Using Funded Ratio to drive retirement investment plan - Part 1 of Funded Ratio series

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Using Funded Ratio to drive retirement investment plan - Part 1 of Funded Ratio series

Post by bobcat2 » Sun May 28, 2017 9:52 am

That TIAA-CREF example reinforces the need for goal- or liability-driven investing. …Regarding the example, it is important to decide whether the pot is a savings account or a retirement account. It is hard to have two different goals because they conflict. One calls for having principal stability, which is a Treasury bill. The other calls for standard-of-living and income stability, which is a long-term bond. You cannot have both.

If you get clients to focus on rates of return and asset mixes, it is likely to be the wrong approach. You should get people to determine their goals instead of asking them how much they want to put in real estate.

Everyone in this room knows what people want for retirement. It is an income. Social security gives an income. DB plans give an income. In DC plans, for some reason, we do not show people the funded ratio. We are showing them the wrong thing, and then we are saying they are making the wrong decisions. We are telling people that risk is the value of their fund, when risk is really how much income they can sustain for retirement.
Jeremy Siegel
The funded ratio is a better indication of success than the account balance. In contrast to generic asset allocation strategies, use a dynamic approach with customization according to age, income, gender, and the funded ratio. The focus should be on improving the funded ratio while managing income volatility.
Robert Merton

EDIT: Here are links to the 2nd & 3rd posts on the funded ratio.
Part 2 - Using the Funded Ratio to determine your asset allocation
Link - viewtopic.php?f=10&t=220261&p=3392084&h ... k#p3392084

Part 3 - The Funded Ratio over the Life-Cycle
Link - viewtopic.php?f=10&t=220489&newpost=3396421



The funded ratio (FR) is a metric that can be used to monitor your retirement investment plan. It is simply the ratio of assets to liabilities, where the assets are the size of your portfolio and the liabilities are the present value of your targeted retirement income stream. The easiest way to estimate the liabilities in the denominator is to price a deferred real life annuity that has payouts that match your targeted retirement income that is derived from your portfolio and begins payments in your expected retirement year. For example, you want to withdrawal $30,000/year ($2,500/month) from your portfolio. Before retirement price a deferred real life annuity that pays out $2,500/month beginning on your expected retirement date. In retirement price an immediate real life annuity for the same $2,500/month payout.*

One additional step needs to be taken before retirement. Deferred real life annuities do not adjust for inflation before the payouts begin. That means you need to estimate inflation between now and the retirement date and adjust the real income target by that amount. For example, if you are ten years from retirement and you estimate cumulative inflation over the next ten years to be 20%, you need to raise the income target in the annuity price by 20%. I would use the break-even inflation rate calculated from the Treasury-TIPS spread for the inflation estimate. The difference between the yield on a nominal Treasury and the real yield on a TIPS bond is the break-even inflation rate. For the above example, you would use the break-even rate between 10 year nominals and TIPS. The yields on nominal Treasuries and TIPS can be found here.
Link - http://www.zvibodie.com/marketindicatorsview

You want the funded ratio to be at least 1.00 at retirement. Ideally it would be between 1.10 and 1.25. Values above that suggest your portfolio should contain few risky assets as you can meet your income goal without taking on much risk. Before retirement you want to track the funded ratio over time and hopefully it is consistently rising towards 1.00. If the funded ratio is not approaching 1.00, the investor needs to save more, retire later, or consider income from home equity. The other alternatives are to lower the income goal, or take more equity risk and live with the consequences of being even worse off if the risk materializes.

Before retirement
FR = portfolio/PV(liabilities) = portfolio/price of deferred real life annuity

In retirement
FR = portfolio/price of immediate real life annuity

But, as the above quotes suggest, the funded ratio can not only be used to monitor your progress, but also to drive the entire retirement investment process, including amount of future savings for retirement, age of retirement, and the asset allocation of the portfolio. As such the funded ratio is a core feature of many liability driven investment (LDI) retirement strategies. (LDI strategies are goal based investment strategies that seek to maximize the probability of reaching a financial goal. Often an LDI strategy is implemented by focusing on duration matching assets to future liabilities.)

The following are factors and techniques used in developing an LDI retirement investment strategy.

- Income goals, both aspirational and floor
- Portion of human capital assigned to retirement income, i.e. future contributions to retirement portfolio
- Funded Ratio [assets/(PV)liabilities]
- Price of real life annuity
- Duration matching of income goals (liabilities) to real bond funds or real bonds
- Rebalance equity with contributions

Advanced techniques
- Monte Carlo analysis
- Writing covered calls on equity portion of portfolio


Developing the portfolio

Keep the number of assets in the portfolio low, typically three or four assets. While you could add additional equity asset class funds or ETFs to gain additional exposure to sub-equity asset classes with slightly higher historical returns, the additional risk and complexity adds little to solving the problem of reaching your retirement income goal.

Use two equity funds, a broad based US stock index fund, and an international stock index fund. Decide on the ratio of US to international exposure you want (say 70/30), and keep that equity ratio constant, regardless of the proportion of equity in the portfolio. Instead of these two equity funds you could instead use only the US fund or simply a global index fund.

For bond exposure in the early years use a nominal LT US or global bond fund. Once you are within about twenty years of your retirement date, replace the nominal bond fund with a LT TIPS fund and later add a ST TIPS fund. You could replace the TIPS bond funds with a TIPS bond ladder. Assuming the duration of the ladder and the funds is the same; then in that case these two methods of providing safe income are equivalent.

During the early years the portfolio is heavily weighted toward stocks, typically 85% to 95% equity. Not because stocks are safe in the long-run (they are not), but because so much of your wealth when you are a young investor consists of relatively safe human capital. In this case the relevant human capital consists of future contributions to your retirement plans by both you and your employer. The present value of these future contributions to your DC plan, IRA, and other personal savings for most investors under 35 dwarfs the retirement portfolio balance. Beyond age 35 the proportion of the portfolio dedicated to stocks begins to decline, as the ratio of portfolio wealth to human capital rises.

Twenty years from retirement you replace the nominal bond fund with a LT TIPS bond fund. When you are about fifteen years from retirement you add the ST TIPS fund, and match the average duration of the two TIPS funds to the duration of the retirement income goal, the liability. (In this case, you are literally matching the duration of the TIPS to the duration of a life annuity that begins payouts at retirement.) The more duration matched TIPS assets you have in the portfolio, the more safe income the portfolio can generate. If nearing retirement the funded ratio was 1.00, then in that case an all TIPS portfolio could be counted on with probability of about 98% of providing the funded ratio level of safe retirement income. This could be done by either purchasing an immediate real life annuity for the aspirational level of income at retirement, or using withdrawals for that amount of income from the TIPS assets until life expectancy, and purchasing a longevity annuity for that amount to begin payouts at life expectancy. In other words, the LDI strategy has done its work of hitting the income goal with high probability.

Following this strategy it is unlikely that you would have more than about 25% of your portfolio dedicated to equities, once you are near or in retirement. Even if you don’t want all your aspirational level of retirement income to be safe, the level of safe TIPS assets should at least cover your targeted floor level of income as you near retirement. This would be the case if you are willing to fall somewhat short of the aspirational income goal in return for having a good shot at surpassing it.

Conclusion
When planning for retirement what’s important is meeting your income goals. This means that the investor should be focused on income for retirement, not growth in the account balance. Likewise, the risk is income shortfall, not portfolio volatility. Therefore, the account balance and its standard deviation are the wrong metrics for determining retirement planning success. What matters is the funded ratio, both in terms of hitting the income goal and measuring its potential shortfall.

Link to previous funded ratio thread - viewtopic.php?f=2&t=205824
In the above thread I began by using a present value calculation based on LT interest rates to determine the present value of the income stream. I now believe using deferred life annuity pricing to be at least as accurate and replaces the TVM calculations with simply getting an annuity price online.

Links to articles about Funded Ratio -
Retirement Security In a Single Number – Eleanor Laise, Kiplinger
http://www.kiplinger.com/article/retire ... umber.html

3600 Retirement Planning – Morgan Stanley
https://www.morganstanleyfa.com/public/ ... 6134f8.pdf

Tips to Manage Spending in Retirement – Paul Sullivan, New York Times
https://www.nytimes.com/2014/04/12/your ... .html?_r=1

Funded Ratio: What is it and what’s yours? – Russell Investments
https://russellinvestments.com/-/media/ ... -ratio.pdf

Funded ratio should replace account balances as the priority - Robert Merton, Benefits Canada’s Defined Contribution Plan Summit in Vancouver
http://www.benefitscanada.com/wp-conten ... Update.pdf

In a later post I give an example of how to use the funded ratio to derive over time a dynamic asset allocation that maximizes the probability of reaching your retirement income goal.

