It’s the income, stupid!

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bobcat2
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Re: It’s the income, stupid!

Post by bobcat2 » Wed Aug 28, 2013 9:06 am

Noted financial planner and all around nice person Paula Hogan weighs in on, it's the income - not the portfolio issue.
At its heart, life-cycle investing is the theory of how an individual should go about creating life-time financial security. “You’re matching a coherent economic theory with what the client wants to do. Life-cycle is about optimizing everything, [especially] your future self,” Hogan stresses.

When used for comprehensive financial planning for individuals, life-cycle also applies principles from the pension world. In this goals-based investing philosophy, goals are funded in priority order. “No matter who you are, you have a limited amount of money. So you want to make sure that the goals you care most about are funded before you run out of money,” Hogan notes.

The cornerstones of life cycle are: (1) human capital—what people do in the world with their skills and talents, and how they are remunerated and (2) that most people care more about lifetime standard of living than about portfolio wealth. These priorities change the focus of attention from the portfolio to the client and in so doing, from return management to risk management.
Link - http://www.thinkadvisor.com/2013/04/29/ ... ing?page=1

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 » Wed Aug 28, 2013 6:03 pm

My circumstances were different from most investors back in 2009 when I chose to take SS early. My decision worked out well for me, but I think it's sound advice to delay taking SS benefits for most people. Bearing in mind that if you die before your delayed benefits start or for a few years after that, you will lose money. So delay might not be wise for those with serious health problems. Also you should be certain that your financial needs in near and intermediate term are well taken care of in the absence of immediate SS benefits.

In early 2009, there was plenty of uncertainty in my mind given the extent of the market crash and the fact that other than my portfolio, I had no source of income whatsoever. So getting a guaranteed check every month looked good at the time as opposed to selling risk assets at fire sale prices or tapping into my limited supply of high quality bond funds which was the only anchor I had during that hurricane. There is no doubt that luck was on my side in that choice and I have not forgotten that Lady Luck is fickle.

Garland Whizzer

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Re: It’s the income, stupid!

Post by grayfox » Mon Sep 02, 2013 2:26 am

bobcat2 wrote:
John Greenwood reports from across the pond.

Link to full article. http://www.moneymarketing.co.uk/channel ... 78.article

BobK
There are two concepts, levels and flows. Nearly all investors focus on the level, i.e. their net worth or portfolio balance.

I figured out a while ago that the flow is what is important. To live, you need to provide a flow: say X dollars per month. Almost all expenses are paid periodically: monthly rent, monthly utilities, monthly food bill, monthly cable bill, annual property tax, etc. Almost no living expense is paid as a one-time lump sum. So, in simple terms, you need a monthly income to live.

The net worth can fluctuate wildly down 50%, up 100% but as long as you can maintain a minimum required flow, the fluctuations in level are irrelevant.

This is significant for investors because it means that pretty much all the investment analysis is... I won't say it's wrong, but it is irrelevant, because it is looking at the wrong thing, the level, rather than than the flow.

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Re: It’s the income, stupid!

Post by bobcat2 » Mon Sep 02, 2013 2:00 pm

grayfox wrote:
bobcat2 wrote:There are two concepts, levels and flows. Nearly all investors focus on the level, i.e. their net worth or portfolio balance.

I figured out a while ago that the flow is what is important. To live, you need to provide a flow: say X dollars per month. Almost all expenses are paid periodically: monthly rent, monthly utilities, monthly food bill, monthly cable bill, annual property tax, etc. Almost no living expense is paid as a one-time lump sum. So, in simple terms, you need a monthly income to live.

The net worth can fluctuate wildly down 50%, up 100% but as long as you can maintain a minimum required flow, the fluctuations in level are irrelevant.

This is significant for investors because it means that pretty much all the investment analysis is... I won't say it's wrong, but it is irrelevant, because it is looking at the wrong thing, the level, rather than than the flow.
:thumbsup :thumbsup

I think this is one of the little secrets of finance. There are three analytic pillars of finance: optimization over time; asset valuation; and risk management.
The optimization over time analytic pillar is suggestive that flows are generally more important than stocks (levels). That intuition is generally correct. If you are calculating the stock of something at different points of time to arrive at optimization of whatever - ask yourself - am I doing the right thing? You may be correct, but there is a good chance you should be looking at a flow instead. :happy

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 JamesG » Tue Sep 03, 2013 8:06 am

BobK, Thank you for this stimulating discussion.

In your earlier post in this discussion, you said "For most Americans SS will provide roughly 50% of their aspirational retirement income goal. Their personal investments need to supply the other half. The safe floor might be something like SS and 20% more with the remaining AA of retirement assets getting them to 100% of the aspirational retirement income goal. Safe retirement income can come from TIP ladders and Ibonds as well as annuities. Not all retirement income needs to come from safe assets. But at a minimum your retirement income floor goal should be met with safe assets"

If i understand correctly, this puts the target income share from flooring assets at 70% of the aspirational target, with the remaining 30% coming from assets that (unlike the flooring assets) do not need to be indexed and safe in their entirety.

