Finding Middle Ground on the LMP

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Horton
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Re: Finding Middle Ground on the LMP

Post by Horton » Sun Jun 28, 2020 1:18 pm

Ben Mathew wrote:
Sun Jun 28, 2020 1:06 pm
vineviz wrote:
Sun Jun 28, 2020 12:01 pm
Ben Mathew wrote:
Sun Jun 28, 2020 11:50 am

I'm disappointed that inflation indexed annuities are not available except for social security. A compromise for those seeking more than what social security provides would be to buy a TIPS that pays out at age 90, and use the proceeds to purchase a nominal SPIA at age 90. You avoid inflation risk till age 90, and longevity risk after. It's a middle ground between inflation risk and longevity risk.
What you describe is very close to the lowest risk solution, but not quite right. The goal would be to buy a TIPS with a duration which matches the current duration of the annuity you intend to purchase later.

In other words if you are currently 70 and want to fund a SPIA to be purchased at age 90, you’d need a TIPS that currently has a duration of 24 years and not a maturity of 20 years.
Yes. I think of bonds in terms of their payout date, but maybe did not make that clear. You'd ideally structure this so the payout comes at age 90. With zero coupon bonds, it would be straightforward, duration=maturity=years left till age 90. With a coupon bond like TIPS, you'd want longer maturity to compensate for the earlier coupons. Put zero coupon TIPS as another financial product I think should exist, but does not (as far as I know).
vineviz’s point is that the SPIA purchased at age 90 has a duration of say 4-5 years. So, at age 70 you basically need a bond that pays from age 90 through life expectancy of the policyholder rather than a zero coupon bond that pays out at age 90.

dbr
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Re: Finding Middle Ground on the LMP

Post by dbr » Sun Jun 28, 2020 1:27 pm

Ben Mathew wrote:
Sun Jun 28, 2020 11:50 am
dbr wrote:
Sun Jun 28, 2020 9:40 am
Considering that the purest, maybe even the only real, LMP is an inflation indexed annuity, which is what SS is, it would seem that advocating a fixed income bridge to SS and then SS is pretty much as 100% pure an LMP as you are going to find.
I'm disappointed that inflation indexed annuities are not available except for social security. A compromise for those seeking more than what social security provides would be to buy a TIPS that pays out at age 90, and use the proceeds to purchase a nominal SPIA at age 90. You avoid inflation risk till age 90, and longevity risk after. It's a middle ground between inflation risk and longevity risk.
dbr wrote:
Sun Jun 28, 2020 9:40 am
I always thought the LMP idea was for "absolutely" needed spending and that there is also a "risk" portfolio for discretionary spending.

I suspect in a lot of cases there is no decision power here but just words about what people want to call things.
Thinking about it from a utility function perspective can help sharpen concepts. Suppose you are down to a portfolio, which if 100% invested in bonds, is just enough to fund $20,000 per year in guaranteed spending for the rest of your life. Would you still invest a portion of your portfolio in stocks? Or would you in no way consider the possibility of dropping below $20,000 per year of spending. If you would decline to invest in stocks, and choose to live on $20,000 per year thereafter, then that means you should fence off $20,000 in an LMP. Your consumption will never fall below $20,000 per year and the cost of achieving that is worth it to you.
It takes a lot of comment about the if's and if-not's, but I would say in summary that attempts to take uncertainty out of retirement income by using only "low risk/no risk" investing costs too much and has too many drawbacks compared to more balanced approaches. A utility function combines the dimensions of risk and hedonistic reward (aka spending more) is a tricky prospect, especially in the real world.

I do think annuitization is helpful on this utility point of view, which is why Social Security is really important for those who obtain a significant fraction of income from that. Significant might mean a third to a half. And I think being annuitized for half one's income can be very helpful. But I can't see it helping to put most of one's actual investments in bonds, and almost everyone, by one scheme or another, does put about half their investments in bonds in retirement. I can see a TIPS ladder accounting for half the income if a person is not annuitized, and the invested assets would be balance between stocks and bonds.

