Grok's LMP-4: The 3-legged stool approach to retirement planning

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grok87
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Grok's LMP-4: The 3-legged stool approach to retirement planning

Post by grok87 » Mon Mar 26, 2018 5:46 pm

Grok's LMP-4: The 3-legged stool approach to retirement planning

Long, long ago in an economy far, far away retirement planners once talked of something called the "3-legged stool."
https://www.investopedia.com/ask/answer ... rement.asp
The idea was for retirees to create a balanced approach to retirement income with 1/3 coming from social security, 1/3 coming from employer pensions, and 1/3 coming from savings/investments.

Employer pensions are now of course largely a thing of the past, covering less than 20% of workers https://www.ssa.gov/policy/docs/ssb/v69n3/v69n3p1.html
While it is possible to fill the void with individual annuities, one needs to be careful about pricing (you'll be paying retail not institutional pricing like a pension plan would), insurer credit risk, and the limitations of the state guArantee fund system (watch the limits and know that this is not a state guarantee, but a post-funded system relying on future assessments on other insurance companies).

An alternate approach for this 2nd leg is to build up a portfolio of long-dated tips and then maybe annuitize sometime in one's early 80s. Let's look at an example in some detail to see how this all might work.

Let's consider a person 50 years old with current salary of $126k. Her aim is to retire at 65 with retirement income of 50% of salary of $63k. Hence the target for each leg of the stool would be $63k/3 = $21 k.

Leg 1: SociAl Security: she runs the calculator and estimates that she can expect to receive $26k per year starting at age 65. This is good news! She is $5k over the target for this leg.

Leg 2: Employer Pension: Now the bad news. She has no employer pension coming. As above, Let's say she plans to fill the void with a portfolio of long-dated tips and perhaps buy an annuity later. How should she go about this?

Since her social security is $5k a year above target, she only needs $16k per year for this leg. She decides to multiply by 30 to cover herself from age 65-95. That works out to $480k. But of course she doesn't need to have that all funded now. Since she is roughLy half way through her career she decides to fund the first half of the $480k tips portfolio now and then fund the 2nd half over the next 15 years.

The next question is what to buy. She could buy individual tips bonds and build a ladder but decides instead to go with a combination of the pimco long-date tips etf LTPZ (average maturity 25.3 years) and the Vanguard tips fund VIPSX (average maturity 8.2 years). Here's how that math might look as she builds it from now till her retirement at age 65:

Age.....tips-portfolio.....for-ages....avg maturity....LTPZ......VIPSX
50........$240k................65-80......22.5 yrs...........$201k....$39k
55........$320k................65-85......20.0 yrs...........$221k....$99k
60........$400k................65-90......17.5. yrs...........$218k....$182k
65........$480k................65-95......15.0 yrs...........$191k.....$289k

Leg 3: savings/investments: after due consideration she decides on a safe-withdrawal-rate of 3.5%. That implies a portfolio of size $21k/0.035 = $600k. She decides to fund this in full and invest it ala David Swensen's portfolio:
$330k vanguard world stock index (55%)
$90k reits (15%)
$90k tips (15%)
$90k treasuries (15%)

A age 50 the overall asset allocation ex social security is 50/50. By age 65 it is down to 39/61.

Cheers,
Grok

Note: this is the 4th in an occasional series on liability matching portfolio strategies.
Keep calm and Boglehead on. KCBO.

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Re: Grok's LMP-4: The 3-legged stool approach to retirement planning

Post by JoeRetire » Mon Mar 26, 2018 5:59 pm

I guess I plan a 2-legged approach. I wish I had a pension coming my way, but I don't. Still I see no need for annuities.

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Re: Grok's LMP-4: The 3-legged stool approach to retirement planning

Post by 2015 » Mon Mar 26, 2018 7:41 pm

No offense, but entirely too much complexity for my taste. In real life, the map is never the territory. Lots of excellent non-fiction books out there on the chasm between theory and reality.

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Re: Grok's LMP-4: The 3-legged stool approach to retirement planning

Post by jalbert » Mon Mar 26, 2018 8:22 pm

Rather than equal thirds, why not just set the asset level of the TIPs and/or annuity leg so that it plus SS covers projected expenses in real terms?

This would then be the income flooring method, and because projected expenses are covered, any remaining assets then could be invested aggressively or moderately aggressively.
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Re: Grok's LMP-4: The 3-legged stool approach to retirement planning

Post by MindBogler » Mon Mar 26, 2018 8:38 pm

The big question mark I have about TIPS generally is how well would they actually track inflation when they were really needed? Let's assume a 1975-85 scenario, would they actually hold up or would the latency between hyperinflation and each periodic 6 month payment / adjustment be too high and eventually erode a significant amount of purchasing power?

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Re: Grok's LMP-4: The 3-legged stool approach to retirement planning

Post by nisiprius » Mon Mar 26, 2018 8:46 pm

Just a little gripe about that "three-legged stool" phrase. I don't know who invented it. It's annoyed me for a long time. It's just a way of taking a chaotic, patchwork, unplanned, irrational, inadequate situation and pretending that it is a rational system designed to meet a need.

It's sort of like college students, hungry at 3 a.m., searching through their kitchen for food and coming up with a bag of Doritos, a cold pizza, and a container of yogurt, and saying "Let's call that a balanced meal."

It's part and parcel of pretending that the 401(k) was somehow designed to be a retirement system, when it was really just a brainstorm Ted Benna had for boosting his consulting business by using a provision of the tax code for a purpose it wasn't designed for.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

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Re: Grok's LMP-4: The 3-legged stool approach to retirement planning

Post by grok87 » Mon Mar 26, 2018 10:00 pm

JoeRetire wrote:
Mon Mar 26, 2018 5:59 pm
I guess I plan a 2-legged approach. I wish I had a pension coming my way, but I don't. Still I see no need for annuities.
That's inteesting. As per my post i am not a huge fan of buying individual annuities at an early age, ie at 65. But i think they can play a useful role later in retirement, say in ones 80s.
Cheers,
Grok
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Re: Grok's LMP-4: The 3-legged stool approach to retirement planning

Post by grok87 » Mon Mar 26, 2018 10:06 pm

2015 wrote:
Mon Mar 26, 2018 7:41 pm
No offense, but entirely too much complexity for my taste. In real life, the map is never the territory. Lots of excellent non-fiction books out there on the chasm between theory and reality.
No offense taken,

Not sure who said "Everything should be made as simple as possible, but not simpler."