I wonder if you would mind expanding on this 70/30 ratio? Is there an economic theory or logic that should take the rational investor to a ratio like this, or is it ultimately a matter of individual preference?
He who has a garden and a library wants for nothing. Cicero.

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Re: It’s the income, stupid!

Post by Ketawa » Tue Sep 03, 2013 8:18 am

Note that if SS provides 50% of the aspirational income goal, then with safe assets providing an additional 20% of the aspirational goal and risky assets 30%, that would seem to be more like a traditional 60/40 portfolio.

I wonder what BobK's opinion is on rebalancing. If your aspirational goal isn't going to be met because the risk shows up in your risky assets, my guess is that you have to adjust expectations for an achievable aspirational income goal, rather than sell the safe assets to rebalance your overall portfolio.

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Re: It’s the income, stupid!

Post by bobcat2 » Tue Sep 03, 2013 9:13 am

JamesG wrote:BobK, ...In your earlier post in this discussion, you said "For most Americans SS will provide roughly 50% of their aspirational retirement income goal. Their personal investments need to supply the other half. The safe floor might be something like SS and 20% more with the remaining AA of retirement assets getting them to 100% of the aspirational retirement income goal. Safe retirement income can come from TIP ladders and Ibonds as well as annuities. Not all retirement income needs to come from safe assets. But at a minimum your retirement income floor goal should be met with safe assets"

If i understand correctly, this puts the target income share from flooring assets at 70% of the aspirational target, with the remaining 30% coming from assets that (unlike the flooring assets) do not need to be indexed and safe in their entirety.

I wonder if you would mind expanding on this 70/30 ratio? Is there an economic theory or logic that should take the rational investor to a ratio like this, or is it ultimately a matter of individual preference?
This is an empirical question - not a theory question. The gold standard for assessing how much income households need to keep their pre-retirement standard of living in retirement are life-cycle models based on dynamic programming. These complicated models have been developed by many economists studying household behavior. Perhaps the best known of these models are those developed by John Karl Scholz at Wisconsin and Larry Kotlikoff at Boston University. These models typically indicate that most households, to keep the same standard of living in retirement as before retirement, need between 55% and 70% of their pre-retirement income. A few households need even less than 55% and a few need more than 70% to keep the pre-retirement living standard. Whether a particular household will be on the low end or the high end depends on many factors, some specific to the household.

Another thing to keep in mind is that the percentage of income SS replaces depends on several factors. For example, lower income households have a larger percentage of their pre-retirement income replaced by SS than higher income households. Other things that affect how much income SS replaces include at what age you start SS, whether you are single or married, and, if you are married, whether you a two income or one income household.

So the roughly in my response was exactly that, roughly. Your mileage may vary. :)

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 bertilak » Tue Sep 03, 2013 9:18 am

Ketawa wrote:Note that if SS provides 50% of the aspirational income goal, then with safe assets providing an additional 20% of the aspirational goal and risky assets 30%, that would seem to be more like a traditional 60/40 portfolio.

I wonder what BobK's opinion is on rebalancing. If your aspirational goal isn't going to be met because the risk shows up in your risky assets, my guess is that you have to adjust expectations for an achievable aspirational income goal, rather than sell the safe assets to rebalance your overall portfolio.
My take is that there are two portfolios. One is the "safe" portfolio and the other is the "aspirational" portfolio. These are often called the Liability Matching Portfolio (LMP) and the Risky Portfolio (RP).

The two portfolios are managed independently and re-balancing is not done between them, EXCEPT if the RP is very successful one may decide to move some of it to the LMP (converting the moved money to a "safe" asset and/or income stream). This is not traditional re-balancing where one aims for a constant equity/fixed-income ratio. That concept applies to the RP independently from the LMP.
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Re: It’s the income, stupid!

Post by bobcat2 » Tue Sep 03, 2013 9:31 am

Ketawa wrote:I wonder what BobK's opinion is on rebalancing. If your aspirational goal isn't going to be met because the risk shows up in your risky assets, my guess is that you have to adjust expectations for an achievable aspirational income goal, rather than sell the safe assets to rebalance your overall portfolio.
If before retirement you are falling short of your aspirational retirement income goal there are only three ways to improve the chances of getting it: Save more now ( consume less prior to retirement), work longer (retire later), or take even more risk (and accept an even larger loss if the risk continues show up). You can, of course, do any combination of the above three actions to achieve the goal. The other alternative is to accept a lower goal.

