50,000 a year. Now you say to them, congratulations, I have preserved your £1m. But they say, yes and I am getting £4,000 to £5,000 a year. I can’t live on that,” he adds.
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Re: It’s the income, stupid!

Post by Browser » Tue Aug 27, 2013 9:10 am

BobK - If your description of using TIPS to fund a delayed annuity is correct, is there any reason that a somewhat sophisticated investor can't do the same thing? In other words, if the methodology used by DFA or FE is discoverable, can't it pretty much be used as a framework by an individual investor? However, a major impediment is that most individuals may not be able to utilize the appropriate investment vehicles inside their employer retirement accounts. If such income-oriented managed DB accounts were to become an option within retirement plans, then that would be a new opportunity. Within that context, I can see an argument for this approach. I agree that individuals are pretty much limited to doing their best to appropriately manage their own Total Return portfolio right up to their retirement date, and the outcome for the majority depends too much on dumb luck. It would be a great benefit to most people if they had a better option in their employer retirement plans.
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Re: It’s the income, stupid!

Post by umfundi » Tue Aug 27, 2013 9:18 am

garlandwhizzer wrote: If I fear that I'm becoming senile and incapable of handling my portfolio, ... then I would consider the annuity path, but fortunately I'm not there yet.

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How would you know?

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Re: It’s the income, stupid!

Post by Browser » Tue Aug 27, 2013 9:26 am

umfundi wrote:
garlandwhizzer wrote: If I fear that I'm becoming senile and incapable of handling my portfolio, ... then I would consider the annuity path, but fortunately I'm not there yet.

Garland Whizzer
How would you know?

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EXACTLY! :thumbsup
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Re: It’s the income, stupid!

Post by bertilak » Tue Aug 27, 2013 9:27 am

umfundi wrote:
garlandwhizzer wrote: If I fear that I'm becoming senile and incapable of handling my portfolio, ... then I would consider the annuity path, but fortunately I'm not there yet.

Garland Whizzer
How would you know?

Keith
Keith, that is funny :D but I have some experience in this area with my late father. Several years ago he realized he was no longer able to deal with his finances and turned things over to me. Later on, I'm pretty sure he was beyond making a decision like that.

So, I think one would know. Also, your joke is one my father would have liked.
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Re: It’s the income, stupid!

Post by umfundi » Tue Aug 27, 2013 9:48 am

bertilak wrote:
umfundi wrote:
garlandwhizzer wrote: If I fear that I'm becoming senile and incapable of handling my portfolio, ... then I would consider the annuity path, but fortunately I'm not there yet.

Garland Whizzer
How would you know?

Keith
Keith, that is funny :D but I have some experience in this area with my late father. Several years ago he realized he was no longer able to deal with his finances and turned things over to me. Later on, I'm pretty sure he was beyond making a decision like that.

So, I think one would know. Also, your joke is one my father would have liked.
Bertilak,

It's not a joke, though I do think the line is funny. It is something W. Edwards Deming would often say.

Almost by definition, a person suffering cognitive decline would not recognize it.

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Re: It’s the income, stupid!

Post by bobcat2 » Tue Aug 27, 2013 9:59 am

Browser wrote:BobK - If your description of using TIPS to fund a delayed annuity is correct, is there any reason that a somewhat sophisticated investor can't do the same thing? In other words, if the methodology used by DFA or FE is discoverable, can't it pretty much be used as a framework by an individual investor? However, a major impediment is that most individuals may not be able to utilize the appropriate investment vehicles inside their employer retirement accounts. If such income-oriented managed DB accounts were to become an option within retirement plans, then that would be a new opportunity. Within that context, I can see an argument for this approach. I agree that individuals are pretty much limited to doing their best to appropriately manage their own Total Return portfolio right up to their retirement date, and the outcome for the majority depends too much on dumb luck. It would be a great benefit to most people if they had a better option in their employer retirement plans.
I would guess that a financial engineer given the info DFA has made available can figure out in general what they are doing. She probably cannot know exactly how they do it, because I am pretty that the specific algorithms used are patented. However, to do this well as a DC plan participant would require financial knowledge well beyond that of a "somewhat sophisticated investor". This is difficult. I believe the individual should be in charge of the important decisions that they do understand - the aspirational and floor income goals, how much to save, when to retire, and how much risk to take above the floor safe level and then the details of making this process work should be left to professionals who have expertise in these matters. To me for individuals handling the details here makes no more sense than my instructing the heart surgeon on exactly how many & what type sutures should be applied to my chest at the end of the surgery. :)