Disclaimer: We have some SS income, some fixed pension income, and income from a portfolio of stocks and bonds -- so my thinking is what we have because it works. If someone has a really different model and that works, it would be good to hear from them.

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Ben Mathew
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Re: Finding Middle Ground on the LMP

Post by Ben Mathew » Sun Jun 28, 2020 1:52 pm

Horton wrote:
Sun Jun 28, 2020 1:18 pm
Ben Mathew wrote:
Sun Jun 28, 2020 1:06 pm
vineviz wrote:
Sun Jun 28, 2020 12:01 pm
Ben Mathew wrote:
Sun Jun 28, 2020 11:50 am

I'm disappointed that inflation indexed annuities are not available except for social security. A compromise for those seeking more than what social security provides would be to buy a TIPS that pays out at age 90, and use the proceeds to purchase a nominal SPIA at age 90. You avoid inflation risk till age 90, and longevity risk after. It's a middle ground between inflation risk and longevity risk.
What you describe is very close to the lowest risk solution, but not quite right. The goal would be to buy a TIPS with a duration which matches the current duration of the annuity you intend to purchase later.

In other words if you are currently 70 and want to fund a SPIA to be purchased at age 90, you’d need a TIPS that currently has a duration of 24 years and not a maturity of 20 years.
Yes. I think of bonds in terms of their payout date, but maybe did not make that clear. You'd ideally structure this so the payout comes at age 90. With zero coupon bonds, it would be straightforward, duration=maturity=years left till age 90. With a coupon bond like TIPS, you'd want longer maturity to compensate for the earlier coupons. Put zero coupon TIPS as another financial product I think should exist, but does not (as far as I know).
vineviz’s point is that the SPIA purchased at age 90 has a duration of say 4-5 years. So, at age 70 you basically need a bond that pays from age 90 through life expectancy of the policyholder rather than a zero coupon bond that pays out at age 90.
I see. Yes, that makes sense. If interest rates have fallen by the time you reach age 90, SPIAs would become more expensive, and you would need more funds to purchase a SPIA that pays out according to your original plan. The longer duration TIPS pays out more, allowing you to buy the desired level of consumption, thereby taking out the interest rate risk in the SPIA (but not the inflation risk). Good point!

bigskyguy
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Re: Finding Middle Ground on the LMP

Post by bigskyguy » Sun Jun 28, 2020 2:16 pm

Ben Mathew wrote:
Sun Jun 28, 2020 1:06 pm
vineviz wrote:
Sun Jun 28, 2020 12:01 pm
Ben Mathew wrote:
Sun Jun 28, 2020 11:50 am

I'm disappointed that inflation indexed annuities are not available except for social security. A compromise for those seeking more than what social security provides would be to buy a TIPS that pays out at age 90, and use the proceeds to purchase a nominal SPIA at age 90. You avoid inflation risk till age 90, and longevity risk after. It's a middle ground between inflation risk and longevity risk.
What you describe is very close to the lowest risk solution, but not quite right. The goal would be to buy a TIPS with a duration which matches the current duration of the annuity you intend to purchase later.

In other words if you are currently 70 and want to fund a SPIA to be purchased at age 90, you’d need a TIPS that currently has a duration of 24 years and not a maturity of 20 years.
Yes. I think of bonds in terms of their payout date, but maybe did not make that clear. You'd ideally structure this so the payout comes at age 90. With zero coupon bonds, it would be straightforward, duration=maturity=years left till age 90. With a coupon bond like TIPS, you'd want longer maturity to compensate for the earlier coupons. Put zero coupon TIPS as yet another financial product that I think should exist, but does not (as far as I know).
First of all, thank you for this subtle but important clarification. I must say that I struggle with the concept of duration, so maybe a real life example might help.
Say I'm 60 and female, and intend to purchase a longevity annuity at age 80, and I want to take the approach of purchasing a quantity of TIPS today to fund this purchase. Please walk me through the process, utilizing the duration concept that you espouse. And if you would, contrast that with my simplified mind telling me to purchase a TIPS with a 20 year maturity instead.
This is more than a theoretical consideration. This is precisely what we are considering for my wife's IRA investments.