In general it is not a good idea to sacrifice the safe floor assets in an effort to get to the aspirational income goal. That advice, however, will not stop many people from doing exactly that. :wink:

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 Beagler » Tue Sep 03, 2013 9:36 am

I always recall the following when contemplating using insurance products for part of the income floor:
wbern wrote:...
I take zero, absolutely zero, comfort that few insurance companies have failed thus far, just as the wise person took should have taken no comfort about the security of the United States on December 6 1941 or September 10, 2001.

I have always believed that there are risky assets, which have high returns, and riskless ones, which have low returns, and that investors should deploy both.

I just don't consider SPIA's, in the absence of a federal guarantee, to be in the latter category.

Best,

Bill
wbern wrote:While the state guarantees would be useful with an isolated failure, in a severe systemic crisis they wouldn't even be a speed bump.

Bill
http://www.bogleheads.org/forum/viewtopic.php?p=1088243
“The only place where success come before work is in the dictionary.” Abraham Lincoln. This post does not provide advice for specific individual situations and should not be construed as doing so.

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Re: It’s the income, stupid!

Post by bobcat2 » Tue Sep 03, 2013 9:45 am

I think of this as one portfolio with two goals and the goals have separate funding strategies. If the portion of the portfolio that consists of diversified risky and non-risky assets to get from safe to aspirational income does better than expected you move the excess to the safe assets and raise the safe income goal. If instead the portion of the portfolio that consists of diversified risky and non-risky assets to get from safe to aspirational income does worse than expected you keep the safe floor assets and, as in a previous response, "Save more now ( consume less prior to retirement), work longer (retire later), or take even more risk (and accept an even larger loss if the risk continues show up). You can, of course, do any combination of the above three actions to achieve the goal. The other alternative is to accept a lower goal."

Ideally you want the safe goal to be getting close to the aspirational goal as you near retirement - then you have the pleasant choice of either aiming for the aspirational income to consist entirely of relatively safe assets, or raising the aspirational goal while keeping the safe goal relatively high. :D

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 bobcat2 » Tue Sep 03, 2013 10:16 am

Beagler wrote:I always recall the following when contemplating using insurance products for part of the income floor:
wbern wrote:...
I take zero, absolutely zero, comfort that few insurance companies have failed thus far, just as the wise person took should have taken no comfort about the security of the United States on December 6 1941 or September 10, 2001.

I have always believed that there are risky assets, which have high returns, and riskless ones, which have low returns, and that investors should deploy both.

I just don't consider SPIA's, in the absence of a federal guarantee, to be in the latter category.

Best,

Bill
wbern wrote:While the state guarantees would be useful with an isolated failure, in a severe systemic crisis they wouldn't even be a speed bump.

Bill
http://www.bogleheads.org/forum/viewtopic.php?p=1088243
In August of last year Joe Tomlinson, an actuary and independent financial planner, discussed the safety of life annuities and in particular William Bernstein's concerns about them in an article in "Advisor Perspectives". Here are the concluding remarks in the article.
Why insurers have done better than banks

Since insurance companies and banks are both major financial institutions, one might ask why the insurance industry as a whole has been much better than banks at weathering financial storms. I discussed this issue with Gavin Magor, who heads up the insurance ratings division for Weiss Ratings, a company that rates both banks and insurance companies.

Magor points out that a key difference is that the insurance industry is better capitalized. This fact was particularly important during the financial crisis. Magor also credits insurance regulators who have overseen capital requirements for insurers.

Based on my own experience as a former insurance company actuary, I would say that the risk-based, balance sheet focus, and actuarial culture of insurance companies makes a difference. It helps that insurance company obligations (i.e., insurance contracts and annuities) tend to be longer-term than bank liabilities (i.e., deposits), and that, for insurers, much of their business is life- and health-contingent and actuarially quantifiable. Banks depend more on investments, the markets for which can be driven by emotion as well as fundamentals.

Insurers certainly do have their financial problems, the most recent arising from the effect of the financial crisis on living benefit guarantees in variable annuities. But, at least so far, the industry has been able to deal with its problems and move on, unlike banking, where problems too often become national emergencies.
Link to article - http://advisorperspectives.com/newslett ... uities.php

Link to Joe Tomlinson's web site - http://www.josephtomlinson.com/

Hat tip to Wade Pfau for pointing out this article. :D

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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 Browser » Tue Sep 03, 2013 10:31 am

In a systemic crisis severe enough to take out multiple major insurance companies and state guarantee agencies (and undoubtedly the banks too) what would be the low-risk asset? TIPS? FDIC guaranteed CDs? Maybe not.
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Re: It’s the income, stupid!