BobK

* Edit - I've been asked down thread to add to this original post where you can price real (inflation-adjusted) life annuities on the internet. Here's where I go to price real life annuities.

The website is immediateannuities.com and you need to use their 'advanced' calculator to get a real (inflation-adjusted) life annuity quote. The link I provide takes you to the 'advanced' calculator page. But even when using the 'advanced' calculator you have to click the "Show More Annuity Options" box on the 2nd page to select the real life annuity option.
Link: https://www.immediateannuities.com/annu ... rs/?sce=hc
Last edited by bobcat2 on Tue Jun 13, 2017 10:15 am, edited 5 times in total.
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Re: Using the Funded Ratio to drive your retirement investment plan

Post by nedsaid » Sun May 28, 2017 10:10 am

Excellent work. You answered questions about asset allocation and then how to transition from a growth portfolio to a matching portfolio. This has the specificity that I have asked for and it clears some things up.
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Re: Using the Funded Ratio to drive your retirement investment plan

Post by TomP10 » Sun May 28, 2017 10:42 am

Bobcat

An excellent post (along with several other recent threads you've been a part of). Full of wisdom and good suggestions.

For what it's worth, I've long been against investing in long bonds. I'm still at least a decade from retirement and during my accumulation phase I've always used intermediate bonds -- never thought the duration premium was worth the extra risk. Over the last several years I've begun purchasing $10,000 annually in iBonds so I now have at least a small percent of my bond portfolio in inflation protected securities.

Thinking in terms of the retirement phase your posts are making me think I need to embrace long TIPs. Thank you. I understand the argument but am struggling with the required mindset change. The analytical side of my brain says "that makes sense" but the emotional side says "yikes, I'm afraid of long bonds". Any advice for overcoming this behavioral bias/hurdle?
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Re: Using the Funded Ratio to drive your retirement investment plan

Post by Teague » Sun May 28, 2017 10:52 am

Very useful, thank you very much. I will explore this further.

A question, as I'm pretty new to the liability matching portfolio concept - When pricing the real life annuity, does one price an annuity with COLA, or without COLA? I'm sure the answer is obvious, but not to me unfortunately.
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Re: Using the Funded Ratio to drive your retirement investment plan

Post by alec » Sun May 28, 2017 1:06 pm

Teague wrote:Very useful, thank you very much. I will explore this further.

A question, as I'm pretty new to the liability matching portfolio concept - When pricing the real life annuity, does one price an annuity with COLA, or without COLA? I'm sure the answer is obvious, but not to me unfortunately.
Real life annuity means inflation adjusted, so one with an inflation cola.
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Re: Using the Funded Ratio to drive your retirement investment plan

Post by Teague » Sun May 28, 2017 1:11 pm

alec wrote:
Teague wrote:Very useful, thank you very much. I will explore this further.

A question, as I'm pretty new to the liability matching portfolio concept - When pricing the real life annuity, does one price an annuity with COLA, or without COLA? I'm sure the answer is obvious, but not to me unfortunately.
Real life annuity means inflation adjusted, so one with an inflation cola.
Thanks much.
Semper Augustus

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Re: Using the Funded Ratio to drive your retirement investment plan

Post by alec » Sun May 28, 2017 1:31 pm

TomP10 wrote:Bobcat

An excellent post (along with several other recent threads you've been a part of). Full of wisdom and good suggestions.

For what it's worth, I've long been against investing in long bonds. I'm still at least a decade from retirement and during my accumulation phase I've always used intermediate bonds -- never thought the duration premium was worth the extra risk. Over the last several years I've begun purchasing $10,000 annually in iBonds so I now have at least a small percent of my bond portfolio in inflation protected securities.

Thinking in terms of the retirement phase your posts are making me think I need to embrace long TIPs. Thank you. I understand the argument but am struggling with the required mindset change. The analytical side of my brain says "that makes sense" but the emotional side says "yikes, I'm afraid of long bonds". Any advice for overcoming this behavioral bias/hurdle?
If you're scared of interest rate risk of long term bonds, it's important to remember that changes in real interest rates affect both your assets (long term tips) and liabilities (future consumption) in the same direction. You can see this by using different real interest rates to discount the denominator of the FR from retirement to now. When you match assets to liabilities like Bob has demonstrated, there is no interest rate risk.
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Re: Using the Funded Ratio to drive your retirement investment plan

Post by HawkDriver » Sun May 28, 2017 4:28 pm

Great post! I've often thought that it was illogical to base an asset allocation decision on one's age irrespective of how close they are to fulfilling their income needs in retirement.

I use a somewhat similar approach in my own retirement planning, however the denominator in my "funded ratio" is my projected yearly income needs in today's dollars. My thoughts were if I continually updated my yearly income need projection, interest rates/inflation and changes to my personal situation would be reflected in the ratio, which I use to construct an allocation glideslope which reduces portfolio risk as I approach my funding goal.

Is this substantively different or less optimal than this Funded Ratio approach?

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Re: Using the Funded Ratio to drive your retirement investment plan

Post by itstoomuch » Sun May 28, 2017 5:01 pm

:sharebeer :sharebeer :sharebeer
Rev90517; 4 Incm stream buckets: SS+pension; dfr'd GLWB VA & FI anntys, by time & $$ laddered; Discretionary; Rentals. LTCi. Own, not asset. Tax 25%. Early SS. FundRatio (FR) >1.1 67/70yo

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Re: Using the Funded Ratio to drive your retirement investment plan

Post by Lieutenant.Columbo » Sun May 28, 2017 5:28 pm

Bob,
Great post for continuous reference.
bobcat2 wrote:...The easiest way to estimate the liabilities in the denominator is to price a deferred real life annuity that has payouts that match your targeted retirement income that is derived from your portfolio and begins payments in your expected retirement year...
would you please add to OP a link to where you price annuities?
bobcat2 wrote:...You want the funded ratio to be at least 1.00 at retirement. Ideally it would be between 1.10 and 1.25...
bobcat2 wrote:...Twenty years from retirement you replace the nominal bond fund with a LT TIPS bond fund. When you are about fifteen years from retirement you add the ST TIPS fund, and match the average duration of the two TIPS funds to the duration of the retirement income goal, the liability. (In this case, you are literally matching the duration of the TIPS to the duration of a life annuity that begins payouts at retirement.) The more duration matched TIPS assets you have in the portfolio, the more safe income the portfolio can generate. If nearing retirement the funded ratio was 1.00, then in that case an all TIPS portfolio could be counted on with probability of about 98% of providing the funded ratio level of safe retirement income. This could be done by either purchasing an immediate real life annuity for the aspirational level of income at retirement, or using withdrawals for that amount of income from the TIPS assets until life expectancy, and purchasing a longevity annuity for that amount to begin payouts at life expectancy. In other words, the LDI strategy has done its work of hitting the income goal with high probability
say one reaches retirement with a portfolio that is very different from what you recommend but FR at that time is 1.15: are they really fully funded? If Not, what's their strategy at That point?
Thanks.
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Re: Using the Funded Ratio to drive your retirement investment plan

Post by TomP10 » Mon May 29, 2017 8:55 am

bobcat2 wrote:
The easiest way to estimate the liabilities in the denominator is to price a deferred real life annuity that has payouts that match your targeted retirement income that is derived from your portfolio and begins payments in your expected retirement year. For example, you want to withdrawal $30,000/year ($2,500/month) from your portfolio. Before retirement price a deferred real life annuity that pays out $2,500/month beginning on your expected retirement date. In retirement price an immediate real life annuity for the same $2,500/month payout.