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vineviz
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Re: Finding Middle Ground on the LMP

Post by vineviz » Sun Jun 28, 2020 2:50 pm

Ben Mathew wrote:
Sun Jun 28, 2020 1:52 pm
Horton wrote:
Sun Jun 28, 2020 1:18 pm
vineviz’s point is that the SPIA purchased at age 90 has a duration of say 4-5 years. So, at age 70 you basically need a bond that pays from age 90 through life expectancy of the policyholder rather than a zero coupon bond that pays out at age 90.
I see. Yes, that makes sense. If interest rates have fallen by the time you reach age 90, SPIAs would become more expensive, and you would need more funds to purchase a SPIA that pays out according to your original plan. The longer duration TIPS pays out more, allowing you to buy the desired level of consumption, thereby taking out the interest rate risk in the SPIA (but not the inflation risk). Good point!
Yep, that's what I was trying to get at. Thanks for making it more clear than I did.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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willthrill81
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Re: Finding Middle Ground on the LMP

Post by willthrill81 » Sun Jun 28, 2020 2:55 pm

Ben Mathew wrote:
Sun Jun 28, 2020 1:52 pm
Horton wrote:
Sun Jun 28, 2020 1:18 pm
Ben Mathew wrote:
Sun Jun 28, 2020 1:06 pm
vineviz wrote:
Sun Jun 28, 2020 12:01 pm
Ben Mathew wrote:
Sun Jun 28, 2020 11:50 am

I'm disappointed that inflation indexed annuities are not available except for social security. A compromise for those seeking more than what social security provides would be to buy a TIPS that pays out at age 90, and use the proceeds to purchase a nominal SPIA at age 90. You avoid inflation risk till age 90, and longevity risk after. It's a middle ground between inflation risk and longevity risk.
What you describe is very close to the lowest risk solution, but not quite right. The goal would be to buy a TIPS with a duration which matches the current duration of the annuity you intend to purchase later.

In other words if you are currently 70 and want to fund a SPIA to be purchased at age 90, you’d need a TIPS that currently has a duration of 24 years and not a maturity of 20 years.
Yes. I think of bonds in terms of their payout date, but maybe did not make that clear. You'd ideally structure this so the payout comes at age 90. With zero coupon bonds, it would be straightforward, duration=maturity=years left till age 90. With a coupon bond like TIPS, you'd want longer maturity to compensate for the earlier coupons. Put zero coupon TIPS as another financial product I think should exist, but does not (as far as I know).
vineviz’s point is that the SPIA purchased at age 90 has a duration of say 4-5 years. So, at age 70 you basically need a bond that pays from age 90 through life expectancy of the policyholder rather than a zero coupon bond that pays out at age 90.
I see. Yes, that makes sense. If interest rates have fallen by the time you reach age 90, SPIAs would become more expensive, and you would need more funds to purchase a SPIA that pays out according to your original plan. The longer duration TIPS pays out more, allowing you to buy the desired level of consumption, thereby taking out the interest rate risk in the SPIA (but not the inflation risk). Good point!
By the time you're 90, interest rates play a small role in the pricing of a SPIA because the annuitant's life expectancy is so low. Payout rates are very high at that point, even if interest rates are zero.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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vineviz
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Re: Finding Middle Ground on the LMP

Post by vineviz » Sun Jun 28, 2020 3:04 pm

bigskyguy wrote:
Sun Jun 28, 2020 2:16 pm
First of all, thank you for this subtle but important clarification. I must say that I struggle with the concept of duration, so maybe a real life example might help.
Say I'm 60 and female, and intend to purchase a longevity annuity at age 80, and I want to take the approach of purchasing a quantity of TIPS today to fund this purchase. Please walk me through the process, utilizing the duration concept that you espouse. And if you would, contrast that with my simplified mind telling me to purchase a TIPS with a 20 year maturity instead.
This is more than a theoretical consideration. This is precisely what we are considering for my wife's IRA investments.
In principle, the first step is to estimate your life expectancy at age 80. In other words, if you live to age 80 what will be your remaining life expectancy on that date? Let's say it's about 10 years at that point. So add that number (10 years) to the time between now and age 80 (i.e. 20 years) and you get target duration of about 30 years.