Post by Beagler » Tue Sep 03, 2013 12:23 pm

From one of the above-quoted links:
" In my review of the historical record, I could only find a few cases where annuity owners ended up with less than their insurer promised. One resulted from the 1983 bankruptcy of Baldwin-United, which involved a takeover by MetLife and a court-ordered reduction in benefits. Another involved the 1991 failure of Executive Life, which continued to pay annuity benefits in state-managed rehabilitation mode until this year, when balance sheet deterioration led to liquidation. Going forward, owners of Executive Life annuities that exceed state guaranty caps will suffer losses."

If the insurance safety net is so robust, why have there been *any* losses?

Also, note that State guarantees seem relatively meager.
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Re: It’s the income, stupid!

Post by bobcat2 » Thu Sep 05, 2013 11:05 pm

JamesG wrote:BobK, ...In your earlier post in this discussion, you said "For most Americans SS will provide roughly 50% of their aspirational retirement income goal. Their personal investments need to supply the other half. The safe floor might be something like SS and 20% more with the remaining AA of retirement assets getting them to 100% of the aspirational retirement income goal. Safe retirement income can come from TIP ladders and Ibonds as well as annuities. Not all retirement income needs to come from safe assets. But at a minimum your retirement income floor goal should be met with safe assets"

If i understand correctly, this puts the target income share from flooring assets at 70% of the aspirational target, with the remaining 30% coming from assets that (unlike the flooring assets) do not need to be indexed and safe in their entirety.

I wonder if you would mind expanding on this 70/30 ratio? Is there an economic theory or logic that should take the rational investor to a ratio like this, or is it ultimately a matter of individual preference?
I thought I answered the above question by JamesG earlier, but now realize I didn't answer the question asked. I instead answered the question of what the ratio of retirement aspirational income typically is to pre-retirement income, if the goal is to keep the same standard of living in retirement. :oops:

Here's my answer to the question actually asked. :happy
The flooring percentage is a matter of individual preference. It's the amount of retirement income you want to be very safe - meaning that it is invested safely before retirement, produces safe income in retirement, and is invested before retirement in such a way that the probability of meeting this goal is very high. But it is only a floor. You would really like to have more safe income than that with a high probability of success, but not as high a probability as the floor income probability. Ideally near retirement you would have enough safe assets to fund nearly all of your aspirational retirement income goal - plus a little bit of risky assets to get you to your goal and maybe a little bit beyond it.

Remember though that if you take considerable risk to get beyond the aspirational goal, then you lessen the chances of actually meeting or exceeding the goal. :( But you do raise the chances of simply exceeding the goal. :| This last part in counter intuitive to a lot of people. Nonetheless, it is true. You don't raise the probability of meeting or exceeding the goal by taking more risk when taking less risk should get you to the goal. Instead you now have a small probability of greatly exceeding the goal (where before that probability was nil), a greater chance of exceeding the goal by a modest amount, and less chance of meeting the goal. That last part is lowered enough so that overall the chances of meeting or exceeding the goal are less.

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 cbeck » Thu Sep 05, 2013 11:59 pm

Beagler wrote:I always recall the following when contemplating using insurance products for part of the income floor:
wbern wrote:...
I take zero, absolutely zero, comfort that few insurance companies have failed thus far, just as the wise person took should have taken no comfort about the security of the United States on December 6 1941 or September 10, 2001.

I have always believed that there are risky assets, which have high returns, and riskless ones, which have low returns, and that investors should deploy both.

I just don't consider SPIA's, in the absence of a federal guarantee, to be in the latter category.

Best,

Bill
wbern wrote:While the state guarantees would be useful with an isolated failure, in a severe systemic crisis they wouldn't even be a speed bump.

Bill
These arguments typify the opposition to buying annuities in that they are emotional in nature. While Bernstein may have substantive reasons for the opinions expressed, none are given here.

The real reason people don't like annuities is because they habitually overvalue control as a goal in itself. This is obvious from the frequent examples of new retirees who will typically choose a lump sum distribution in preference to an annuity, thereby increasing their control, even if the lump sum is not enough to buy an equivalent annuity, which is usually the case. This preference for control is a cognitive defect that is compounded by the well-known investor defect of over-confidence, which in the case of refusing an annuity in favor of a lump sum distribution amounts to the belief that the investor can outperform both the investment manager of the insurance company and the mortality credits from the pool of annuitants, less the company's profit margin. Some will succeed no doubt, but the odds are against you.

The other analytical defect is a failure to compare and judge risk levels in a realistic way. Although it is true that all financial instruments have some level of risk, including annuities, it is also true that both stocks and bonds have historical risk levels that are orders of magnitude greater than that of private annuities. If Bernstein is worried about singularities in financial history why a government guarantee be acceptable? Governments sometimes fail and renege on obligations also. Like most emotional arguments this one substitutes strong expression for careful reasoning.

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Re: It’s the income, stupid!