What the somewhat sophisticated investor participant should do is remain engaged in the process. This means being actively involved in setting the goals, keeping informed on progress by carefully reviewing the monthly or quarterly status reports, and asking questions if something is bothering him or her or something is unclear, and making further decisions fully engaged with the professionals, either if the plan is falling short or if things have gone particularly well and the income goals could be raised.

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Re: It’s the income, stupid!

Post by umfundi » Tue Aug 27, 2013 10:06 am

garlandwhizzer wrote:bobcat2 wrote
do you find increasing annuitized income flows by delaying SS benefits and DB pension benefits appealing?
I did not delay taking SS benefits because to delay them meant I would have to sell portions of my portfolio to provide for living expenses in the meantime.

Garland Whizzer
I seriously suggest you reevaluate this choice. In the present environment, for a single person it is an incredibly good deal. For a couple who have separate SS entitlements it is an outrageously good deal.

Of course, if you are not age 62 - 70, the choice is not applicable to you.

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Re: It’s the income, stupid!

Post by Browser » Tue Aug 27, 2013 10:08 am

BobK - there is no doubt in my mind that current DC retirement plans are in dire need of improvement. They do not serve most individuals well. They typically have too few investment choices, the expenses are too high, they require individuals to manage their own total return investment portfolio which exceeds the level of knowledge and ability that most people have, and their nestegg outcome ends up being too much of a crapshoot. Many plans now offer a target date fund default option with the false impression that this sort of investment vehicle is going to produce a DB-like outcome and relieve them of the responsibility of managing their own retirement portfolio. Phony and misleading, IMO. That wheel needs to be re-invented and perhaps the managed DB- type plan is one way to do it.
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Re: It’s the income, stupid!

Post by bertilak » Tue Aug 27, 2013 11:13 am

umfundi wrote:Almost by definition, a person suffering cognitive decline would not recognize it.
Yes, I get it.

My point was that, although clever word-play, it is not necessarily true.
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Re: It’s the income, stupid!

Post by Browser » Tue Aug 27, 2013 11:23 am

bertilak wrote:
umfundi wrote:Almost by definition, a person suffering cognitive decline would not recognize it.
Yes, I get it.

My point was that, although clever word-play, it is not necessarily true.
However, I have observed it to be true at least for a couple folks I know. Incompetence + unawareness is a bad combination and I fear it's not uncommon. And even if you do have enough marbles left to know you're slipping, what do you do if you have no-one trustworthy to turn things over to?
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Re: It’s the income, stupid!

Post by The Wizard » Tue Aug 27, 2013 11:23 am

bertilak wrote:
umfundi wrote:Almost by definition, a person suffering cognitive decline would not recognize it.
Yes, I get it.

My point was that, although clever word-play, it is not necessarily true.
It probably depends on the nature of the cognitive decline along with the stubbornness factor of the decliner.
IOW, individual variation...
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Re: It’s the income, stupid!

Post by garlandwhizzer » Tue Aug 27, 2013 11:54 am

I wrote
I did not delay taking SS benefits because to delay them meant I would have to sell portions of my portfolio to provide for living expenses in the meantime.

Garland Whizzer
umifund wrote
I seriously suggest you reevaluate this choice. In the present environment, for a single person it is an incredibly good deal. For a couple who have separate SS entitlements it is an outrageously good deal.

Of course, if you are not age 62 - 70, the choice is not applicable to you.
I'm 66 now and I made that choice 4 years ago and started getting benefits immediately in 2009 when the market was crashing. That SS income stream in 2009 helped me avoid selling any equities at all during the worst of the crash and in fact helped to allow me to increase my risk profile when risk asset values got so compelling that I couldn't resist. In fact I have made a lot more money that way (>100%) than by deferring SS entitlements. So reevaluation of my choice which Keith recommends clearly reinforces my decision.