Because TIPS always pay a coupon, coupon bonds always have a duration < maturity, and the longest maturity TIPS are 30 years, the longest-term TIPS are going to have a duration somewhat less than 30 years.

Which is fine: buying a 30-year TIPS would be the lowest-risk way currently available to pre-fund the SPIA you intend to purchase at age 80. Definitely gets you into the "close enough" range IMHO.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

pascalwager
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Re: Finding Middle Ground on the LMP

Post by pascalwager » Sun Jun 28, 2020 3:07 pm

WoodSpinner wrote:
Thu Jun 25, 2020 8:00 pm
OP,

I am also using a similar approach with a bit of a twist....

I have a cash flow spreadsheet projecting out my expenses (core+discretionary) and income through age 90. Based on this, it seems like once SS begins at 70, I will have minimal need to tap my portfolio. I have built an LMP portfolio (Short (3 years cash-flow)/Intermediate Treasuries (remaining years Cash-flow) ) to cover the years from 58 till start of SS at 70.

Spreadsheet is updated yearly and I rebalance as needed (as expenses change) at least yearly.

I do hold some bonds in the Growth part of the Portfolio as well — this allows me to hit an overall target AA of 55/45. I rebalance this section of the portfolio yearly as well, plus 5/20 bands for shorter term volatility.

The LMP funds are reserved for expenses and are never used for rebalancing.

This slide illustrates my approach (note, I currently have 10 years till start of SS)
Image

WoodSpinner
One thing.

I would replace "Growth" with "Growth/Shrinkage"--or even better, "Risk". Otherwise, why even have an LMP?

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Ben Mathew
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Re: Finding Middle Ground on the LMP

Post by Ben Mathew » Sun Jun 28, 2020 3:59 pm

bigskyguy wrote:
Sun Jun 28, 2020 2:16 pm
I must say that I struggle with the concept of duration, so maybe a real life example might help.
Say I'm 60 and female, and intend to purchase a longevity annuity at age 80, and I want to take the approach of purchasing a quantity of TIPS today to fund this purchase. Please walk me through the process, utilizing the duration concept that you espouse. And if you would, contrast that with my simplified mind telling me to purchase a TIPS with a 20 year maturity instead.
This is more than a theoretical consideration. This is precisely what we are considering for my wife's IRA investments.
If you look up SPIA quotes on
]immediateannuities.com
, you see that for an 80 year old woman, $300,000 buys $2,420 per month. Your wife decides she'd like to buy a policy like that when she is 80. She would like to pay $300,000 to receive $2,420 per month. If inflation has doubled prices between now and age 80, she would have to pay $600,000 to receive $4,840 per month to get the same payout as the policy she has in mind.

To fund this purchase twenty years from now, she socks away bonds. The bonds needs to be inflation adjusted. Otherwise, if inflation is higher than expected, the bonds will pay her only $600,000 when the SPIA costs $700,000. So she decides to get an inflation protected bond (TIPS) that pays out $300,000 in today's dollars 20 years from now when she reaches 80. The inflation problem is solved. If prices double, she will have $600,000. If it triples, she will have $900,000. Looks like she can afford the SPIA she has in mind regardless of inflation.

But there is another risk remaining--interest rate risk. Suppose real interest rates are lower when she reaches 80. That will make the annuity more expensive, even after adjusting for inflation. Even though your wife's TIPS protected your purchasing power against unexpected inflation, it does not protect against falling interest rates. The solution to that would be to get TIPS that pays out, not at age 80, but a little later. The extra duration makes it so that if interest rates are low, even though her SPIA becomes more expensive, her TIPS will also become correspondingly more expensive. So your wife will still get enough money from selling the TIPS to purchase the SPIA she had in mind.
Last edited by Ben Mathew on Sun Jun 28, 2020 4:22 pm, edited 1 time in total.