Any suggestions for best websites to find prices for a deferred annuity and/or SPIA?
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Re: Using the Funded Ratio to drive your retirement investment plan

Post by bertilak » Mon May 29, 2017 9:20 am

TomP10 wrote:Any suggestions for best websites to find prices for a deferred annuity and/or SPIA?
I would start here: https://investor.vanguard.com/annuity/
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Re: Using the Funded Ratio to drive your retirement investment plan

Post by nisiprius » Mon May 29, 2017 10:06 am

On the one hand, that all makes sense and actually is pretty close to what I was doing on my own back in 2006-2007 when I was planning my own retirement.

On the other hand, just to point out the obvious: how do you "use the Funded Ratio to drive your retirement investment plan" when the funded ratio is exactly as volatile as your portfolio?

Circa 1999 or so, a colleague of mine at work, a Russian emigre who'd been seriously saving for retirement for less than ten years, bothered me when I learned that he was 100% invested in stocks, with a very heavy emphasis on tech, because he felt he had to invest aggressively to make up for inadequate savings. I am sure that if he'd known his "funded ratio" the only effect would have been to make him even more determined to invest aggressively. An elementary school teacher, let me think, circa 2004 or 2005, about five years from retirement--no Social Security because she had a state-provided DB pension, I think--also mentioned that she had picked the "most aggressive" prepackaged portfolio option in her 403(b) because she "hadn't saved enough." Once again, a Funded Ratio would just have confirmed that she hadn't saved enough and would probably have led to the same choice.

To put it another way, how does the Funded Ratio help? At any point in time, if you have twice as much money, you can buy an annuity that will eventually deliver twice as much income. The future income is in direct proportion to the size of your current lump sum, so why does it matter which one you choose to look at? How does framing the decision in terms of "funded ratio" affect your portfolio risk-taking behavior?

If you have a funded ratio that is far, far above 100%, then it might stop you from mindlessly taking risk for no good reason, but how many people are actually in that situation?

In your personal experience, Bob, how many people have you run into who calculated their funded ratio and discovered it was well over 100%?

For a spot check I'm going to read the first article you linked to. If it contains any information about the actual distribution of real-life funded ratios of real savers, and shows that many people have funded ratios over 100% and are taking unnecessary risk, then I'll still post this but I'll put a strikeout through it and follow it with the facepalm emotion.

Nope, it didn't. Just hypotheticals on what people should do if.
Last edited by nisiprius on Mon May 29, 2017 10:42 am, edited 1 time in total.
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Re: Using the Funded Ratio to drive your retirement investment plan

Post by nisiprius » Mon May 29, 2017 10:34 am

Ranting on:
Retirees should be on high alert if their funded ratio drops below 105% or 104%, Rogerson says. They should cut back nonessential expenses to keep their funded ratio from dropping below 100%.

And what if your retirement is overfunded? With a funded ratio of 125% or more, Rogerson says, retirees are "so well funded, they can think about doing other things with their money," such as giving gifts to charity or leaving it to heirs.
OK, suppose you have an income of $125,000/year. You are male, 62 and will retire in 2020. Suppose that you have a moderately aspirational idea for desired income in retirement, and that someone like Charles Schwab has convinced you that you really ought to have 100% replacement of your working income in retirement*. So, you "need" $125,000 a year.

Social Security will pay you $25,000 a year. You need to make up $100,000. You have all your retirement savings in a T. Rowe Price year-2020 target-date fund in your 401(k). 60% stocks. The price of an annuity that pays $100,000/year initially and increases by 3% per year is $2.1 million if you can get it (Vanguard's annuity partner won't provide quotes for annuities paying out anywhere near that much, but... it's just a calculation so we'll use the quote for $833/month and multiply by ten.) So, you need $2.1 million.

Rogerson says if you have a funded ratio of 125% you can start giving away money. So, to be at that level, you need to have 125% of 2.1 million in your 401(k) = $2.625 million. So there you are, sitting there smug and happy and giving away your extra money.

Then the stock market crashes by 50%. That took less than 18 months last time. So your T. Rowe Price fund drops in value by 30%. So now you have only $1.84 million in your 401(k). And, lo and behold... your "funded ratio" has quickly dropped from 125% to 1.84 / 2.1 = 87%.

According to Rogerson, you were supposed to "go on high alert" and "cut back nonessential expenses" when it crossed "105% or 104%" on the way down. Yeah.

You are supposed to cut back expenses enough to keep your funded ratio above 100%? That means you are supposed to save an extra $2.1 million - $1.84 million = $260,000 over a period of less than a year, on a salary of $125,000 a year.

Suuuuurrrreeeeeee....

"Funded ratio" may be better than just admiring the pile of dollars... remember Scrooge McDuck's money bin, with the level ruler measuring the depth in feet... because it does bear some relationship to need instead of to the childhood delight in millions, billions and gazillions. But it doesn't really change things.

Stuff like "105% or 104%" is a miracle of false precision and assumes that the stock market moves in gentle, smooth, glides. It doesn't. Framing the problem in terms of "funded ratio" doesn't change anything much about the process except possibly to convince a few rare overfunded individuals to move to a more conservative allocation and/or start buying income annuities earlier. And it's completely goofy to suggest that a "funded ratio" of 125% provides such solid security that you can start giving the extra to charity.


*Not a straw man and not a joke. He says exactly that in a retirement advice book.
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Re: Using the Funded Ratio to drive your retirement investment plan

Post by Seasonal » Mon May 29, 2017 10:40 am

bertilak wrote:
TomP10 wrote:Any suggestions for best websites to find prices for a deferred annuity and/or SPIA?
I would start here: https://investor.vanguard.com/annuity/
When I try that, it asks me to pick an inflation rate from 1% to 5%. It didn't offer me an annuity protecting against actual inflation, which is what is contemplated by the OP.

Pricing a real annuity seems much better than trying to calculate a present value, but the difficulties in finding pricing seems an issue. Obviously one can estimate, but that's not quite the same as getting a quote.

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Re: Using the Funded Ratio to drive your retirement investment plan

Post by nisiprius » Mon May 29, 2017 10:48 am

Seasonal wrote:
bertilak wrote:
TomP10 wrote:Any suggestions for best websites to find prices for a deferred annuity and/or SPIA?
I would start here: https://investor.vanguard.com/annuity/
When I try that, it asks me to pick an inflation rate from 1% to 5%. It didn't offer me an annuity protecting against actual inflation, which is what is contemplated by the OP.
Yeah. Up until the end of last year, Vanguard's annuity partner had at least one insurance company that wrote actual CPI-linked income annuities. For a long time, AIG and The Principal did. Then AIG apparently stopped writing them... and, for whatever reason, Income Solutions stopped offering annuities from The Principal. What's also frustrating is that they are now showing quotes from Lincoln Financial Group, which once offered CPI-linked but apparently no longer does. And what's also startling is that in the past, every one of their insurance companies offered "fixed-percentage-increasing" annuities and now it looks as if only some of them do.

Something's happening... insurance companies are getting nervous about promising higher future payouts, it looks like.

In the past, for as long as I've been watching (off and on, for about ten years) the price of a CPI-linked annuity, when available, was just about the same as a 3%-per-year-compounded-increasing annuity, so just for calculating "funded ratio" that might be OK. I think someone in the forum posted that The Principal still writes CPI-linked annuities, but the question is where to go to get a quote.
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Re: Using the Funded Ratio to drive your retirement investment plan

Post by EHEngineer » Mon May 29, 2017 11:04 am

bertilak wrote:
TomP10 wrote:Any suggestions for best websites to find prices for a deferred annuity and/or SPIA?
I would start here: https://investor.vanguard.com/annuity/
The youngest quoted age from vanguard is 55.
Immediateannuities.com quotes at age 40 with a maximum deferment of 25 years.

I couldn't find quotes from either that inflation adjust the starting payout value. Inflation rate must be assumed; inflation risk is not mitigated.
Or, you can ... decline to let me, a stranger on the Internet, egg you on to an exercise in time-wasting, and you could say "I'm probably OK and I don't care about it that much." -Nisiprius

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Re: Using the Funded Ratio to drive your retirement investment plan

Post by stlutz » Mon May 29, 2017 11:36 am

I think someone in the forum posted that The Principal still writes CPI-linked annuities, but the question is where to go to get a quote.
I am able to get a quote at immediateannuties.com for one. For $100,000, I can get $547/mo. with no adjustment, $400 with a 3% annual adjustment, and $384 with a CPI adjustment.