My main point is that the duration of the bond side of ones portfolio should have some relation to the duration of ones expected retirement spending needs.

Cheers
Grok
Keep calm and Boglehead on. KCBO.

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Re: Grok's LMP-4: The 3-legged stool approach to retirement planning

Post by grok87 » Mon Mar 26, 2018 10:09 pm

jalbert wrote:
Mon Mar 26, 2018 8:22 pm
Rather than equal thirds, why not just set the asset level of the TIPs and/or annuity leg so that it plus SS covers projected expenses in real terms?

This would then be the income flooring method, and because projected expenses are covered, any remaining assets then could be invested aggressively or moderately aggressively.
It's a good point. I would agree with that approach for those on the cusp of retirement. If one is 15-20 years away, as in the example i posted, i think its hard to estimate your projected expenses.
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Re: Grok's LMP-4: The 3-legged stool approach to retirement planning

Post by grok87 » Mon Mar 26, 2018 10:13 pm

MindBogler wrote:
Mon Mar 26, 2018 8:38 pm
The big question mark I have about TIPS generally is how well would they actually track inflation when they were really needed? Let's assume a 1975-85 scenario, would they actually hold up or would the latency between hyperinflation and each periodic 6 month payment / adjustment be too high and eventually erode a significant amount of purchasing power?
I agree we don't really know how tips will hold up in a hyperinflation scenario. One obvious point is that it would be important to hold them in the tax sheltered accounts in that scenario. Otherwise one would get killed on taxes.
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Re: Grok's LMP-4: The 3-legged stool approach to retirement planning

Post by grok87 » Mon Mar 26, 2018 10:14 pm

nisiprius wrote:
Mon Mar 26, 2018 8:46 pm
Just a little gripe about that "three-legged stool" phrase. I don't know who invented it. It's annoyed me for a long time. It's just a way of taking a chaotic, patchwork, unplanned, irrational, inadequate situation and pretending that it is a rational system designed to meet a need.

It's sort of like college students, hungry at 3 a.m., searching through their kitchen for food and coming up with a bag of Doritos, a cold pizza, and a container of yogurt, and saying "Let's call that a balanced meal."

It's part and parcel of pretending that the 401(k) was somehow designed to be a retirement system, when it was really just a brainstorm Ted Benna had for boosting his consulting business by using a provision of the tax code for a purpose it wasn't designed for.
Thanks.
You might be interested in this link.
https://www.ssa.gov/history/stool.html
Keep calm and Boglehead on. KCBO.

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Re: Grok's LMP-4: The 3-legged stool approach to retirement planning

Post by MindBogler » Mon Mar 26, 2018 10:38 pm

grok87 wrote:
Mon Mar 26, 2018 10:13 pm
I agree we don't really know how tips will hold up in a hyperinflation scenario. One obvious point is that it would be important to hold them in the tax sheltered accounts in that scenario. Otherwise one would get killed on taxes.
I suppose it would be fair to say that they would retain more of their value than a nominal bond of the same duration, which would get destroyed. Maybe that is the the best possible outcome given rapid inflation which is probably the worst case realistic scenario for bonds?

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Re: Grok's LMP-4: The 3-legged stool approach to retirement planning

Post by stlutz » Tue Mar 27, 2018 12:16 am

Grok: Can I propose more of a challenge for you? Somebody who has $1M at age 65 can do the mental arithmetic any number of ways but still be able to fund a quite comfortable lifestyle for the duration of their retirement.

Someone who retires with $300K is still well above average in terms of savings. How do you recommend that this person/couple approach the subject?

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Re: Grok's LMP-4: The 3-legged stool approach to retirement planning

Post by jalbert » Tue Mar 27, 2018 4:18 am

It's a good point. I would agree with that approach for those on the cusp of retirement. If one is 15-20 years away, as in the example i posted, i think its hard to estimate your projected expenses.
15-20 years from retirement I would just suggest an investment portfolio with a suitable asset allocation. Dividing the assets to be 50% TIPs ladder and 50% investment portfolio seems very conservative if 15-20 years from retirement.

At the cusp of retirement, some (or all if necessary) of the portfolio would be converted to assets that would combine with SS and any pensions to create an income floor.
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Re: Grok's LMP-4: The 3-legged stool approach to retirement planning

Post by Grt2bOutdoors » Tue Mar 27, 2018 6:15 am

grok87 wrote:
Mon Mar 26, 2018 10:13 pm
MindBogler wrote:
Mon Mar 26, 2018 8:38 pm
The big question mark I have about TIPS generally is how well would they actually track inflation when they were really needed? Let's assume a 1975-85 scenario, would they actually hold up or would the latency between hyperinflation and each periodic 6 month payment / adjustment be too high and eventually erode a significant amount of purchasing power?
I agree we don't really know how tips will hold up in a hyperinflation scenario. One obvious point is that it would be important to hold them in the tax sheltered accounts in that scenario. Otherwise one would get killed on taxes.
And therein lies the quandary - one in their 40s and early 50’s a) may not have access to a brokerage window in retirement plan and b) may not have enough in assets to dedicate any meaningful amount towards Tips and or annuities; and c) may be better suited towards investing their money with an eye towards growth; d) if and when they did hold Tips in taxable, clicking the button “sell” could alleviate them of an undesirable tax situation - worrying about hyperinflation. If we have hyperinflation in this country, the tax situation will be least of problems.
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Re: Grok's LMP-4: The 3-legged stool approach to retirement planning

Post by Nestegg_User » Tue Mar 27, 2018 6:40 am

nisiprius wrote:
Mon Mar 26, 2018 8:46 pm
Just a little gripe about that "three-legged stool" phrase. I don't know who invented it. It's annoyed me for a long time. It's just a way of taking a chaotic, patchwork, unplanned, irrational, inadequate situation and pretending that it is a rational system designed to meet a need.