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Re: Finding Middle Ground on the LMP

Post by Ben Mathew » Sun Jun 28, 2020 4:06 pm

vineviz wrote:
Sun Jun 28, 2020 3:04 pm
In principle, the first step is to estimate your life expectancy at age 80. In other words, if you live to age 80 what will be your remaining life expectancy on that date? Let's say it's about 10 years at that point. So add that number (10 years) to the time between now and age 80 (i.e. 20 years) and you get target duration of about 30 years.
If life expectancy is 10 years remaining at age 80, shouldn't the target duration be increased only by around 5 years to age 85? Because the SPIA's payouts start immediately, the averaging for the duration calculation would include year 1 (age 80) payouts, year 2 (age 81) payouts, etc.

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Re: Finding Middle Ground on the LMP

Post by bigskyguy » Sun Jun 28, 2020 4:17 pm

Ben Mathew wrote:
Sun Jun 28, 2020 3:59 pm
bigskyguy wrote:
Sun Jun 28, 2020 2:16 pm
I must say that I struggle with the concept of duration, so maybe a real life example might help.
Say I'm 60 and female, and intend to purchase a longevity annuity at age 80, and I want to take the approach of purchasing a quantity of TIPS today to fund this purchase. Please walk me through the process, utilizing the duration concept that you espouse. And if you would, contrast that with my simplified mind telling me to purchase a TIPS with a 20 year maturity instead.
This is more than a theoretical consideration. This is precisely what we are considering for my wife's IRA investments.
If you look up SPIA quotes on
]immediateannuities.com
, you see that for an 80 year old woman, $300,000 buys $2,420 per month. Your wife decides she'd like to buy a policy like that when she is 80. She would like to pay $300,000 to receive $2,420 per month. If inflation has doubled prices between now and age 80, she would have to pay $600,000 to receive $4,840 per month to get the same payout as the policy she has in mind.

To fund this purchase twenty years from now, she socks away bonds. The bonds needs to be inflation adjusted. Otherwise, if inflation is higher than expected, the bonds will pay her only $600,000 when the SPIA costs $700,000. So decide to get an inflation protected bond (TIPS) that pays out pays out $300,000 in today's dollars 20 years from now when she reaches. The inflation problem is solved. If prices double, she will have $600,000. If it triples, she will have $900,000. Looks like she can afford the SPIA she has in mind regardless of inflation.

But there is another risk remaining--interest rate risk. Suppose real interest rates are lower when she reaches 80. That will make the annuity more expensive, even after adjusting for inflation. Even though your wife's TIPS protected your purchasing power against unexpected inflation, it does not protect against falling interest rates. The solution to that would be to get TIPS that pays out, not at age 80, but a little later. That makes it so that if interest rates are low, even though your SPIA becomes expensive, your TIPS also becomes expensive. So your wife will still get enough money from selling the TIPS to purchase the SPIA she had in mind.
Now that makes sense. Much appreciated.

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Re: Finding Middle Ground on the LMP

Post by Ben Mathew » Sun Jun 28, 2020 4:25 pm

willthrill81 wrote:
Sun Jun 28, 2020 2:55 pm
Ben Mathew wrote:
Sun Jun 28, 2020 1:52 pm
Horton wrote:
Sun Jun 28, 2020 1:18 pm
Ben Mathew wrote:
Sun Jun 28, 2020 1:06 pm
vineviz wrote:
Sun Jun 28, 2020 12:01 pm


What you describe is very close to the lowest risk solution, but not quite right. The goal would be to buy a TIPS with a duration which matches the current duration of the annuity you intend to purchase later.