Given that the Fed has a long-term target of 2% inflation, they would have to miss by quite a bit for the CPI one to be better. On the 3% one, it's in year 12 that the monthly payments start to exceed the unadjusted one. It's not until year 21 that the total payments will start to exceed to the unadjusted one (which is exactly what I would expect as that is about the life expectancy of a 65 year old today).

As to nisi's question as to why more CPI ones aren't offered, I'm thinking that is driven more from the demand side than the supply side--I just don't think many people want to buy them. Too many people either think that inflation is essentially zero or that the government understates it in a dramatic way meaning that I still get screwed with a CPI-adjusted annuity.

As such, to most people the product is saying you'll get $384 now and we'll let you know how much you'll get in the future when the future arrives. People who don't want certainty of payout are more likely not buying annuities or are buying more complex or variable annuities anyhow.

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Re: Using the Funded Ratio to drive your retirement investment plan

Post by TomP10 » Mon May 29, 2017 11:46 am

I have found the series of threads on the concept of "Funded Ratio" and the thinking about moving toward a liability driven portfolio as one approaches retirement very, very interesting. Bill Bernstein has written about similar ideas but (as far as I can recall) in much less actionable ways. The only thing I can recall Bill discussing was creating a TIPs ladder. Seemed like more work than I wanted to do.

Using the DFA material, I've computed the following glide path in an attempt to proxy DFA's approach. I've assume duration of short term TIPs is 3 years, intermediate term TIPs is 8 years, and Long Term Tips is 22.5 years.

The time horizon starts 20 years before retirement and the glide path goes until 15 years after retirement. At that point the glide path stabilizes.

Does this look reasonable? Any thoughts?

Code: Select all

Time           Target        Short TIPS   Intermed TIPS       Long TIPs
Horizon    TIPS Duration
45             22.5             0%              0%              100%
44             22.0             0%              3%              97%
43             21.5             0%              7%              93%
42             21.0             0%              10%             90%
41             20.5             0%              14%             86%
40             20.0             0%              17%             83%
39             19.5             0%              21%             79%
38             19.0             0%              24%             76%
37             18.5             0%              28%             72%
36             18.0             0%              31%             69%
35             17.5             0%              34%             66%
34             17.0             0%              38%             62%
33             16.5             0%              41%             59%
32             16.0             0%              45%             55%
31             15.5             0%              48%             52%
30             15.0             0%              52%             48%
29             14.5             0%              55%             45%
28             14.0             0%              59%             41%
27             13.5             0%              62%             38%
26             13.0             0%              66%             34%
25 (retire)    12.5             0%              69%             31%
24             12.0             0%              72%             28%
23             11.5             0%              76%             24%
22             11.0             0%              79%             21%
21             10.5             0%              83%             17%
20             10.0             0%              86%             14%
19             9.5              0%              90%             10%
18             9.0              0%              93%             7%
17             8.5              0%              97%             3%
16             8.0              0%             100%             0%
15             7.5              10%             90%             0%
14             7.0              20%             80%             0%
13             6.5              30%             70%             0%
12             6.0              40%             60%             0%
11             5.5              50%             50%             0%
10             5.0              60%             40%             0%
9              4.5              70%             30%             0%
8              4.0              80%             20%             0%
7              3.5              90%             10%             0%
6              3.0             100%              0%             0%
5              2.5             100%              0%             0%
4              2.0             100%              0%             0%
3              1.5             100%              0%             0%
2              1.0             100%              0%             0%
1              0.5             100%              0%             0%
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Re: Using the Funded Ratio to drive your retirement investment plan

Post by nedsaid » Mon May 29, 2017 11:50 am

nisiprius wrote:
Seasonal wrote:
bertilak wrote:
TomP10 wrote:Any suggestions for best websites to find prices for a deferred annuity and/or SPIA?
I would start here: https://investor.vanguard.com/annuity/
When I try that, it asks me to pick an inflation rate from 1% to 5%. It didn't offer me an annuity protecting against actual inflation, which is what is contemplated by the OP.
Yeah. Up until the end of last year, Vanguard's annuity partner had at least one insurance company that wrote actual CPI-linked income annuities. For a long time, AIG and The Principal did. Then AIG apparently stopped writing them... and, for whatever reason, Income Solutions stopped offering annuities from The Principal. What's also frustrating is that they are now showing quotes from Lincoln Financial Group, which once offered CPI-linked but apparently no longer does. And what's also startling is that in the past, every one of their insurance companies offered "fixed-percentage-increasing" annuities and now it looks as if only some of them do.

Something's happening... insurance companies are getting nervous about promising higher future payouts, it looks like.

In the past, for as long as I've been watching (off and on, for about ten years) the price of a CPI-linked annuity, when available, was just about the same as a 3%-per-year-compounded-increasing annuity, so just for calculating "funded ratio" that might be OK. I think someone in the forum posted that The Principal still writes CPI-linked annuities, but the question is where to go to get a quote.
This is why Bobcat2 doesn't talk so much about real annuities anymore as they are harder to find. He has switched to talking about TIPS. The thing is that the real rates on TIPS are less than one percent, hardly the time to be backing up the truck. Professor Merton has some great ideas for guaranteed income in retirement but markets keep messing with those ideas.

This is why I have stressed investor flexibility and that an investor should be willing to use a variety of approaches to assure income in retirement. Unfortunately, as much as we like the idea of a guaranteed, inflation adjusted income stream in retirement; in real life we have to make trade-offs for a somewhat less than optimal solution. Nothing out there is perfect. As Ben Stein would say, if you want a guarantee, buy a toaster.

I also think the low real returns of TIPS is a big reason for the scarcity of real inflation adjusted annuities. That should give us folks some pause.

Another thing that gives me pause is that during the financial crisis of 2008-2009; TIPS acted in a way I did not expect. I assumed the market would treat them like any other treasury instrument. Nominal treasuries rallied and did great, TIPS as I recall fell 10% to 11%. Insurance companies probably looked at that too and probably scared them a bit as I would expect TIPS to be the foundation for a real inflation adjusted annuity. Fortunately, the drop in TIPS was temporary and turned out to be quite a buying opportunity.

As much as I like TIPS, I don't want to overload my portfolio with them as in a market crisis, they may not act as expected. Markets have a way of doing that.
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Re: Using the Funded Ratio to drive your retirement investment plan

Post by itstoomuch » Mon May 29, 2017 12:25 pm

nisprius wrote:Stuff like "105% or 104%" is a miracle of false precision and assumes that the stock market moves in gentle, smooth, glides. It doesn't. Framing the problem in terms of "funded ratio" doesn't change anything much about the process except possibly to convince a few rare overfunded individuals to move to a more conservative allocation and/or start buying income annuities earlier. And it's completely goofy to suggest that a "funded ratio" of 125% provides such solid security that you can start giving the extra to charity.
nisprius wrote:Yeah. Up until the end of last year, Vanguard's annuity partner had at least one insurance company that wrote actual CPI-linked income annuities. For a long time, AIG and The Principal did. Then AIG apparently stopped writing them... and, for whatever reason, Income Solutions stopped offering annuities from The Principal. What's also frustrating is that they are now showing quotes from Lincoln Financial Group, which once offered CPI-linked but apparently no longer does. And what's also startling is that in the past, every one of their insurance companies offered "fixed-percentage-increasing" annuities and now it looks as if only some of them do.

Something's happening... insurance companies are getting nervous about promising higher future payouts, it looks like. I viewed this as risk sharing by the ins co with the annuitant. In contrast to 100% risk ownership in a strict S/B portfolio.
THINK Income not in S/B ratios or the Financial Independence Number Value.
Took me 6 months of investigation to find a nice GLWB VA, Nov 2008. The last strategy NOT completely closed by the annuity companies is the protection of the Income Account when inflation hits (a drop in the equity account) but this option has a variable fee. Mine is fixed at 1%.
We're getting close to 1.25
YMMV :greedy
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Re: Using the Funded Ratio to drive your retirement investment plan

Post by itstoomuch » Mon May 29, 2017 12:41 pm

nedsaid wrote:Another thing that gives me pause is that during the financial crisis of 2008-2009; TIPS acted in a way I did not expect. I assumed the market would treat them like any other treasury instrument. Nominal treasuries rallied and did great, TIPS as I recall fell 10% to 11%. Insurance companies probably looked at that too and probably scared them a bit as I would expect TIPS to be the foundation for a real inflation adjusted annuity. Fortunately, the drop in TIPS was temporary and turned out to be quite a buying opportunity.