It's sort of like college students, hungry at 3 a.m., searching through their kitchen for food and coming up with a bag of Doritos, a cold pizza, and a container of yogurt, and saying "Let's call that a balanced meal."

It's part and parcel of pretending that the 401(k) was somehow designed to be a retirement system, when it was really just a brainstorm Ted Benna had for boosting his consulting business by using a provision of the tax code for a purpose it wasn't designed for.
C’mon Nisi
You know that a balanced meal at that time would also have to include :beer

(Alas, I couldn’t afford that part of the “balanced” meal in undergrad or grad school back in the day. I do remember pilchards (half the price of tuna) and ramen; many decades later I still don’t touch those ...)

I agree though.... trying to arrange finances on an outdated model isn’t really illustrative nor useful for the current generation. Better to simply describe a portfolio that can effectively supplement SS - a model far more people will find useful, and then you only need to talk about the survivability of ....(let’s not go there)

and while we have all three legs, we may add a fourth leg (SPIA) in the future: it’s more stable
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Re: Grok's LMP-4: The 3-legged stool approach to retirement planning

Post by rkhusky » Tue Mar 27, 2018 6:48 am

jalbert wrote:
Mon Mar 26, 2018 8:22 pm
Rather than equal thirds, why not just set the asset level of the TIPs and/or annuity leg so that it plus SS covers projected expenses in real terms?

This would then be the income flooring method, and because projected expenses are covered, any remaining assets then could be invested aggressively or moderately aggressively.
The interesting thing about a 3-legged stool is that the legs always make contact with the floor, no matter how bumpy the floor. The same is not true of a 4-legged chair. And one can make the seat level by changing the lengths of the legs. Therefore, I don't see why the analogy would require equal size legs. Self-adjusting legs would be ideal.

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Re: Grok's LMP-4: The 3-legged stool approach to retirement planning

Post by Nestegg_User » Tue Mar 27, 2018 6:54 am

husky

I think companies have “adjusted” one leg of the stool quite a bit over time :twisted:

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Re: Grok's LMP-4: The 3-legged stool approach to retirement planning

Post by 2pedals » Tue Mar 27, 2018 7:48 am

Grok

What is wrong with the hybrid endowment approach with 2% fixed withdrawal and 2% variable withdrawal, using 50% stocks and 50% bonds? The 50% of bonds can be TIPS, CDs, bond funds, Ibonds, etc for diversity. The withdrawal method should account for a rising or falling market with a portion of the withdrawal fixed (and adjusted for inflation) at retirement, i.e. use 2% fixed and 2% variable based on portfolio value. The social security portion is an additional amount above the withdrawal.

Would it be too challenging to have a variable withdrawal method that protects some markets risks, such as sequence of returns? I don't think it would be, if withdrawals and SS cover more that the basic living expenses, say 125%.

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Re: Grok's LMP-4: The 3-legged stool approach to retirement planning

Post by nisiprius » Tue Mar 27, 2018 8:00 am

grok87 wrote:
Mon Mar 26, 2018 10:14 pm
nisiprius wrote:
Mon Mar 26, 2018 8:46 pm
Just a little gripe about that "three-legged stool" phrase. I don't know who invented it. It's annoyed me for a long time. It's just a way of taking a chaotic, patchwork, unplanned, irrational, inadequate situation and pretending that it is a rational system designed to meet a need...
Thanks.
You might be interested in this link.
https://www.ssa.gov/history/stool.html
:o :!: :!: :!: :D
Yes, that's quite interesting, thank you.

It does, however, confirm my bias/preconception that "three-legged stool" is basically a euphemistic way of saying "Social Security isn't fully adequate by itself." And that the "three-legged stool" metaphor was added by an insurance company representative who wanted to advocate insurance products as the appropriate way to provide the rest.

By the way, I don't know exactly what he means by "individual insurance . . . the second, a variety of employee benefit plans of which Group insurance is an outstanding American contribution," do you?
Nestegg_User wrote:
Tue Mar 27, 2018 6:54 am
...I think companies have “adjusted” one leg of the stool quite a bit over time :twisted:
When I hear "three-legged stool" I always think of Victor Borge's comedy routine in which he demonstrates how the famous "On the Trail" part of Ferde Grofe's "Grand Canyon Suite" could have been inspired by a piano stool with unequal legs.
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Re: Grok's LMP-4: The 3-legged stool approach to retirement planning

Post by Ron » Tue Mar 27, 2018 8:41 am

grok87 wrote:
Mon Mar 26, 2018 10:00 pm
JoeRetire wrote:
Mon Mar 26, 2018 5:59 pm
I guess I plan a 2-legged approach. I wish I had a pension coming my way, but I don't. Still I see no need for annuities.
That's inteesting. As per my post i am not a huge fan of buying individual annuities at an early age, ie at 65. But i think they can play a useful role later in retirement, say in ones 80s.
Cheers,
Grok
Being contrarian, I purchased an SPIA shortly after my retirement at age 59. Its intent was to provide me with a constant source of income beyond just my investments and act the same way as a private company pension would (e.g. not inflation adjusted, but 100% to the survivor). My company had a pension when I started with them back in '79, but by 1983 it was eliminated. It also provided a bit of market risk protection for an unknown future. Sure, we can debate if it was a good idea with the market increases from 2010-17, but those facts were not known at the time - especially the fact that the market would tank in 2008-09, just a few months after I retired and purchased the SPIA.

The idea was not only to replicate a pension, but also act as "gap insurance" for the period of my retirement at age 59 until FRA SS, a period of seven years. What actually happened is that it worked well (under a low inflation period) that I delayed SS until this year, at age 70. The SPIA continues to provide income on top of SS (and a small VA disability) to act as a "topping" to my SS "sundae".