In other words if you are currently 70 and want to fund a SPIA to be purchased at age 90, you’d need a TIPS that currently has a duration of 24 years and not a maturity of 20 years.
Yes. I think of bonds in terms of their payout date, but maybe did not make that clear. You'd ideally structure this so the payout comes at age 90. With zero coupon bonds, it would be straightforward, duration=maturity=years left till age 90. With a coupon bond like TIPS, you'd want longer maturity to compensate for the earlier coupons. Put zero coupon TIPS as another financial product I think should exist, but does not (as far as I know).
vineviz’s point is that the SPIA purchased at age 90 has a duration of say 4-5 years. So, at age 70 you basically need a bond that pays from age 90 through life expectancy of the policyholder rather than a zero coupon bond that pays out at age 90.
I see. Yes, that makes sense. If interest rates have fallen by the time you reach age 90, SPIAs would become more expensive, and you would need more funds to purchase a SPIA that pays out according to your original plan. The longer duration TIPS pays out more, allowing you to buy the desired level of consumption, thereby taking out the interest rate risk in the SPIA (but not the inflation risk). Good point!
By the time you're 90, interest rates play a small role in the pricing of a SPIA because the annuitant's life expectancy is so low. Payout rates are very high at that point, even if interest rates are zero.
Probably true. But it's a free lunch. So why not?

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Re: Finding Middle Ground on the LMP

Post by bigskyguy » Sun Jun 28, 2020 4:50 pm

vineviz wrote:
Sun Jun 28, 2020 3:04 pm
bigskyguy wrote:
Sun Jun 28, 2020 2:16 pm
First of all, thank you for this subtle but important clarification. I must say that I struggle with the concept of duration, so maybe a real life example might help.
Say I'm 60 and female, and intend to purchase a longevity annuity at age 80, and I want to take the approach of purchasing a quantity of TIPS today to fund this purchase. Please walk me through the process, utilizing the duration concept that you espouse. And if you would, contrast that with my simplified mind telling me to purchase a TIPS with a 20 year maturity instead.
This is more than a theoretical consideration. This is precisely what we are considering for my wife's IRA investments.
In principle, the first step is to estimate your life expectancy at age 80. In other words, if you live to age 80 what will be your remaining life expectancy on that date? Let's say it's about 10 years at that point. So add that number (10 years) to the time between now and age 80 (i.e. 20 years) and you get target duration of about 30 years.

Because TIPS always pay a coupon, coupon bonds always have a duration < maturity, and the longest maturity TIPS are 30 years, the longest-term TIPS are going to have a duration somewhat less than 30 years.

Which is fine: buying a 30-year TIPS would be the lowest-risk way currently available to pre-fund the SPIA you intend to purchase at age 80. Definitely gets you into the "close enough" range IMHO.
So then as I understand it, since the pricing of the annuity and the pricing of the long term TIPS move in similar directions, it would make abundant sense to extend the length of the TIPS as closely to the life expectancy as one can. It sure makes purchasing an annuity in the future rather than now more attractive, at least to us.

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2pedals
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Re: Finding Middle Ground on the LMP

Post by 2pedals » Sun Jun 28, 2020 6:55 pm

Horton, thank you for sharing this paper. i find the ideas an interesting read.

With all the different approaches/methods that are available for withdrawal in retirement it is very difficult to know what will work the best in the future. I don't think any of them works well for us simply because we are expected to under spend. I have been tracking my spending and reviewing, bigfoot's RPM, Welch's I-ORP, McClung’s ECM and longinvest Variable Percentage Withdrawal (VPW) recommended amounts. These methods had similar numbers but were all well above our spending so far. They do give us some metrics to follow and some confidence that we are on the right track. We can spend more, if DW wishes but we probably won't. I expect that much of our spending will be lumpy discretionary spending in the future and I would start to get worried if my expected average annual spending exceeds for a long period of time (~5 years ??). If that happens it would be time to pull back. I am planning to flexible and embrace the uncertainty with as little as possible impacts to discretionary spending.