There was a real question if "Western Economic Systems would survive," Hank Paulson, Sec of Treas; "the Dark Ages," Ben Bernake, FR Chairman.
YMMV
Rev90517; 4 Incm stream buckets: SS+pension; dfr'd GLWB VA & FI anntys, by time & $$ laddered; Discretionary; Rentals. LTCi. Own, not asset. Tax 25%. Early SS. FundRatio (FR) >1.1 67/70yo

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Re: Using the Funded Ratio to drive your retirement investment plan

Post by nedsaid » Mon May 29, 2017 12:45 pm

itstoomuch wrote:
nedsaid wrote:Another thing that gives me pause is that during the financial crisis of 2008-2009; TIPS acted in a way I did not expect. I assumed the market would treat them like any other treasury instrument. Nominal treasuries rallied and did great, TIPS as I recall fell 10% to 11%. Insurance companies probably looked at that too and probably scared them a bit as I would expect TIPS to be the foundation for a real inflation adjusted annuity. Fortunately, the drop in TIPS was temporary and turned out to be quite a buying opportunity.

There was a real question if "Western Economic Systems would survive," Hank Paulson, Sec of Treas; "the Dark Ages," Ben Bernake, FR Chairman.
YMMV
I lot of people felt scared enough that they could have soiled their pants. I know I was pretty scared. 2000-2002 was painful but not scary as the economy for the most part rolled on. 2008-2009 was both painful and scary. We were looking at the prospect of an actual depression and not just a recession. The sad fact is that nothing is guaranteed in life. Good solutions are out there but if you are looking for an optimal solution, you will be looking for a very long time.
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Re: Using the Funded Ratio to drive your retirement investment plan

Post by VictoriaF » Mon May 29, 2017 12:58 pm

Bob,

I am grateful for your presentation on this topic at the local D.C. Bogleheads meeting and answering my questions in the D.C. thread. This thread provides relevant information in great detail. Thanks a lot!

As a retiree, I have some certainty in estimating my assets, expenses and needs. I am delaying taking Social Security until the age of 70, so that in combination with my Federal pension it will provide me with income fairly close to my floor. My aspirational level of income is quite a bit higher, and I need to assure it with a combination of real assets and income using the principles you have described.

Right now I hold a motley collection of TIPS in Roth IRAs that I have purchased at large discounts in 2008-2009 and that have a weighted duration slightly lower than what I need for my estimated life expectancy. One of my TIPS will be maturing in July, and I want to replace it with an equivalent. I am considering two options:
1. Buy a PIMCO LTPZ EFT with expense ratio = 0.20% and 1-year NAV Total Returns (after fees) = 1.80%
Source: http://www.pimcoetfs.com/Funds/Pages/PI ... l=fund_nav
or
2. Buy a 30-year TIPS on the secondary market. The latest (02/28/2017) 30-year TIPS have interest rate of 0.875%, which together with inflation is higher than LTPZ's yield.
Source: https://www.treasurydirect.gov/instit/i ... m?upcoming

I am inclined to buy a 30-year TIPS on the secondary market in July, as soon as my current TIPS matures. It would not be a part of a large coherent strategy, but seems "good enough" in the context of a prudent strategy. If I decide that my TIPS duration is too high, I can always buy a ST TIPS fund in Vanguard.

If you have a chance please comment. Specifically, are there any reasons for me to prefer EFTZ to buying a TIPS directly?

Thank you again,
Victoria
Last edited by VictoriaF on Mon May 29, 2017 2:08 pm, edited 3 times in total.
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Re: Using the Funded Ratio to drive your retirement investment plan

Post by Seasonal » Mon May 29, 2017 1:01 pm

bobcat2 wrote:When you are about fifteen years from retirement you add the ST TIPS fund, and match the average duration of the two TIPS funds to the duration of the retirement income goal, the liability. (In this case, you are literally matching the duration of the TIPS to the duration of a life annuity that begins payouts at retirement.)
How does one calculate "the duration of the retirement income goal, the liability" or " the duration of a life annuity that begins payouts at retirement".

An example, in which lifespan is not known, would be helpful.

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Re: Using the Funded Ratio to drive your retirement investment plan

Post by Seasonal » Mon May 29, 2017 1:04 pm

nedsaid wrote:Another thing that gives me pause is that during the financial crisis of 2008-2009; TIPS acted in a way I did not expect. I assumed the market would treat them like any other treasury instrument. Nominal treasuries rallied and did great, TIPS as I recall fell 10% to 11%. Insurance companies probably looked at that too and probably scared them a bit as I would expect TIPS to be the foundation for a real inflation adjusted annuity. Fortunately, the drop in TIPS was temporary and turned out to be quite a buying opportunity.

As much as I like TIPS, I don't want to overload my portfolio with them as in a market crisis, they may not act as expected. Markets have a way of doing that.
If you are periodically selling TIPS, I can see why unexpected behavior would give you pause. If you are using interest from TIPS and principal at maturity, it would seem market movements would not be important to you.

Presumably insurance companies are buying TIPS at the time they would sell an inflation adjusted annuity, so they would seem immune from subsequent market movements.

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Re: Using the Funded Ratio to drive your retirement investment plan

Post by Grt2bOutdoors » Mon May 29, 2017 1:08 pm

itstoomuch wrote:
nisprius wrote:Stuff like "105% or 104%" is a miracle of false precision and assumes that the stock market moves in gentle, smooth, glides. It doesn't. Framing the problem in terms of "funded ratio" doesn't change anything much about the process except possibly to convince a few rare overfunded individuals to move to a more conservative allocation and/or start buying income annuities earlier. And it's completely goofy to suggest that a "funded ratio" of 125% provides such solid security that you can start giving the extra to charity.
nisprius wrote:Yeah. Up until the end of last year, Vanguard's annuity partner had at least one insurance company that wrote actual CPI-linked income annuities. For a long time, AIG and The Principal did. Then AIG apparently stopped writing them... and, for whatever reason, Income Solutions stopped offering annuities from The Principal. What's also frustrating is that they are now showing quotes from Lincoln Financial Group, which once offered CPI-linked but apparently no longer does. And what's also startling is that in the past, every one of their insurance companies offered "fixed-percentage-increasing" annuities and now it looks as if only some of them do.

Something's happening... insurance companies are getting nervous about promising higher future payouts, it looks like. I viewed this as risk sharing by the ins co with the annuitant. In contrast to 100% risk ownership in a strict S/B portfolio.
THINK Income not in S/B ratios or the Financial Independence Number Value.
Took me 6 months of investigation to find a nice GLWB VA, Nov 2008. The last strategy NOT completely closed by the annuity companies is the protection of the Income Account when inflation hits (a drop in the equity account) but this option has a variable fee. Mine is fixed at 1%.
We're getting close to 1.25
YMMV :greedy
How does the Vanguard Variable annuity compare to the one you own? Is it worth exploring? The cost of the GWLB is much higher than 1% though, believe it's 1.2% when exercised.
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Re: Using the Funded Ratio to drive your retirement investment plan

Post by nedsaid » Mon May 29, 2017 1:10 pm

Seasonal wrote:
nedsaid wrote:Another thing that gives me pause is that during the financial crisis of 2008-2009; TIPS acted in a way I did not expect. I assumed the market would treat them like any other treasury instrument. Nominal treasuries rallied and did great, TIPS as I recall fell 10% to 11%. Insurance companies probably looked at that too and probably scared them a bit as I would expect TIPS to be the foundation for a real inflation adjusted annuity. Fortunately, the drop in TIPS was temporary and turned out to be quite a buying opportunity.

As much as I like TIPS, I don't want to overload my portfolio with them as in a market crisis, they may not act as expected. Markets have a way of doing that.
If you are periodically selling TIPS, I can see why unexpected behavior would give you pause. If you are using interest from TIPS and principal at maturity, it would seem market movements would not be important to you.