Being that I'm a graybeard that has gone through the decisions at a younger age, I have no regrets on the action I took to provide income protection early in retirement, along with much larger SS income (along with a superior survivor benefit for my wife, assuming I pass first) and her receiving 100% of the SPIA income until she passes. BTW, any remaining SPIA payments up to age 87 will be paid to our estate, assuming one/both do not make it to that age. In addition, at the time of my retirement and SPIA purchase, I/we were unaware of the SS file/suspend option. We were lucky to take advantage of that option due to our age, resulting in my wife receiving over $60k over the last four years as she delayed her SS until this year, also at age 70. Both her and my delay of SS results in combined additional income that equal our age going forward, in addition to other sources of income, which include the SPIA.

Just another actual situation for comparison, FWIW.

- Ron

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Re: Grok's LMP-4: The 3-legged stool approach to retirement planning

Post by montanagirl » Tue Mar 27, 2018 8:53 am

New 3-legged stool: 1. Social Security, 2. defined contribution savings, 3. paid-off house.

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Re: Grok's LMP-4: The 3-legged stool approach to retirement planning

Post by bobcat2 » Tue Mar 27, 2018 8:55 am

The LMP Grok proposes is the poor man’s version of the liability driven investment (LDI) strategy Robert Merton has proposed for retirement income. Merton has written two short accessible articles about his strategy and here are links to the articles.

Link- https://www.nestpensions.org.uk/schemew ... cs,PDF.pdf

Link- https://myhbp.org/leadingedge/d/cla?&c= ... 4f47c9f666

Here’s a brief overview of Merton’s proposal. In addition to SS the investor has a 401k and other retirement assets such as an IRA and/or investments that are not tax advantaged. SS and the 401k are used to meet the retirement income goal and the other assets are used for a reserve fund for large special expenditures, bequests, and possibly moving above the income goal.

The LDI strategy early on with regard to the 401k consists of a US stock index fund, an international stock index fund, and a LT bond fund. The 401k is intended to provide all the retirement income beyond the income provided by SS. In the 401k the funded ratio (FR) is used to monitor progress toward meeting the retirement income goal that the 401k assets are targeted to meet. A deferred real life annuity is used to price the denominator of the FR.

Once the investor is less than 20 years from his retirement date the LDI strategy kicks in full force and in the 401k portfolio there is, in addition to the two stock funds, a ST TIPS fund and a LT TIPS fund whose weighted average duration is matched to the duration of the retirement liability, i.e. the duration of the targeted retirement income stream.

If the investor can get the FR to be 1.00 or greater as he approaches retirement, then at least 80% of the annuity price (the denominator of the FR) will be duration matched to the TIPS funds. Assuming the FR is 1.00 or greater at retirement the 401k assets are divided between purchasing a real or graded life annuity and TIPS assets that are mainly duration matched to age 85. The duration matched TIPS assets are the equivalent of a TIPS ladder to age 85. It is up to the investor to decide how much of the income from the 401k assets should be allocated to longevity protected annuitized income vs more flexible conservative income in TIPS that lack longevity protection. The rest of the TIPS assets are invested in a longevity annuity or annuities to replace the TIPS income beyond age 85. This post age 85 longevity protection can be purchased early in retirement or in chunks over time as the retiree ages.

While Grok proposes this be done by individual investors, Merton believes the managers of the 401k assets should be managing the portfolio to reach the retirement income goal. I agree with Merton that very few individual investors could successfully execute this strategy. Read the two Merton articles for a more in-depth and incisive discussion of the LDI retirement strategy.

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Re: Grok's LMP-4: The 3-legged stool approach to retirement planning

Post by livesoft » Tue Mar 27, 2018 9:03 am

bob09245 had a similar setup discussed back in 2012. I don't think we can find any of that stuff anymore.
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Re: Grok's LMP-4: The 3-legged stool approach to retirement planning

Post by iceport » Tue Mar 27, 2018 10:01 am

livesoft wrote:
Tue Mar 27, 2018 9:03 am
bob09245 had a similar setup discussed back in 2012. I don't think we can find any of that stuff anymore.
Yes, and that's a shame. I skimmed enough of his site to get the basic gist, but planned to delve into it more thoroughly when I got closer to retirement. His graphics were excellent, and helped to clarify the concepts he introduced. Unfortunately, it all went away before I got back to it. I think nisiprius found some of the text a while back at archive.org, but the graphics are gone.
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Re: Grok's LMP-4: The 3-legged stool approach to retirement planning

Post by staythecourse » Tue Mar 27, 2018 10:13 am

Thanks for the mental walk through of your idea.

I am an amateur when it comes to bonds (probably because I don't own any), but what are the adv. and diadv. of using zero coupon 30 year treasuries bought at 50 to cover to 80. Somehow I remember reading about that as an idea of covering known future liabilities.

Thanks in advance.

Good luck.
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Re: Grok's LMP-4: The 3-legged stool approach to retirement planning

Post by Doc » Tue Mar 27, 2018 10:16 am

grok87 wrote:
Mon Mar 26, 2018 5:46 pm
The next question is what to buy. She could buy individual tips bonds and build a ladder but decides instead to go with a combination of the pimco long-date tips etf LTPZ (average maturity 25.3 years) and the Vanguard tips fund VIPSX (average maturity 8.2 years). Here's how that math might look as she builds it from now till her retirement at age 65:

Age.....tips-portfolio.....for-ages....avg maturity....LTPZ......VIPSX
50........$240k................65-80......22.5 yrs...........$201k....$39k
55........$320k................65-85......20.0 yrs...........$221k....$99k
60........$400k................65-90......17.5. yrs...........$218k....$182k
65........$480k................65-95......15.0 yrs...........$191k.....$289k
As usual grok has some very good ideas on a retirement portfolio except for using long term TIPS now.

Here's the dilemma:

Image
https://www.treasury.gov/resource-cente ... ation.aspx

Long term real yields are only half of what they were pre Lehman. I don't want to take that loss for 25.3 years.