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Re: Finding Middle Ground on the LMP

Post by vineviz » Sun Jun 28, 2020 7:00 pm

Ben Mathew wrote:
Sun Jun 28, 2020 4:06 pm
vineviz wrote:
Sun Jun 28, 2020 3:04 pm
In principle, the first step is to estimate your life expectancy at age 80. In other words, if you live to age 80 what will be your remaining life expectancy on that date? Let's say it's about 10 years at that point. So add that number (10 years) to the time between now and age 80 (i.e. 20 years) and you get target duration of about 30 years.
If life expectancy is 10 years remaining at age 80, shouldn't the target duration be increased only by around 5 years to age 85? Because the SPIA's payouts start immediately, the averaging for the duration calculation would include year 1 (age 80) payouts, year 2 (age 81) payouts, etc.
No, “remaining life expectancy” is already the weighted average expected number of years remaining for the individual. It’s the point of 50% mortality, in other words, not the point of 100% mortality.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Finding Middle Ground on the LMP

Post by willthrill81 » Sun Jun 28, 2020 7:15 pm

Ben Mathew wrote:
Sun Jun 28, 2020 4:25 pm
willthrill81 wrote:
Sun Jun 28, 2020 2:55 pm
Ben Mathew wrote:
Sun Jun 28, 2020 1:52 pm
Horton wrote:
Sun Jun 28, 2020 1:18 pm
Ben Mathew wrote:
Sun Jun 28, 2020 1:06 pm


Yes. I think of bonds in terms of their payout date, but maybe did not make that clear. You'd ideally structure this so the payout comes at age 90. With zero coupon bonds, it would be straightforward, duration=maturity=years left till age 90. With a coupon bond like TIPS, you'd want longer maturity to compensate for the earlier coupons. Put zero coupon TIPS as another financial product I think should exist, but does not (as far as I know).
vineviz’s point is that the SPIA purchased at age 90 has a duration of say 4-5 years. So, at age 70 you basically need a bond that pays from age 90 through life expectancy of the policyholder rather than a zero coupon bond that pays out at age 90.
I see. Yes, that makes sense. If interest rates have fallen by the time you reach age 90, SPIAs would become more expensive, and you would need more funds to purchase a SPIA that pays out according to your original plan. The longer duration TIPS pays out more, allowing you to buy the desired level of consumption, thereby taking out the interest rate risk in the SPIA (but not the inflation risk). Good point!
By the time you're 90, interest rates play a small role in the pricing of a SPIA because the annuitant's life expectancy is so low. Payout rates are very high at that point, even if interest rates are zero.
Probably true. But it's a free lunch. So why not?
I'm not arguing against it. The objective math that I've seen seems to decidedly favor using one's nominal bond holdings to buy a SPIA at the point of retirement.

My point was just that interest rates are largely irrelevant at age 90. And in point of fact, they don't much more at age 80 for the same reason.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: Finding Middle Ground on the LMP

Post by hudson » Sun Jun 28, 2020 7:26 pm

2pedals wrote:
Sun Jun 28, 2020 6:55 pm

longinvest's Variable Percentage Withdrawal (VPW) recommended amounts.

I would start to get worried if my expected average annual spending exceeds for a long period of time (~5 years ??). If that happens it would be time to pull back.
This fits my plan. I run the old version of VPW to see where I stand. That's my test.
I would also worry and make adjustments if I spend over my VPW number.
I will continue to read all of the LMP related discussions. I'm listening and learning.
My version of the LMP is pretty simple...intermediate term CDs. When they mature, I may change that plan if appropriate.

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Re: Finding Middle Ground on the LMP

Post by Ben Mathew » Sun Jun 28, 2020 7:45 pm

vineviz wrote:
Sun Jun 28, 2020 7:00 pm
Ben Mathew wrote:
Sun Jun 28, 2020 4:06 pm
vineviz wrote:
Sun Jun 28, 2020 3:04 pm
In principle, the first step is to estimate your life expectancy at age 80. In other words, if you live to age 80 what will be your remaining life expectancy on that date? Let's say it's about 10 years at that point. So add that number (10 years) to the time between now and age 80 (i.e. 20 years) and you get target duration of about 30 years.
If life expectancy is 10 years remaining at age 80, shouldn't the target duration be increased only by around 5 years to age 85? Because the SPIA's payouts start immediately, the averaging for the duration calculation would include year 1 (age 80) payouts, year 2 (age 81) payouts, etc.
No, “remaining life expectancy” is already the weighted average expected number of years remaining for the individual. It’s the point of 50% mortality, in other words, not the point of 100% mortality.
Life expectancy is averaging years left across people. If a third of the population die at age 70, a third at age 80, and a third at age 90, then the life expectancy at birth is 80 years, not 40 years. If you get an annuity at birth that pays out evenly over the life of the average person who dies at age 80, the duration of that annuity will be 40 years, not 80 years.