Presumably insurance companies are buying TIPS at the time they would sell an inflation adjusted annuity, so they would seem immune from subsequent market movements.
I am wondering which is the better strategy, buying TIPS individually or in a fund? I own TIPS in two funds, one is managed and the other is an indexed fund.
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Re: Using the Funded Ratio to drive your retirement investment plan

Post by VictoriaF » Mon May 29, 2017 1:14 pm

nedsaid wrote:I am wondering which is the better strategy, buying TIPS individually or in a fund? I own TIPS in two funds, one is managed and the other is an indexed fund.
Earlier in this thread, I asked a similar question, which I am repeating here for clarity:
Is it preferable to buy a LTPZ ETF or a 30-year TIPS on the secondary market?

Victoria
Last edited by VictoriaF on Mon May 29, 2017 2:06 pm, edited 1 time in total.
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Re: Using the Funded Ratio to drive your retirement investment plan

Post by TomP10 » Mon May 29, 2017 1:42 pm

VictoriaF wrote: Earlier in this thread, I asked a similar question, which I am repeating here for clarity:
Is it preferrable to buy an EFTZ ETF or a 30-year TIPS on the secondary market?
Did you mean Pimco fund with the ticker LTPZ?
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Re: Using the Funded Ratio to drive your retirement investment plan

Post by VictoriaF » Mon May 29, 2017 2:05 pm

TomP10 wrote:
VictoriaF wrote: Earlier in this thread, I asked a similar question, which I am repeating here for clarity:
Is it preferable to buy a EFTZ LTPZ ETF or a 30-year TIPS on the secondary market?
Did you mean Pimco fund with the ticker LTPZ?
Yes. Thank you for catching my typo.

Victoria
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Re: Using the Funded Ratio to drive your retirement investment plan

Post by SimpleGift » Mon May 29, 2017 2:11 pm

VictoriaF wrote:
nedsaid wrote:I am wondering which is the better strategy, buying TIPS individually or in a fund? I own TIPS in two funds, one is managed and the other is an indexed fund.
Earlier in this thread, I asked a similar question, which I am repeating here for clarity:
Is it preferable to buy an LTPZ ETF or a 30-year TIPS on the secondary market?
If one is buying TIPS to match a future real liability, then individual TIPS held to maturity would seem to be the safer option. Holding a TIPS fund or ETF for this purpose would just introduce interest rate risk, market risk and fund redemption or "sell-off" risk.

But if one is buying TIPS in a total return portfolio as protection against unexpected inflation, then a TIPS fund might be preferable, due to ease of liquidation, the constant target duration and more frequently updated inflation credit.

Just my two cents.
Cordially, Todd

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Re: Using the Funded Ratio to drive your retirement investment plan

Post by VictoriaF » Mon May 29, 2017 2:25 pm

Simplegift wrote:
VictoriaF wrote:
nedsaid wrote:I am wondering which is the better strategy, buying TIPS individually or in a fund? I own TIPS in two funds, one is managed and the other is an indexed fund.
Earlier in this thread, I asked a similar question, which I am repeating here for clarity:
Is it preferable to buy an LTPZ ETF or a 30-year TIPS on the secondary market?
If one is buying TIPS to match a future real liability, then individual TIPS held to maturity would seem to be the safer option. Holding a TIPS fund or ETF for this purpose would just introduce interest rate risk, market risk and fund redemption or "sell-off" risk.

But if one is buying TIPS in a total return portfolio as protection against unexpected inflation, then a TIPS fund might be preferable, due to ease of liquidation, the constant target duration and more frequently updated inflation credit.

Just my two cents.
Excellent point, thanks!

I have not planned my future liabilities yet. Right now, I am focused on making Roth conversions and having cash ready for paying taxes and living expenses before I start collecting Social Security. Thus, this TIPS purchase will be for a total-return portfolio rather than to match a specific future liability. This would suggest getting LTPZ.

On the other hand, I don't expect to need this money for at least 20 years. In 20 years, a 30-year TIPS will become a 10-year TIPS, and if I have to sell it, I won't lose much on it even in a bad market.

Victoria
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Re: Using the Funded Ratio to drive your retirement investment plan

Post by stlutz » Mon May 29, 2017 2:45 pm

Round-trip trade spreads on individual TIPS are around .5% to .75%. The round-trip trade cost on LTPZ is currently .22% and it has a .20% expense ratio. Basically the individual issue would be cheaper for holding periods of > 2 years.

I guess I would use the individual issue issue in an tax-advantaged account but the ETF in a taxable account (as we do still see a fair number of reports of brokers messing up the tax reporting on TIPS still).

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Re: Using the Funded Ratio to drive your retirement investment plan

Post by TomP10 » Mon May 29, 2017 3:04 pm

Simplegift wrote:
VictoriaF wrote:
nedsaid wrote:I am wondering which is the better strategy, buying TIPS individually or in a fund? I own TIPS in two funds, one is managed and the other is an indexed fund.
Earlier in this thread, I asked a similar question, which I am repeating here for clarity:
Is it preferable to buy an LTPZ ETF or a 30-year TIPS on the secondary market?
If one is buying TIPS to match a future real liability, then individual TIPS held to maturity would seem to be the safer option. Holding a TIPS fund or ETF for this purpose would just introduce interest rate risk, market risk and fund redemption or "sell-off" risk.

But if one is buying TIPS in a total return portfolio as protection against unexpected inflation, then a TIPS fund might be preferable, due to ease of liquidation, the constant target duration and more frequently updated inflation credit.
I think there is an additional complication that leads one to favor a TIPS fund if you are interested in pursuing this strategy. Namely, the approach exposed by Merton and used by DFA involves a changing percentage of TIPS of various maturities in order to properly match the changing duration of one's liabilities. Each year your duration needs to shrink a bit. I would think the ease of rebalancing with TIPS funds would make such duration matching a much easier task.

Am I missing something?
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Re: Using the Funded Ratio to drive your retirement investment plan

Post by stlutz » Mon May 29, 2017 3:06 pm

how do you "use the Funded Ratio to drive your retirement investment plan" when the funded ratio is exactly as volatile as your portfolio?
One critical point that bobcat has explained in other threads is that the "funded ratio" is somewhat impervious to interest rate changes. If I have intermediate-to-longer duration TIPS now and real interest rates go up by 1%, the value of my TIPS goes down, but the income I can generate from buying an annuity goes up (because interest rates are higher). As such, I'm not actually any worse off in terms of the income I can generate from my fixed income portfolio. So, the TIPS portion of my portfolio may be volatile, but my funded ratio remains unchanged.

I think the concept is very helpful in evaluating ones need to take risk. If you're 55 and your funded ratio is .25, then it probably makes sense to load up on equities and accept what you get. If you're the same age and your funded ratio is 1.25, then why would you take the risk of equities with anything over the 1.0 portion?

For BH-type savers, I think bobcat's approach generally results in a much more conservative approach than a typical Target Retirement fund. Whether that is correct is certainly open to debate (the guy at earlyretirmentnow.com who we've been discussing a lot lately would certainly do so!) but it is in any case a helpful/viable/rational way to approach the challenges of retirement planning.

Thanks bobcat2! :sharebeer

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Re: Using the Funded Ratio to drive your retirement investment plan

Post by Peter G » Mon May 29, 2017 5:26 pm

I think this approach would suit some people very well, and I see its appeal, but I'm no expert. However, a couple of observations:
say one reaches retirement with a portfolio that is very different from what you recommend but FR at that time is 1.15: are they really fully funded? If Not, what's their strategy at That point?
A reason why you would not be fully funded at that time is that you do not own the very safe annuity or inflation protected sovereign bonds which we're tacitly recognising are the safest ways to hold your assets. For example if your FR 1.15 assets are all equities, then tomorrow they could be worth 0.9 instead of 1.15 if the market collapses. Under-estimating your future needs by >15% would also lead you to be not fully funded.
So your strategy might be to exchange volatile at-risk assets with inflation protected life-time annuities and non-rolling TIPS ladders.
Circa 1999 or so, a colleague of mine at work, a Russian emigre
I don't think a poor decision by a Russian emigre to take on excessive investment risk to reach a difficult goal invalidates a planning approach which attempts to quantify future funding needs and then match those with non-volatile, fairly secure assets which address at least one of the 'deep' risks, namely inflation.
You want the funded ratio to be at least 1.00 at retirement. Ideally it would be between 1.10 and 1.25. Values above that suggest your portfolio should contain few risky assets as you can meet your income goal without taking on much risk.
I'm guessing that 1.1-1.25 gives some allowance for having under-estimated future needs or longevity (if you rely on a non-rolling bond ladder). But if your FR is >1.25 (or, pick a number), it seems to me that some assets can then be in very risky investments if you've secured 1.25 times your spending needs with safe products like annuities or inflation protected sovereign bonds. Indeed, with a ratio of 2.5, surely half your financial assets could be in high risk volatile products if that's your fancy.