Post by umfundi » Fri Sep 06, 2013 12:09 am

wbern wrote:While the state guarantees would be useful with an isolated failure, in a severe systemic crisis they wouldn't even be a speed bump.

Bill
There are no state guarantees of annuities. The guarantees are provided by the insurance industry, subject to laws that vary (fairly widely) by state.

I believe the insurance industry very well understands the importance of consumer confidence. The value of my SPIA with Prudential (used to be a GM DB Pension) far exceeds the limits governed by state law. This is very low on my list of concerns.

Keith
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Re: It’s the income, stupid!

Post by JamesG » Sat Sep 07, 2013 1:18 am

BobK,

Thank you very much for the clarification.

This discussion reminds me of a story told by a colleague a few months ago.

Visiting the superannuation office on the Friday of their retirement, upon learning of their accumulated retirement balances, his parents left esctatic, having never felt richer. Returning to the same office the following Monday to discuss retirement incomes, they departed dejected, having never felt poorer.
He who has a garden and a library wants for nothing. Cicero.

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Re: It’s the income, stupid!

Post by LH » Sat Sep 07, 2013 9:39 am

bobcat2 wrote:
Clearly_Irrational wrote:The problem is that by focusing solely on income you can end up buying products that have a negative total return and in the long run that isn't sustainable.
Merton is talking about retirement income outcomes, which doesn't necessarily mean investing in income investments before retirement.

BobK
"Merton is talking about retirement income outcomes, which doesn't necessarily mean investing in income investments before retirement."

Ok, the risk of failure was brought up, and then the reply was as above. Can anyone decipher this for me?

"Retirement income outcomes", well, does he mean the income outcome of detroit pensioner? If not, what? This is a pretty typical answer when simple failure is brought up.

The whole thing swings on simply mentioning words like guaranteed, near certainty, risk less, then when failure is raised, waving of hands.

Neccessarily, any money given to a government or a private company is going to be invested in something, especially if one purports to be able to take away inflation risk (not to mention market risk).

Annuities are like the underwear gnomes from Southpark:


1)give your money to another entity, pay them fees

2)

3) Market risk, inflation risk, all risk disappear long term. "near certainty" "gauranteed" because why they promise it! because of step 2. Its quite the trick.

Mention anything about 2..... well.....

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Re: It’s the income, stupid!

Post by wander » Sat Sep 07, 2013 10:18 am

I know a family with both husband and wife are medicine doctors. And they are in debt trouble. I know some average income earners, but they are not in debt trap.

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Re: It’s the income, stupid!

Post by bertilak » Sat Sep 07, 2013 10:22 am

LH wrote: 1)give your money to another entity, pay them fees

2)

3) Market risk, inflation risk, all risk disappear long term. "near certainty" "gauranteed" because why they promise it! because of step 2. Its quite the trick.

Mention anything about 2..... well.....
When speaking of annuities, mortality credits have been mentioned MANY times in on these forums.

Also mentioned but perhaps not as directly: Having a large enough portfolio supplies it own "guarantee/insurance" against both longevity and inflation.

Annuity companies invest in bonds (that's one reason day-to-day SPIA quotes vary with prevailing interest rates) and bonds avoid the market risk you mention.

The annuity companies are under contract, which is a form of guarantee. The companies have been, overall, reassuringly successful in their ability to honor those contracts. The contracts are backed by the industry itself with government oversight.

Everyone already concedes that there are no absolute guarantees in life. In context, "guaranteed" and "risk free" are a matter of degree. I don't think any appreciable number of people have said that "all risk disappear" (completely).

I think all the above says a lot about the "trick" of number 2, and all of it has been discussed extensively.

One may disagree about the degree to which those guarantees are reliable, but it is not fair to say it is a magic step which everyone avoids discussing. Arthur C. Clarke said: "Any sufficiently advanced technology is indistinguishable from magic." Perhaps the technology of annuities is "sufficiently advanced."
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Re: It’s the income, stupid!

Post by umfundi » Sat Sep 07, 2013 10:40 am

bertilak wrote:The contracts are backed by the industry itself with government oversight.

Everyone already concedes that there are no absolute guarantees in life. In context, "guaranteed" and "risk free" are a matter of degree. I don't think any appreciable number of people have said that "all risk disappear" (completely).

Further, in my opinion, companies like Prudential are "too big to fail". Also, the failure mode is most likely to be an inability to pay 100% of the contract. I find it hard to imagine that anyone would lose all of their benefit.

Keith
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Re: It’s the income, stupid!

Post by AlohaBill » Sat Sep 07, 2013 11:50 am

When considering annuities, the insurance industry is making a lot of money. However, not that many people buy annuities, I hear. The answer is to save enough, so you don't have to be fleeced.

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Re: It’s the income, stupid!

Post by bertilak » Sat Sep 07, 2013 12:28 pm

umfundi wrote:
bertilak wrote:The contracts are backed by the industry itself with government oversight.