Garland Whizzer

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Re: It’s the income, stupid!

Post by Browser » Tue Aug 27, 2013 1:32 pm

I'm 66 now and I made that choice 4 years ago and started getting benefits immediately in 2009 when the market was crashing. That SS income stream in 2009 helped me avoid selling any equities at all during the worst of the crash and in fact helped to allow me to increase my risk profile when risk asset values got so compelling that I couldn't resist. In fact I have made a lot more money that way (>100%) than by deferring SS entitlements. So reevaluation of my choice which Keith recommends clearly reinforces my decision.
Sometimes we get lucky. But are you really sure you made more money? The PV of increasing one's lifetime SS payments by 20% or more by delaying is a substantial sum for many people. And it is guaranteed and inflation-adjusted money. Perhaps you should revisit your spreadsheet before drawing a certain conclusion.
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Re: It’s the income, stupid!

Post by The Wizard » Tue Aug 27, 2013 1:37 pm

Browser wrote:
I'm 66 now and I made that choice 4 years ago and started getting benefits immediately in 2009 when the market was crashing. That SS income stream in 2009 helped me avoid selling any equities at all during the worst of the crash and in fact helped to allow me to increase my risk profile when risk asset values got so compelling that I couldn't resist. In fact I have made a lot more money that way (>100%) than by deferring SS entitlements. So reevaluation of my choice which Keith recommends clearly reinforces my decision.
Sometimes we get lucky. But are you really sure you made more money? The PV of increasing one's lifetime SS payments by 20% or more by delaying is a substantial sum for many people. And it is guaranteed and inflation-adjusted money. Perhaps you should revisit your spreadsheet before drawing a certain conclusion.
No he shouldn't. It's done for him, either way.
Other people should generally consider waiting till age 70, assuming good health, yes...
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Re: It’s the income, stupid!

Post by Browser » Tue Aug 27, 2013 1:42 pm

No he shouldn't. It's done for him, either way.
Other people should generally consider waiting till age 70, assuming good health, yes...
Plus, I overlooked that he started benefits at age 62, thereby taking reduced benefits for life. When you add that into the mix, delaying would have really made a difference in lifetime inflation-adjusted income from social security. Frankly, I woulda found a way to survive the market crash by getting a part-time job or something rather than giving that up.
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Re: It’s the income, stupid!

Post by Ketawa » Tue Aug 27, 2013 2:00 pm

I think delaying SS is oversold sometimes on the forum. Depending on the level of safe real interest rates, the breakeven point is in an investor's early 80s. Delaying is not always a slam dunk.

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Re: It’s the income, stupid!

Post by sls239 » Tue Aug 27, 2013 2:04 pm

Your standard of living is mainly determined by your income.
Actually, I don't think it is. From what I understand, the best predictor of your future standard of living is not your income, but your assets.

That may very well be just as applicable to a retiree as a working person.

Just think, someone who already has things like a comfortable place to live is going to be able to weather a disruption in income fairly well because they won't need to spend as much. Someone who is always scrambling to get their needs met is going to live a less comfortable life, even if their income is steady.

That is why many elderly people can get by on extremely little income - they have accumulated most of what they need for a comfortable existence during their working years.

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Re: It’s the income, stupid!

Post by The Wizard » Tue Aug 27, 2013 2:08 pm

Ketawa wrote:I think delaying SS is oversold sometimes on the forum. Depending on the level of safe real interest rates, the breakeven point is in an investor's early 80s. Delaying is not always a slam dunk.
True and recall that it's supposed to be actuarially based such that the total payout is the same, on average, no matter when you claim.
The advantage is for those of us planning to live into our 90s so that we lock in greater inflation protection...
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Re: It’s the income, stupid!

Post by The Wizard » Tue Aug 27, 2013 2:16 pm

sls239 wrote: That is why many elderly people can get by on extremely little income - they have accumulated most of what they need for a comfortable existence during their working years.
Well, perhaps.
But some of them are still depleting their after-tax assets to supplement their "income" for better or worse.
We need to look at cash flow, whether it's taxable income of some sort or whether it's spending down a half-mil savings account...
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Re: It’s the income, stupid!