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Re: Using the Funded Ratio to drive your retirement investment plan

Post by bobcat2 » Mon May 29, 2017 6:36 pm

Lieutenant.Columbo wrote:Would you please add to OP a link to where you price annuities?...
Thanks.
I'll eventually add the link to the OP, but for right now I'm putting it here.

The website is immediateannuities.com and you need to use their 'advanced' calculator to get a real (inflation-adjusted) life annuity quote. The link I provide takes you to the 'advanced' calculator page. But even when using the 'advanced' calculator you have to click the "Show More Annuity Options" box on the 2nd page to select the real life annuity option.
Link: https://www.immediateannuities.com/annu ... rs/?sce=hc

My understanding is the main reason Principal no longer sells life annuities thru Income Solutions, but does still sell them at immediatieannuities is because many of the insurance agents working with Principal didn't have access to Income Solutions and its slightly lower wholesale pricing model, and were complaining to Principal. Principal decided to make the agents happy by closing the Income Solutions channel to their annuities. I could be wrong about this, but that's the scuttlebutt I heard.

What if nobody sells real life annuities at some point in the future? As long as they continue to sell escalating life annuities I would pick the escalation factor just above breakeven inflation at 20 years or so. (Where breakeven inflation is the spread between a 20 year Treasury and and a 20 year TIPS yield. You can pick another year other than 20 if you want.) Example - 20 year nominal Treasury bond yield is 2.4% and yield on TIPS maturing in 20 years is 0.8%. Breakeven inflation estimate is the difference, 1.6%. In that case pick the escalating life annuity that escalates at 2% to price the liability in the denominator of the funded ratio.

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Re: Using the Funded Ratio to drive your retirement investment plan

Post by nisiprius » Mon May 29, 2017 8:09 pm

bobcat2 wrote:...As long as they continue to sell escalating life annuities I would pick the escalation factor just above breakeven inflation at 20 years or so...
("Escalating life annuities." Thanks. I didn't know the term.) Yes, but whereas in the time I've been paying attention--about the last ten years--literally every company that sold SPIAs offered escalating annuities with the sole exception of Berkshire Hathaway Direct (no longer operating), I was nonplussed this morning to find that only about half of the quotations through Vanguard/Income Solutions offered them. So I worry that they, too, are vanishing.
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Re: Using the Funded Ratio to drive your retirement investment plan

Post by bobcat2 » Mon May 29, 2017 8:12 pm

TomP10 wrote:I think there is an additional complication that leads one to favor a TIPS fund if you are interested in pursuing this strategy. Namely, the approach exposed by Merton and used by DFA involves a changing percentage of TIPS of various maturities in order to properly match the changing duration of one's liabilities. Each year your duration needs to shrink a bit. I would think the ease of rebalancing with TIPS funds would make such duration matching a much easier task.

Am I missing something?
Not much.

The dynamic rebalancing with TIPS funds is equivalent to building a TIPS ladder over the same number of years. Done properly, they will both be duration matched over time to the targeted income stream. I think it's a matter of personal preference as to which is better. I think using the funds is easier, and I don't care that it's not a 'perfect' duration match. It's relatively close and it will produce safe retirement income. OTOH I am almost certain #Cruncher believes the TIPS bond ladder is the better way to go. :D That's fine. But personally I don't see a big difference - both techniques have plusses and minuses.

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Re: Using the Funded Ratio to drive your retirement investment plan

Post by nisiprius » Mon May 29, 2017 8:16 pm

nedsaid wrote:I am wondering which is the better strategy, buying TIPS individually or in a fund?
Here's my $0.02 speaking as someone who has owned individual TIPS from 1998 through 2015. I'm just going to state the conclusions I came to.
  • In theory, in every respect, individual TIPS appeared to be preferable.
  • As nearly as I could figure it, owning a long-term TIPS fund and a short-term TIPS fund and adjusting their relative allocation on a glide slope so as to keep shortening the average duration, absolutely was not equivalent or even similar to holding TIPS to maturity.
  • Despite all that, for a "mass affluent" investor, managing a portfolio of twenty or more TIPS issue was a serious PITA. Up until fairly recently, there were fee issues (Treasury Direct didn't offer IRAs); there were purchase quantity issues (buying less than ten); for market purchases I had strong unease about bid-asked spread on transactions of less than ten bonds. And I also felt that should "anything" happen, my wife was quite capable of managing a portfolio of a handful of mutual funds--and no chance at all she could cope with a portfolio of individual TIPS. I decided that holding individual TIPS was mostly ego and that based on practical considerations, funds are a wiser move.
Sane people could come to different conclusions.
nedsaid wrote:Another thing that gives me pause is that during the financial crisis of 2008-2009; TIPS acted in a way I did not expect. I assumed the market would treat them like any other treasury instrument. Nominal treasuries rallied and did great, TIPS as I recall fell 10% to 11%.
Me, too. I want to qualify that a bit because if you look at a longer stretch of time centered on 2008-2009, I wouldn't say TIPS fell 10%, exactly, because that fall was preceded just about a year earlier with an eerie 10% rise. Charting TIPS along with nominal bonds it is mostly above the nominal bonds, and the only point at which you'd have lost money during the fall was if you'd bought in that one-year time window.

That's spin, of course, and it is the kind of thing people say about asset classes they have gotten attached to. "I forgive TIPS that 10% drop because it came after a 10% rise." The important thing is that it misbehaved. Exactly as you say, it did not behave like other Treasuries--for whatever the reason.

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Re: Using the Funded Ratio to drive your retirement investment plan

Post by bobcat2 » Mon May 29, 2017 8:38 pm

Seasonal wrote:
bobcat2 wrote:When you are about fifteen years from retirement you add the ST TIPS fund, and match the average duration of the two TIPS funds to the duration of the retirement income goal, the liability. (In this case, you are literally matching the duration of the TIPS to the duration of a life annuity that begins payouts at retirement.)
How does one calculate "the duration of the retirement income goal, the liability" or " the duration of a life annuity that begins payouts at retirement".

An example, in which lifespan is not known, would be helpful.
You raise a good point. The best answer I have for the duration of life annuities are these posts from #Cruncher. Read #Cruncher's posts below and also read thru the threads the posts are on.
Links to #Cruncher posts on calculating duration of life annuities.
viewtopic.php?f=10&t=166687&p=2607671&h ... n#p2607671
viewtopic.php?f=10&t=174991&p=2646038&h ... n#p2646038
viewtopic.php?f=2&t=182799&p=2771752&hi ... n#p2771752

#Cruncher has to be one of the top five posters at Bogleheads. :sharebeer

You can read about #Cruncher and his TIPS website here.
https://tipswatch.com/2011/07/22/an-inc ... tips-data/

and here is the link to #Cruncher's website.
http://eyebonds.info/tips/index.html

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Re: Using the Funded Ratio to drive your retirement investment plan

Post by Seasonal » Tue May 30, 2017 7:55 am

bobcat2 wrote:
Seasonal wrote:
bobcat2 wrote:When you are about fifteen years from retirement you add the ST TIPS fund, and match the average duration of the two TIPS funds to the duration of the retirement income goal, the liability. (In this case, you are literally matching the duration of the TIPS to the duration of a life annuity that begins payouts at retirement.)
How does one calculate "the duration of the retirement income goal, the liability" or " the duration of a life annuity that begins payouts at retirement".

An example, in which lifespan is not known, would be helpful.
You raise a good point. The best answer I have for the duration of life annuities are these posts from #Cruncher. Read #Cruncher's posts below and also read thru the threads the posts are on.
Links to #Cruncher posts on calculating duration of life annuities.
viewtopic.php?f=10&t=166687&p=2607671&h ... n#p2607671
viewtopic.php?f=10&t=174991&p=2646038&h ... n#p2646038
viewtopic.php?f=2&t=182799&p=2771752&hi ... n#p2771752

#Cruncher has to be one of the top five posters at Bogleheads. :sharebeer

You can read about #Cruncher and his TIPS website here.
https://tipswatch.com/2011/07/22/an-inc ... tips-data/

and here is the link to #Cruncher's website.
http://eyebonds.info/tips/index.html

BobK
#Cruncher's calculations depend on life expectancy, which would seem to run the risk that actual lifespan exceeds life expectancy.