Replace at least some of the LTPZ with VIPSX for the next 8.2 years and I'll buy in completely. :sharebeer
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Re: Grok's LMP-4: The 3-legged stool approach to retirement planning

Post by bobcat2 » Tue Mar 27, 2018 10:32 am

Doc wrote:
Tue Mar 27, 2018 10:16 am
grok87 wrote:
Mon Mar 26, 2018 5:46 pm
The next question is what to buy. She could buy individual tips bonds and build a ladder but decides instead to go with a combination of the pimco long-date tips etf LTPZ (average maturity 25.3 years) and the Vanguard tips fund VIPSX (average maturity 8.2 years). Here's how that math might look as she builds it from now till her retirement at age 65:

Age.....tips-portfolio.....for-ages....avg maturity....LTPZ......VIPSX
50........$240k................65-80......22.5 yrs...........$201k....$39k
55........$320k................65-85......20.0 yrs...........$221k....$99k
60........$400k................65-90......17.5. yrs...........$218k....$182k
65........$480k................65-95......15.0 yrs...........$191k.....$289k
As usual grok has some very good ideas on a retirement portfolio except for using long term TIPS now.

Here's the dilemma:
Long term real yields are only half of what they were pre Lehman. I don't want to take that loss for 25.3 years.
Replace at least some of the LTPZ with VIPSX for the next 8.2 years and I'll buy in completely. :sharebeer
This is a misunderstanding of both Merton's plan and Grok's more simplistic plan. The long TIPS fund is needed because the duration of the VIPSX TIPS fund is too short for the duration matching to work. These plans depend on duration matching to succeed. Take the LT TIPS etf out of the mix and this plan doesn't exist.

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Re: Grok's LMP-4: The 3-legged stool approach to retirement planning

Post by Doc » Tue Mar 27, 2018 10:50 am

bobcat2 wrote:
Tue Mar 27, 2018 10:32 am
This is a misunderstanding of both Merton's plan and Grok's more simplistic plan. The long TIPS fund is needed because the duration of the VIPSX TIPS fund is too short for the duration matching to work. These plans depend on duration matching to succeed. Take the LT TIPS etf out of the mix and this plan doesn't exist.
You missed the now. The idea is to use shorter term TIPS now because the yield curve is very flat and roll them into longer term in ~10 years when hopefully the curve will have gone back to more historical norms. You give up a little real yield in the shorter term for the expectation of getting higher real yields over the longer term while still retaining you inflation protection.

In grok's ladder threads I've recommended tens now rolling them into twenty's when they mature. You have a little less flexibility to fine adjust using funds instead of a ladder but the idea is the same. The heavy front loading in the current proposal also complicates the math.
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Re: Grok's LMP-4: The 3-legged stool approach to retirement planning

Post by bobcat2 » Tue Mar 27, 2018 11:00 am

Doc wrote:
Tue Mar 27, 2018 10:50 am
bobcat2 wrote:
Tue Mar 27, 2018 10:32 am
This is a misunderstanding of both Merton's plan and Grok's more simplistic plan. The long TIPS fund is needed because the duration of the VIPSX TIPS fund is too short for the duration matching to work. These plans depend on duration matching to succeed. Take the LT TIPS etf out of the mix and this plan doesn't exist.
You missed the now.
I didn't miss the now. Your suggestion doesn't work with either of these plans now or in the future. You have to duration match between now and the end of your retirement in these plans. That's an average duration a lot longer than 8 years when you are in your 60s or younger. What you are doing is not what either of these plans are doing.

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Re: Grok's LMP-4: The 3-legged stool approach to retirement planning

Post by SGM » Tue Mar 27, 2018 11:10 am

Three legged stool was a pretty adequate description for one parent who had a defined benefit plan and SS. The third leg was savings in the form of a house that had appreciated greatly in value.

Another parent had real estate income, SS, a portfolio of stocks and bonds and a home. Maybe a 4 legged easy chair.

We opted for a 8-legged L shaped couch. :D

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Re: Grok's LMP-4: The 3-legged stool approach to retirement planning

Post by Doc » Tue Mar 27, 2018 11:19 am

bobcat2 wrote:
Tue Mar 27, 2018 11:00 am
You have to duration match between now and the end of your retirement in these plans.
You don't have to match it all now although you do have to make the investment now. In the ladder example which is easier to visualize you buy a ten now instead of a thirty. When that ten matures you replace it with a twenty. The matching still exists. You are matching an obligation thirty years in the future with money invested today in both cases. The difference is giving up some real yield for the first 10 years with the expectation of more than making it up in the last 20 years because the real yield curve is currently flatter than historical norms. It is just a nuance on grok's "LMP with TIPS" basic idea.

Grok's argument against this idea is that he is not counting on the coupon anyway and that's fine. But giving up 1% for ten years and gaining 1% for twenty seems like a reasonable approach to me. That's a 10% difference in what your have to spend when you're 80. Either way you keep the inflation component the same.
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Re: Grok's LMP-4: The 3-legged stool approach to retirement planning

Post by Socal77 » Tue Mar 27, 2018 11:20 am

nisiprius wrote:
Mon Mar 26, 2018 8:46 pm
Just a little gripe about that "three-legged stool" phrase. I don't know who invented it. It's annoyed me for a long time. It's just a way of taking a chaotic, patchwork, unplanned, irrational, inadequate situation and pretending that it is a rational system designed to meet a need.

It's sort of like college students, hungry at 3 a.m., searching through their kitchen for food and coming up with a bag of Doritos, a cold pizza, and a container of yogurt, and saying "Let's call that a balanced meal."

It's part and parcel of pretending that the 401(k) was somehow designed to be a retirement system, when it was really just a brainstorm Ted Benna had for boosting his consulting business by using a provision of the tax code for a purpose it wasn't designed for.
Are you sure you aren't taking the "3 legged stool" metphaphor too personally for some reason? If what you say is correct about a guy with connections creating a rent seeking opportunity for himself I understand your angst. But it sounds more like he just saw the benefit and publicized it to his clients, which sounds mutually beneficial to me.

I wrote a paper about when to retire in college which included references to the "3 legged stool" and my interpretation is that it is just a metaphor for how stable your retirement could be. It could take other forms such as including a couple with 2 social security payments and 2 401K payments and then be considered a chair implying a more stable retirement.

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Re: Grok's LMP-4: The 3-legged stool approach to retirement planning

Post by bobcat2 » Tue Mar 27, 2018 11:41 am

Doc, there is a difference between safely duration matching retirement assets and betting on higher LT yields in the future. Insurance companies don't fail to duration match bond assets with annuity liabilities because they think LT yields will go up in the future. If you can't see the difference, there is no point in continuing the discussion.