Post by umfundi » Tue Aug 27, 2013 2:38 pm

Browser wrote:
No he shouldn't. It's done for him, either way.
Other people should generally consider waiting till age 70, assuming good health, yes...
Plus, I overlooked that he started benefits at age 62, thereby taking reduced benefits for life. When you add that into the mix, delaying would have really made a difference in lifetime inflation-adjusted income from social security. Frankly, I woulda found a way to survive the market crash by getting a part-time job or something rather than giving that up.
This is getting Off Topic for this thread, but I don't think he is done.

I think he can suspend SS payments and get the benefit for the remaining years until he is 70. I think there is (was?) even an option to reset the clock and repay benefits already received.

Remember that old term, stagflation? That's the risk here. I agree that Garland has maybe been lucky to choose to not defer SS in favor of market returns in the very recent past.

Personally, I have 8%, indexed for inflation, guaranteed for life. And, in the meantime we'll get 50% of my deferred payment because of my wife's SS entitlement.

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Re: It’s the income, stupid!

Post by LadyGeek » Tue Aug 27, 2013 3:20 pm

Try to stay on-topic.
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Re: It’s the income, stupid!

Post by bertilak » Tue Aug 27, 2013 6:07 pm

Another thread pointed me to Bogle's Twelve Pillars of Wisdom where I noticed this:
Pillar 9. You May Have a Stable Principal Value or a Stable Income Stream, But You May Not Have Both.
Seemed appropriate here!
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Re: It’s the income, stupid!

Post by bobcat2 » Wed Aug 28, 2013 8:39 am

Earlier in this thread the history of life annuities, particularly over the last 300 years in England, was discussed. Here Moshe Milevsky weighs in on the topic.
In London, England, almost two centuries ago a very clever chap by the name of John Finlaison wrote an urgent letter to the chancellor of the British Exchequer, imploring the government to change the way it priced and sold life annuities to the public.

You might not have known this, but in the late 17th and 18th centuries, many countries financed their national debt with the sale of life annuities and tontines, not the coupon-bearing bonds they use nowadays. So, for example, in exchange for a £100 initial investment (lent) to Her Majesty’s government, the annuitant would receive an annual income of £10 for the rest of their life. There was an active market in what might be called longevity-contingent claims.

Now, John Finlaison was no commoner exercising his democratic right to complain about prices and yields. Rather, his official position was “actuary of the national debt” from the years 1822 to 1851. Arguably he was the world’s first full-time actuary, who then went on to launch the British Institute of Actuaries, where his son and then grandson served in the same roles. There are entire buildings named after him in downtown London. More interestingly and relevant, in contrast to most people who might complain that the prices of goods and services purchased by retirees were too high, John Finlaison’s concern was that prices were in fact too low.

In handwritten letters to members of Parliament, he presented very convincing data that British retirees and pensioners were living much longer than what was assumed in the government’s pricing schedule. This then meant that payments were made for longer, costing the government more than it had budgeted for. John Finlaison expressed great concern that pricing wasn’t sustainable and urged officials to lower the payouts and raise the fees. At the very least, he argued, males and females should be paying different prices for annuities. Prior to his work in 1829, nobody thought to differentiate pricing by gender. ... To boil this all down to its financial essence, according to Mr. Finlaison’s calculations on the eve of the Victorian Era, Her Majesty’s government was selling annuities worth £175 in present values term, for a mere £100 up-front cost, which was a jolly good deal.
Link - http://www.thinkadvisor.com/2013/08/26/ ... en-and-now

Milevsky's article is in the context of actuaries mispricing insurance products both then and now. Two hundred years ago it was life annuities. Today it is LTCi and variable annuities. Read the whole article. It is good stuff. :) Interesting that variable annuities are mispriced today primarily because the owners of the annuities are acting more rational, not less rational, than the actuarial models had assumed they would.

BobK
In finance risk is defined as uncertainty that is consequential (nontrivial). | The two main methods of dealing with financial risk are the matching of assets to goals & diversifying.

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