If the general idea is to buy a TIPS portfolio with cash flows that match our planned spending (the liability side of liability matching), what do we do if we live longer than expected? Any excess we hold (for example, in a broad equity index) might fill in the gap. Or not.

A real life annuity would solve this problem (subject to the credit worthiness of the issuing insurance companies and the protection from state backup mechanisms). As noted, there are not many real life annuities available.

The answer may be that this is the best we can do to minimize risk.

#Cruncher does some very nice work. :sharebeer

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Re: Using the Funded Ratio to drive your retirement investment plan

Post by bobcat2 » Tue May 30, 2017 9:27 am

Seasonal wrote:#Cruncher's calculations depend on life expectancy, which would seem to run the risk that actual lifespan exceeds life expectancy.

If the general idea is to buy a TIPS portfolio with cash flows that match our planned spending (the liability side of liability matching), what do we do if we live longer than expected? Any excess we hold (for example, in a broad equity index) might fill in the gap. Or not.

A real life annuity would solve this problem (subject to the credit worthiness of the issuing insurance companies and the protection from state backup mechanisms). As noted, there are not many real life annuities available.

The answer may be that this is the best we can do to minimize risk.

#Cruncher does some very nice work. :sharebeer
The question you originally raised was how to calculate the duration of the life annuity. #Cruncher's calculations make a reasonable estimate of that.

Here's my take on the broader issue of TIPS and longevity. Basically I am following Robert Merton's advice on this.

There are two ways to get safe real (inflation-adjusted) income in retirement. One is real life annuities - Social Security, real pensions, and real commercial life annuities, and the other is real bonds – TIPS & I-bonds. IMO they are complements, not substitutes, for providing safe retirement income. The real life annuities have longevity protection, but provide inflexible income. The real bonds provide flexible income, but lack longevity protection.

Because of the lack of longevity protection here is how I handle my TIPS funds. I consider them safe flexible income above the safe income streams provided by my SS and pension benefits. I try to duration match my ST & LT TIPS funds to my IRA withdrawals from now until age 85. Age 85 is picked because that is approximately my life expectancy, and also the age at which you can last purchase life annuities.

If I get to 75 healthy, I intend to purchase a longevity annuity that begins payouts at age 85 for about a third of my annual withdrawals from the TIPS. I would then purchase another third at about age 80 if healthy, and the remaining third as I approach age 85. Beyond 85 I want longevity protection and I don’t want my future elderly, and possibly senile, self to be attempting to dynamically adjust TIPS allocations between funds.

Here is a link to an article where Merton discusses the two types of safe retirement income.
Link - http://www.nestpensions.org.uk/schemewe ... cs,PDF.pdf

Start with the subheading, Managed DC post-retirement income solution, on page 3 of the 7 page article. It's numbered page 66 in the report.

BobK

PS - If my wife and I didn't both have pensions and Social Security, we would have purchased life annuities near our retirement ages to augment the Social Security safe floor income provided by annuitized assets.
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Re: Using the Funded Ratio to drive your retirement investment plan

Post by itstoomuch » Tue May 30, 2017 8:55 pm

bobcat2 wrote: If I get to 75 healthy, I intend to purchase a longevity annuity that begins payouts at age 85 for about a third of my annual withdrawals from the TIPS. I would then purchase another third at about age 80 if healthy, and the remaining third as I approach age 85. Beyond 85 I want longevity protection and I don’t want my future elderly, and possibly senile, self to be attempting to dynamically adjust TIPS allocations between funds.
The problem that I saw, and experiencing, is that one can be healthy at 75 and very sick at 76. So an longevity annuity (spia, inflation annuity), would be very expensive in pseudo fees if one should die before 85 or soon after reaching 85.
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Re: Using the Funded Ratio to drive your retirement investment plan

Post by stlutz » Tue May 30, 2017 9:46 pm

I actually have a question for you BobK (which hopefully doesn't take us off topic).

How would you approach it if you were eyeing a very early retirement? That is, suppose someone was 50 and was thinking of stopping working and would otherwise live off a 3% withdrawal rate adjusted for inflation having never heard of your ideas. Most people who are doing early retirements are counting on good equity returns (i.e. at least a few percentage points above bonds) on average (i.e. not each and every year) over the course of their retirement to make it work. How would you approach this challenge?

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Re: Using the Funded Ratio to drive your retirement investment plan

Post by bobcat2 » Tue May 30, 2017 9:57 pm

stlutz wrote:I actually have a question for you BobK (which hopefully doesn't take us off topic).

How would you approach it if you were eyeing a very early retirement? That is, suppose someone was 50 and was thinking of stopping working and would otherwise live off a 3% withdrawal rate adjusted for inflation having never heard of your ideas. Most people who are doing early retirements are counting on good equity returns (i.e. at least a few percentage points above bonds) on average (i.e. not each and every year) over the course of their retirement to make it work. How would you approach this challenge?
I would advise working longer or inheriting a lot of money before ending one's working career. :D You could also consider marrying or being married to a very wealthy person. :wink:

Seriously, my advice would be to find something you like and at least work part-time longer. I wouldn't encourage any healthy individual to retire before 58, and if you enjoy what you are doing, keep working to a ripe old age.

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Re: Using the Funded Ratio to drive your retirement investment plan

Post by bobcat2 » Tue May 30, 2017 10:16 pm

itstoomuch wrote:
bobcat2 wrote: If I get to 75 healthy, I intend to purchase a longevity annuity that begins payouts at age 85 for about a third of my annual withdrawals from the TIPS. I would then purchase another third at about age 80 if healthy, and the remaining third as I approach age 85. Beyond 85 I want longevity protection and I don’t want my future elderly, and possibly senile, self to be attempting to dynamically adjust TIPS allocations between funds.
The problem that I saw, and experiencing, is that one can be healthy at 75 and very sick at 76. So an longevity annuity (spia, inflation annuity), would be very expensive in pseudo fees if one should die before 85 or soon after reaching 85.
The longevity annuity wouldn't be very expensive. It means at 75 I am buying a delayed life annuity that doesn't begin payments until I turn 85. This is close to pure longevity insurance in case I live beyond life expectancy for a 75 year old male. I checked the pricing. They weren't offering a COLA policy, but the nominal policy best buy was a 30.5% payout rate. So I could get $7,000/year starting at age 85 and purchased at age 75 for about $23,000. I picked $7,000 if my TIPS are supporting $21,000/year and I replace that TIPS income at age 85 by thirds, i.e. purchasing 1/3 @ age 75, 1/3 @ age 80, and 1/3 @ age 84.

BobK
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Re: Using the Funded Ratio to drive your retirement investment plan

Post by jalbert » Wed May 31, 2017 1:12 am

For example, you want to withdrawal $30,000/year ($2,500/month) from your portfolio. Before retirement price a deferred real life annuity that pays out $2,500/month beginning on your expected retirement date.
Where can one find such an annuity? The only DIAs I've seen quote an initial payout in nominal terms and may only be COLA'd after the payout starts.

Also, insurance companies are unlikely to quote a DIA for, say, a 30-year-old retirement saver. They would be trying to estimate the present value of about a 60-year liability, and there are not 60-year market rates available to use as a discount rate. They also would be absorbing the risk of rising life expectancies over a 60-year span of medical advancement.
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Re: Using the Funded Ratio to drive your retirement investment plan

Post by Lieutenant.Columbo » Wed May 31, 2017 4:18 am

bobcat2 wrote:
stlutz wrote:...suppose someone was 50 and was thinking of stopping working and would otherwise live off a 3% withdrawal rate adjusted for inflation having never heard of your ideas...
...at least work part-time longer. I wouldn't encourage any healthy individual to retire before 58, and if you enjoy what you are doing, keep working to a ripe old age
Bob,
In stlutz's example, if that person's portfolio, say 75% stocks and no TIPS, is large enough that his FR is 1 or above, couldn't he just AT THAT POINT convert his portfolio to low equity + TIPS funds and then be ready for retirement? If not, can you explain? Thanks.
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