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Re: Grok's LMP-4: The 3-legged stool approach to retirement planning

Post by nisiprius » Tue Mar 27, 2018 11:56 am

Serious question. Is there, in fact, any real body of real-life data on the actual experiences of real retirees who have actually closely followed one or another retirement plan?

My preconception is that no, I doubt that there is. Before the 401(k) became really popular, which probably means some time in the late 1980s, I don't think there were very many ordinary people saving for retirement out of salary and investing it in stocks, bonds, or mutual funds. It's all paper and theory. All of the very confident advice I was given in my employer's retirement seminar on What To Do was theory based on backtesting, not real-world application of any of that advice.

It is only about now that, for the first time, we are getting real retirees who are sitting on rickety stools with several unequal-length legs.

(And TIPS of course were not available until, was it 1997? I bought my first in 1998, and for the entire time I've been holding TIPS in various forms, I've heard nothing but a drumbeat of reasons why TIPS suck, while for the entire time they have in fact done reasonably well. Possibly Doc's guidance would have done better, but reasonably well, no complaints, not even in 2008.)
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Re: Grok's LMP-4: The 3-legged stool approach to retirement planning

Post by B. Wellington » Tue Mar 27, 2018 12:03 pm

grok87 wrote:
Mon Mar 26, 2018 10:06 pm
2015 wrote:
Mon Mar 26, 2018 7:41 pm
No offense, but entirely too much complexity for my taste. In real life, the map is never the territory. Lots of excellent non-fiction books out there on the chasm between theory and reality.
No offense taken,

Not sure who said "Everything should be made as simple as possible, but not simpler."


My main point is that the duration of the bond side of ones portfolio should have some relation to the duration of ones expected retirement spending needs.

Cheers
Grok
grok, I believe it was Albert Einstein...? :beer

I also try to keep my investing life as simple as possible these days.

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Re: Grok's LMP-4: The 3-legged stool approach to retirement planning

Post by B. Wellington » Tue Mar 27, 2018 12:14 pm

nisiprius wrote:
Tue Mar 27, 2018 11:56 am
Serious question. Is there, in fact, any real body of real-life data on the actual experiences of real retirees who have actually closely followed one or another retirement plan?

My preconception is that no, I doubt that there is. Before the 401(k) became really popular, which probably means some time in the late 1980s, I don't think there were very many ordinary people saving for retirement out of salary and investing it in stocks, bonds, or mutual funds. It's all paper and theory. All of the very confident advice I was given in my employer's retirement seminar on What To Do was theory based on backtesting, not real-world application of any of that advice.

It is only about now that, for the first time, we are getting real retirees who are sitting on rickety stools with several unequal-length legs.

(And TIPS of course were not available until, was it 1997? I bought my first in 1998, and for the entire time I've been holding TIPS in various forms, I've heard nothing but a drumbeat of reasons why TIPS suck, while for the entire time they have in fact done reasonably well. Possibly Doc's guidance would have done better, but reasonably well, no complaints, not even in 2008.)
+1 Agree, and much of that "planning" was done with yields and advice very different than today.

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Re: Grok's LMP-4: The 3-legged stool approach to retirement planning

Post by bobcat2 » Tue Mar 27, 2018 12:38 pm

Some differences between Merton LDI strategy and Grok LMP

How is plan success or failure monitored?
Merton -
Funded ratio (FR) beginning in investor’s late 20s or early 30s and continuing throughout life.

Grok -
Withdrawal rate picked at age 50. WR uses arbitrary 30x criterion for part of retirement income.


How are bonds and income matched?
Merton-
Duration matched

Grok-
Talks vaguely about bond maturities.


How is saving rate and retirement year determined?
Merton -
Both are conditioned on how well the investor's FR is approaching 1.00 over time. Both can change over time as the FR evolves over time.

Grok -
Neither the saving rate or changing the retirement year is addressed.


How is allocation to TIPS assets vs equities determined prior to retirement?
Merton -
AA between TIPS and equities is determined over time conditional on how values of FR evolve over time.

Grok -
Arbitrarily picks 50% allocation to TIPS at age 50 and increases that allocation to 61% at age 65. Criteria for this increase is not given.


What are the retirement income assets early in retirement?
Merton -
SS
TIPS ladder replication using mutual funds
Life annuity
Remaining portfolio can be used to increase income from TIPS

Grok -
SS
TIPS ladder replication using mutual funds
Portfolio withdrawals


What are the retirement income assets late in retirement? (Beyond age 85)
Merton -
SS
Life annuity
Longevity annuity

Grok -
SS
TIPS ladder replication using mutual funds
Life annuity
Portfolio withdrawals


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Re: Grok's LMP-4: The 3-legged stool approach to retirement planning

Post by jalbert » Tue Mar 27, 2018 1:09 pm

The LDI strategy early on with regard to the 401k consists of a US stock index fund, an international stock index fund, and a LT bond fund.
I don’t think a 1-size-fits-all asset location mapping is going to be tax efficient for all retirement savers.
Risk is not a guarantor of return.

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Re: Grok's LMP-4: The 3-legged stool approach to retirement planning

Post by bobcat2 » Tue Mar 27, 2018 1:24 pm

jalbert wrote:
Tue Mar 27, 2018 1:09 pm
The LDI strategy early on with regard to the 401k consists of a US stock index fund, an international stock index fund, and a LT bond fund.
I don’t think a 1-size-fits-all asset location mapping is going to be tax efficient for all retirement savers.
You can add more stock funds if you want, but this is a simple portfolio that will work. An even simpler portfolio would be a global stock index fund. The point is there isn't a whole lot of gain after the two stock funds that cover the globe and expecting a much better portfolio by holding more than six stock funds is most likely wishful thinking. And remember these are holdings in the tax advantaged defined contribution plan only. We want to hold a portfolio in our 401k that produces a reliable stream of retirement income. Retirement income from the DC plan and SS together is targeted to meet our retirement income goal. We are not counting on other financial assets that are not tax advantaged to meet the retirement income goal.