Everyone already concedes that there are no absolute guarantees in life. In context, "guaranteed" and "risk free" are a matter of degree. I don't think any appreciable number of people have said that "all risk disappear" (completely).

Further, in my opinion, companies like Prudential are "too big to fail". Also, the failure mode is most likely to be an inability to pay 100% of the contract. I find it hard to imagine that anyone would lose all of their benefit.

Keith

I read somewhere that even when companies fail (hardly ever) the amount that customers recovered was something like 96 or 97 percent. MOST of the reason it was not 100% was that some customers bought more than the maximum amount covered by the industry guarantee. (This is only a vague memory.)
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Re: It’s the income, stupid!

Post by docneil88 » Sun Sep 08, 2013 12:23 am

bobcat2 wrote:
Investing is boring wrote:...income from dividends, interest, and sale of assets are all the same (sans tax treatment) - and therefore it is total risk adjusted return that matters, not income.
What matters is the risk to your standard of living, not the risk to your portfolio. Your standard of living is mainly determined by your income. The problem with using assets as a proxy for income is that a given level of assets will produce wildly different income flows depending on the level of real interest rates and other factors.
A lot depends on how income is defined and how long an income stream is sustainable. Annuities look attractive because the payments received each year often total much more than the expected yearly total return of most non-annuity investments, especially for those with a short actuarial life expectancy. But that is so because the annuity payments will contractually cease on a particular date, e.g. the date of death, and the balance will then be zero. Not so for the income from and balance for a portfolio of stocks, bonds, and/or real estate. Upon one's death the balance will be transferred to heirs or non-profits. It would give an unfair advantage to annuities to focus on the dollar difference between the value of annuity payment(s) received in a year vs. the expected yearly total return of a non-annuity investment.

If one buys an annuity with after-tax dollars, only the interest portion of the payment is considered income for tax purposes, and the rest is considered a return of principal. But I think some mistakenly think of these annuity payments as being all income; I don't know whether Bobcat2 is making that mistake.

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Re: It’s the income, stupid!

Post by bobcat2 » Sun Sep 08, 2013 9:33 am

docneil88 wrote:
bobcat2 wrote:What matters is the risk to your standard of living, not the risk to your portfolio. Your standard of living is mainly determined by your income. The problem with using assets as a proxy for income is that a given level of assets will produce wildly different income flows depending on the level of real interest rates and other factors.
A lot depends on how income is defined and how long an income stream is sustainable. Annuities look attractive because the payments received each year often total much more than the expected yearly total return of most non-annuity investments, especially for those with a short actuarial life expectancy. But that is so because the annuity payments will contractually cease on a particular date, e.g. the date of death, and the balance will then be zero. Not so for the income from and balance for a portfolio of stocks, bonds, and/or real estate. Upon one's death the balance will be transferred to heirs or non-profits. It would give an unfair advantage to annuities to focus on the dollar difference between the value of annuity payment(s) received in a year vs. the expected yearly total return of a non-annuity investment.

If one buys an annuity with after-tax dollars, only the interest portion of the payment is considered income for tax purposes, and the rest is considered a return of principal. But I think some mistakenly think of these annuity payments as being all income; I don't know whether Bobcat2 is making that mistake.
When you are planning for retirement it is income you receive during your retirement that counts, however it is received. You are making the common mistake of conflating retirement planning with estate planning. One needs to set goals for each and if those goals conflict, decide which goal gets precedence.

BobK
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Re: It’s the income, stupid!

Post by umfundi » Sun Sep 08, 2013 11:24 am

docneil88 wrote:
bobcat2 wrote:
Investing is boring wrote:...income from dividends, interest, and sale of assets are all the same (sans tax treatment) - and therefore it is total risk adjusted return that matters, not income.
What matters is the risk to your standard of living, not the risk to your portfolio. Your standard of living is mainly determined by your income. The problem with using assets as a proxy for income is that a given level of assets will produce wildly different income flows depending on the level of real interest rates and other factors.
A lot depends on how income is defined and how long an income stream is sustainable. Annuities look attractive because the payments received each year often total much more than the expected yearly total return of most non-annuity investments, especially for those with a short actuarial life expectancy. But that is so because the annuity payments will contractually cease on a particular date, e.g. the date of death, and the balance will then be zero. Not so for the income from and balance for a portfolio of stocks, bonds, and/or real estate. Upon one's death the balance will be transferred to heirs or non-profits. It would give an unfair advantage to annuities to focus on the dollar difference between the value of annuity payment(s) received in a year vs. the expected yearly total return of a non-annuity investment.