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Re: Grok's LMP-4: The 3-legged stool approach to retirement planning

Post by Doc » Tue Mar 27, 2018 1:40 pm

bobcat2 wrote:
Tue Mar 27, 2018 11:41 am
Doc, there is a difference between safely duration matching retirement assets and betting on higher LT yields in the future. Insurance companies don't fail to duration match bond assets with annuity liabilities because they think LT yields will go up in the future. If you can't see the difference, there is no point in continuing the discussion
  • "Doc, there is a difference between safely duration matching retirement assets and betting on higher LT yields in the future." Yes. I'm just suggesting there is a less expensive (aka higher return) alternative that offers the same insurance.
  • "Insurance companies don't fail to duration match bond assets with annuity liabilities because they think LT yields will go up in the future." Of course not. They add up their expenses and the risk that their investments won't live up to their expectations and they charge you and I and gork accourdingly. This is one of grok's points stated in different words. "Do it yourself" may be a better choice.
  • "If you can't see the difference, there is no point in continuing the discussion." Of course I can see the difference. The insurance companies don't think that rates will go up in the future. Instead they charge more (or offer less) becaue they think the future returns might be less. That's the whole reason why we, as informed individuals are looking at a "do it yourself" inflation protected plan. My only "disagreement" with grok is that I don't think you should commit for thirty years when the long term real rates are below norm by a significant amount. Just buy yourself some insurance. Insurance for ten years that you can extend for another ten or twenty years at little of no course and perhaps less cost (more return). As long as the cost is not too great if rates do increase we come out ahead. We all do that in our everyday lives. Do you have fire insurance on your house or liability insurance on your car? It is money we are willing to spend now, just in case.
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Re: Grok's LMP-4: The 3-legged stool approach to retirement planning

Post by bobcat2 » Tue Mar 27, 2018 2:17 pm

Doc wrote:
Tue Mar 27, 2018 1:40 pm
The insurance companies don't think that rates will go up in the future. Instead they charge more (or offer less) becaue they think the future returns might be less.
No. That is not the reason for the way insurance companies invest in bonds. They duration match bonds against annuity liabilities to shield their financial status from exposure to interest rate fluctuations. In other words, they immunize their financial status against interest rate risk. Usually they do this by duration matching their bond assets to their annuity liabilities. By duration matching it doesn't matter what interest rates do, the insurance company will have the assets to pay the annuity claims. If interest rates go up their duration matched bonds will go down in capital value, but the bond holdings will be reinvested at a higher rate. With duration matching the two effects will be offsetting. If interest rates fall, their duration matched bonds will go up in capital value, but the bonds will be reinvested at a lower rate. Again with duration matching the two effects will be offsetting.

The insurance companies aren't making any forecasts about future interest rates. They are instead hedging interest rate risk with regard to their liabilities by duration matching assets to claims and thereby immunizing themselves against interest rate risks.

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Re: Grok's LMP-4: The 3-legged stool approach to retirement planning

Post by smitcat » Tue Mar 27, 2018 2:23 pm

bobcat2 wrote:
Tue Mar 27, 2018 2:17 pm
Doc wrote:
Tue Mar 27, 2018 1:40 pm
The insurance companies don't think that rates will go up in the future. Instead they charge more (or offer less) becaue they think the future returns might be less.
No. That is not the reason for the way insurance companies invest in bonds. They duration match bonds against annuity liabilities to shield their financial status from exposure to interest rate fluctuations. In other words, they immunize their financial status against interest rate risk. Usually they do this by duration matching their bond assets to their annuity liabilities. By duration matching it doesn't matter what interest rates do, the insurance company will have the assets to pay the annuity claims. If interest rates go up their duration matched bonds will go down in capital value, but the bond holdings will be reinvested at a higher rate. With duration matching the two effects will be offsetting. If interest rates fall, their duration matched bonds will go up in capital value, but the bonds will be reinvested at a lower rate. Again with duration matching the two effects will be offsetting.

The insurance companies aren't making any forecasts about future interest rates. They are instead hedging interest rate risk with regard to their liabilities by duration matching assets to claims and thereby immunizing themselves against interest rate risks.

BobK
BobK,

I am a small business owner that comes to this site to get ideas and insights. I have no formal education or affiliation with any financial institutions or any products that they may offer.
I have read a number of your posts now and they appear to come from some form or experience or career education.

What industry are you in? Are you affiliated with any of the industries or products associated with investing and retirement? If so what is your connection/affiliation?
Thank you

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Re: Grok's LMP-4: The 3-legged stool approach to retirement planning

Post by grok87 » Tue Mar 27, 2018 2:56 pm

MindBogler wrote:
Mon Mar 26, 2018 10:38 pm
grok87 wrote:
Mon Mar 26, 2018 10:13 pm
I agree we don't really know how tips will hold up in a hyperinflation scenario. One obvious point is that it would be important to hold them in the tax sheltered accounts in that scenario. Otherwise one would get killed on taxes.
I suppose it would be fair to say that they would retain more of their value than a nominal bond of the same duration, which would get destroyed. Maybe that is the the best possible outcome given rapid inflation which is probably the worst case realistic scenario for bonds?
Agree
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Re: Grok's LMP-4: The 3-legged stool approach to retirement planning

Post by grok87 » Tue Mar 27, 2018 2:59 pm

stlutz wrote:
Tue Mar 27, 2018 12:16 am
Grok: Can I propose more of a challenge for you? Somebody who has $1M at age 65 can do the mental arithmetic any number of ways but still be able to fund a quite comfortable lifestyle for the duration of their retirement.

Someone who retires with $300K is still well above average in terms of savings. How do you recommend that this person/couple approach the subject?
Fair enough. But I guess we need that persons salary and social security income to further flesh out the example?
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Re: Grok's LMP-4: The 3-legged stool approach to retirement planning

Post by grok87 » Tue Mar 27, 2018 3:09 pm

jalbert wrote:
Tue Mar 27, 2018 4:18 am
It's a good point. I would agree with that approach for those on the cusp of retirement. If one is 15-20 years away, as in the example i posted, i think its hard to estimate your projected expenses.
15-20 years from retirement I would just suggest an investment portfolio with a suitable asset allocation. Dividing the assets to be 50% TIPs ladder and 50% investment portfolio seems very conservative if 15-20 years from retirement.