If one buys an annuity with after-tax dollars, only the interest portion of the payment is considered income for tax purposes, and the rest is considered a return of principal. But I think some mistakenly think of these annuity payments as being all income; I don't know whether Bobcat2 is making that mistake.
With an SPIA or a pension you have a guaranteed income for life. It includes mortality credits, or longevity insurance. The payment is "high" because some of the cohort will die earlier than others.

It is difficult (impossible?) to compare an annuity with a stream of income derived from investments in stocks and bonds. In my opinion, they serve different purposes.

Keith
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Re: It’s the income, stupid!

Post by docneil88 » Sun Sep 08, 2013 11:45 am

Hi BobK, In my last example, do you consider the return of principal portion of an annuity payment to be income? If so, then I think you're stretching the concept of income a bit too far. If one buys a life annuity late in life, that return of principal portion can be the lion's share of the payment. Best, Neil

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Re: It’s the income, stupid!

Post by bobcat2 » Sun Sep 08, 2013 12:06 pm

Economic definition of income

The amount you could spend during a period of time, e.g. a year, while maintaining the wealth you started with.

Income = Net worth[t] - Net worth[t-1] or
Net worth[t-1] = Income + Net worth[t]

In other words income is the change in your net worth from one period in time to another. Typically this is in real terms.

So how is income from an annuity stretching the definition of income?

Edit - my high school algebra has deserted me. :oops:
Net worth[t] = Income + Net worth[t-1]

Thanks to bertilak and Ladygeek for pointing out this thinko. :D

BobK
Last edited by bobcat2 on Sun Sep 08, 2013 12:48 pm, edited 1 time in total.
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Re: It’s the income, stupid!

Post by bertilak » Sun Sep 08, 2013 12:23 pm

bobcat2 wrote:Economic definition of income

The amount you could spend during a period of time, e.g. a year, while maintaining the wealth you started with.

Income = Net worth[t] - Net worth[t-1] or
Net worth[t-1] = Income + Net worth[t]

In other words income is the change in your net worth from one period in time to another. Typically this is in real terms.

So how is income from an annuity stretching the definition of income?

BobK
I don't follow. If part of the definition of income is "maintaining the wealth you started with" then Net worth[t] equals Net worth[t-1], right? so, as far as income is concerned, there is no "change in your net worth from one period in time to another."

Am I missing something? Is there a distinction between wealth and net worth?

I agree with the definition. I just don't follow the rest ("in other words...") UNLESS you are not spending the income. If that's the meaning then it seems like the formula you give is backwards: Net worth[t] should be greater than Net worth[t-1], as follows.

Net worth[t] = Net Worth[t-1] + (Unspent) Income

BTW, I agree income is income -- from an annuity (SS, pension, SPIA) or from dividends.
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Re: It’s the income, stupid!

Post by umfundi » Sun Sep 08, 2013 12:30 pm

bobcat2 wrote:Economic definition of income

The amount you could spend during a period of time, e.g. a year, while maintaining the wealth you started with.

Income = Net worth[t] - Net worth[t-1] or
Net worth[t-1] = Income + Net worth[t]

In other words income is the change in your net worth from one period in time to another. Typically this is in real terms.

So how is income from an annuity stretching the definition of income?

BobK
Bob,

I know what you mean, but the above is not correct.

For example, my net worth is $1 Million, The market tanks 25%, my net worth is now $0.75 Million. By no stretch of the imagination did I get $0.25 Million in "income".

How about: Income is the sustainable cash flow you have available for ongoing living expenses?

Keith
Last edited by umfundi on Sun Sep 08, 2013 2:11 pm, edited 1 time in total.
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Re: It’s the income, stupid!

Post by docneil88 » Sun Sep 08, 2013 12:45 pm

bobcat2 wrote:Economic definition of income

The amount you could spend during a period of time, e.g. a year, while maintaining the wealth you started with.

Income = Net worth[t] - Net worth[t-1] or
Net worth[t-1] = Income + Net worth[t]

In other words income is the change in your net worth from one period in time to another. Typically this is in real terms.

So how is income from an annuity stretching the definition of income?
What I am asserting is that the interest portion of an annuity payout is income, but the return-of-principal portion is not. If you are spending the return of principal portion of an annuity, then, all else being equal, you are not maintaining the wealth/net worth you started with prior to the annuity payment. Suppose one is 85 and buys a life annuity with after-tax dollars. The return-of-principal percentage of each year's total annuity payments will be large in this case. Thus, the present value of the annuity drops significantly with each year's payments. So, assuming those payments are spent, one's net worth at age 86 will be lower, all else being equal. The present value of a life annuity depends both on interest rates and actuarial life expectancy, and actuarial life expectancy decreases each year. Best, Neil

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Re: It’s the income, stupid!

Post by bobcat2 » Sun Sep 08, 2013 1:01 pm

By your reasoning, once we consider human capital, much of your salary is not income, because at the end of the year your human capital has declined as you are one year closer to retirement. Thus that part of your salary that is the decline in human capital is not income.

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Re: It’s the income, stupid!

Post by bobcat2 » Sun Sep 08, 2013 1:11 pm

Here's a clear way of saying the economic definition of income. This definition is from the Business Dictionary.
Amount a person or firm can afford to spend during a given period, and be as well-off at the end of it as at its beginning.
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Re: It’s the income, stupid!

Post by docneil88 » Sun Sep 08, 2013 1:34 pm

bobcat2 wrote:By your reasoning, once we consider human capital, much of your salary is not income, because at the end of the year your human capital has declined as you are one year closer to retirement. Thus that part of your salary that is the decline in human capital is not income.
Interesting reply BobK. My reasoning was partly based on the definition you yourself provided. Plugging the present value of an life annuity into one's net worth calculation is not controversial. Plugging the present value of one's human capital into one's net worth calculation is controversial. Determining the present value of someone's human capital is much more difficult than determining the present value of someone's life annuity based partly on given and widely available actuarial tables. I think there are more variables and more variable variables with the human capital calculation than with the life annuity present value calculation. Best, Neil

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Re: It’s the income, stupid!

Post by bobcat2 » Sun Sep 08, 2013 1:54 pm

Few people have the intention of selling their life annuity and just try to sell a life annuity at its present value. Why do you think JG Wentworth always has that big smile? :D

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Re: It’s the income, stupid!

Post by Browser » Sun Sep 08, 2013 5:29 pm

Recent column by Scott Burns uses some interesting terminology. He refers to social security and pensions as "virtual wealth" not tangible wealth. Most people in retirement have most of their wealth as virtual wealth and not actual wealth. In other words, the present value of their lifetime benefit payments exceeds their savings and investments. Human capital would fit in here also -- representing virtual, not tangible wealth. Given a choice, most people would probably prefer tangible wealth to virtual wealth. Virtual wealth is difficult to estimate and it is uncertain how much will actually become converted to actual wealth, since the individual has no direct control over it. It's not actually owned by him/her. Some virtual wealth comes our way because that's the way it is, there's not much choice in the matter -- social security and defined benefit employment pensions for example. When it comes to buying SPIAs, it may be difficult for many to convert actual wealth into virtual wealth, even though it might seem that is a way to effectively increase one's overall wealth.
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Re: It’s the income, stupid!

Post by bertilak » Sun Sep 08, 2013 6:23 pm

Browser wrote:Human capital would fit in here also -- representing virtual, not tangible wealth. ... the individual has no direct control over it. It's not actually owned by him/her. Some virtual wealth comes our way because that's the way it is, there's not much choice in the matter -- social security and defined benefit employment pensions for example. When it comes to buying SPIAs, it may be difficult for many to convert actual wealth into virtual wealth, even though it might seem that is a way to effectively increase one's overall wealth.
Although one may not have direct control over SS and pension, one certainly has direct control over one's human capital: work hard, get an education, etc.. That will also indirectly contribute to SS and pension.

The parable of The Richest Man in Babylon is all about converting human capital to "actual" wealth (live below your means, save, invest wisely, etc.).

I put quotes around "actual" because human capital is also actual, just not as precisely valued.
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Re: It’s the income, stupid!

Post by Dale_G » Sun Sep 08, 2013 6:53 pm

I haven't read all of the post in this thread, but it sound really good - almost too good to be true.

What I haven't seen discussed is the cost of the program. It must have some cost. How does the cost affect the eventual beneficiaries?

No doubt it is a complex matter, so I'll start with something simple.

I'll start with 1,000,000 25 year olds who will participate in the plan for 42 years until they are 67 years old. In the real world, some of these will die, but I assume their accrued benefits will pass to their trophy wives and super-achieving but hungry progeny. To simplify, I'll assume the entire cohort survives to 67 years old. After that they can die according to the actuarial tables.

If the expense of the program is 0.25%/yr the cohort ends up with 90% of the assets it would have had without the program.

If the expense of the program is 0.5%/yr the cohort ends up with 81% of the assets it would have had without the program.

If the expense of the program is 0.75%/yr the cohort ends up with 73% of the assets it would have had without the program.

I know the thread title is, "It's the income, stupid", but I know of no way the future income of the cohort cannot be based on anything other than the assets of the cohort.

Some will win, some will lose, but the cohort will be poorer to the extent that fees drain away the resources.

I'll rely on the pile of money to generate my own income.

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Re: It’s the income, stupid!

Post by Clearly_Irrational » Sun Sep 08, 2013 8:35 pm

bertilak wrote:The parable of The Richest Man in Babylon is all about converting human capital to "actual" wealth (live below your means, save, invest wisely, etc.).
Just read that book on Friday, it was a pretty decent read.

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