At the cusp of retirement, some (or all if necessary) of the portfolio would be converted to assets that would combine with SS and any pensions to create an income floor.
So to be clear, in my example, at age 50 the tips ladder was $240k and the investment portfolio was $600k for a total of $840k. Of the $600k investment portfolio, 70% was in equities or $420k. Thus the overall stock/bond split was 50/50, ie in line with an age-in-bonds approach.

As I understand it your view is to wait To create a supplemental income floor until the year or two before retirement. The problem I see with that is what if Long term tips rates are very low at that point like they were around 5 years ago? You would then be overpaying for those bonds...
Cheers,
Grok
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Re: Grok's LMP-4: The 3-legged stool approach to retirement planning

Post by grok87 » Tue Mar 27, 2018 3:14 pm

Grt2bOutdoors wrote:
Tue Mar 27, 2018 6:15 am
grok87 wrote:
Mon Mar 26, 2018 10:13 pm
MindBogler wrote:
Mon Mar 26, 2018 8:38 pm
The big question mark I have about TIPS generally is how well would they actually track inflation when they were really needed? Let's assume a 1975-85 scenario, would they actually hold up or would the latency between hyperinflation and each periodic 6 month payment / adjustment be too high and eventually erode a significant amount of purchasing power?
I agree we don't really know how tips will hold up in a hyperinflation scenario. One obvious point is that it would be important to hold them in the tax sheltered accounts in that scenario. Otherwise one would get killed on taxes.
And therein lies the quandary - one in their 40s and early 50’s a) may not have access to a brokerage window in retirement plan
That’s why I wanted to give a shout out to the LTPZ etf. Some people may not be comfortable or able to buy individual bonds (which I actually prefer). But more people may have access to ETFs in their retirement IRAs.

Cheers,
Grok
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Re: Grok's LMP-4: The 3-legged stool approach to retirement planning

Post by grok87 » Tue Mar 27, 2018 3:18 pm

Nestegg_User wrote:
Tue Mar 27, 2018 6:40 am
nisiprius wrote:
Mon Mar 26, 2018 8:46 pm
Just a little gripe about that "three-legged stool" phrase. I don't know who invented it. It's annoyed me for a long time. It's just a way of taking a chaotic, patchwork, unplanned, irrational, inadequate situation and pretending that it is a rational system designed to meet a need.

It's sort of like college students, hungry at 3 a.m., searching through their kitchen for food and coming up with a bag of Doritos, a cold pizza, and a container of yogurt, and saying "Let's call that a balanced meal."

It's part and parcel of pretending that the 401(k) was somehow designed to be a retirement system, when it was really just a brainstorm Ted Benna had for boosting his consulting business by using a provision of the tax code for a purpose it wasn't designed for.
C’mon Nisi
You know that a balanced meal at that time would also have to include :beer

(Alas, I couldn’t afford that part of the “balanced” meal in undergrad or grad school back in the day. I do remember pilchards (half the price of tuna) and ramen; many decades later I still don’t touch those ...)

I agree though.... trying to arrange finances on an outdated model isn’t really illustrative nor useful for the current generation. Better to simply describe a portfolio that can effectively supplement SS - a model far more people will find useful, and then you only need to talk about the survivability of ....(let’s not go there)

and while we have all three legs, we may add a fourth leg (SPIA) in the future: it’s more stable
Just curious if you are thinking about adding a regular SPIA or an inflation adjusted one.
Keep calm and Boglehead on. KCBO.

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Re: Grok's LMP-4: The 3-legged stool approach to retirement planning

Post by Doc » Tue Mar 27, 2018 3:22 pm

bobcat2 wrote:
Tue Mar 27, 2018 2:17 pm
No. That is not the reason for the way insurance companies invest in bonds. They duration match bonds against annuity liabilities to shield their financial status from exposure to interest rate fluctuations. In other words, they immunize their financial status against interest rate risk.
OK I didn't know the fine points. So if they do exactly what you say they do they are matching the maturity value of their bonds to their liabilities. And just pocketing the coupons? Maybe. But how would they be able to sell an insurance policy that just guarantees you get back what you put in and no more. That's the same as a FDIC insured bank account paying zero interest. OK so they are going to give us the coupons also. But then they don't make any money. The insurance company has to make money and it has to avoid all risk that exceed their retained earnings. Grok made some comment about not being able to buy an inflation adjusted annuity. In order to do this the insurance company would have to sell that policy today at one percent real less their overhead and profit. Do you think they would sell many of those annuities? Why not go grok's way. Today we can earn the 1% real and have virtually no expense by buying TIPS at auction. Or we can buy a ladder on the secondary market that looks like the fund portfolio.

Any way you look at it if you buy today - either a single bond or a ladder or a fund - we are going to be accepting a return that is some 1% real less than the historic rate for the next thirty years. If instead you buy the same dollar amount but limit the duration to ten years there is a high probability that you will get more than 1% for the following twenty years which will more than compensate for the 1% less you got the first ten years. But there is no guarantee.

Given grok's 1/3, 1/3, 1/3 breakdown the TIPS portion is much less risky than the equities and maybe even the SS which is not necessary indexed to the retiree's inflation rate.

In any case I like grok's 3 legged stool approach. I would just use tens for the TIPS portion in today's interest rate climate. Since he's buying over time if the interest rates go up you can also extend the duration if the market makes sense at that time. Just don't forget that you have to roll the position at the appropriate duration until the time that you spend it. And even if you buy a "bunch" today you should be able to roll that at essentially no expected cost if you roll it at it's duration (8.2 years for the Vg intermediate fund.).
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Re: Grok's LMP-4: The 3-legged stool approach to retirement planning

Post by LadyGeek » Tue Mar 27, 2018 3:23 pm

This thread is now in the wiki. See: Grok's tips

==============

While the preferred method is to post wiki suggestions in Suggestions for the Wiki, many thanks to the member who got my attention by reporting the post. We'll take suggestions anywhere. :)
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