See the life expectancy given in the last column of this life table. The life expectancy at age 0 for women is 80.96 years. That cannot be the average of the years left in the sense of what we would need for the duration calculation.

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Re: Finding Middle Ground on the LMP

Post by Steve Reading » Sun Jun 28, 2020 7:55 pm

vineviz wrote:
Sun Jun 28, 2020 7:00 pm
Ben Mathew wrote:
Sun Jun 28, 2020 4:06 pm
vineviz wrote:
Sun Jun 28, 2020 3:04 pm
In principle, the first step is to estimate your life expectancy at age 80. In other words, if you live to age 80 what will be your remaining life expectancy on that date? Let's say it's about 10 years at that point. So add that number (10 years) to the time between now and age 80 (i.e. 20 years) and you get target duration of about 30 years.
If life expectancy is 10 years remaining at age 80, shouldn't the target duration be increased only by around 5 years to age 85? Because the SPIA's payouts start immediately, the averaging for the duration calculation would include year 1 (age 80) payouts, year 2 (age 81) payouts, etc.
No, “remaining life expectancy” is already the weighted average expected number of years remaining for the individual. It’s the point of 50% mortality, in other words, not the point of 100% mortality.
Right so you take half of that, as that's the correct duration for the average person. If you take the remaining life expectancy as the duration, then that only actually works out right for whoever lives twice as much as the expectancy. For everyone else (aka most people), that would've been too long of a duration. Duration = 1/2 expected remaining years means that for half of people, it would've been a little too short and for the other half a little too long. Which I think is what you want.
Last edited by Steve Reading on Sun Jun 28, 2020 7:58 pm, edited 1 time in total.

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Re: Finding Middle Ground on the LMP

Post by Steve Reading » Sun Jun 28, 2020 7:56 pm

Ben Mathew wrote:
Sun Jun 28, 2020 7:45 pm
vineviz wrote:
Sun Jun 28, 2020 7:00 pm
Ben Mathew wrote:
Sun Jun 28, 2020 4:06 pm
vineviz wrote:
Sun Jun 28, 2020 3:04 pm
In principle, the first step is to estimate your life expectancy at age 80. In other words, if you live to age 80 what will be your remaining life expectancy on that date? Let's say it's about 10 years at that point. So add that number (10 years) to the time between now and age 80 (i.e. 20 years) and you get target duration of about 30 years.
If life expectancy is 10 years remaining at age 80, shouldn't the target duration be increased only by around 5 years to age 85? Because the SPIA's payouts start immediately, the averaging for the duration calculation would include year 1 (age 80) payouts, year 2 (age 81) payouts, etc.
No, “remaining life expectancy” is already the weighted average expected number of years remaining for the individual. It’s the point of 50% mortality, in other words, not the point of 100% mortality.
Life expectancy is averaging years left across people. If a third of the population die at age 70, a third at age 80, and a third at age 90, then the life expectancy at birth is 80 years, not 40 years. If you get an annuity at birth that pays out evenly over the life of the average person who dies at age 80, the duration of that annuity will be 40 years, not 80 years.

See the life expectancy given in the last column of this life table. The life expectancy at age 0 for women is 80.96 years. That cannot be the average of the years left in the sense of what we would need for the duration calculation.
Lol, yes this is what I meant to say ^

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Re: Finding Middle Ground on the LMP

Post by vineviz » Sun Jun 28, 2020 8:11 pm

Ben Mathew wrote:
Sun Jun 28, 2020 7:45 pm
Life expectancy is averaging years left across people. If a third of the population die at age 70, a third at age 80, and a third at age 90, then the life expectancy at birth is 80 years, not 40 years. If you get an annuity at birth that pays out evenly over the life of the average person who dies at age 80, the duration of that annuity will be 40 years, not 80 years.
Because life expectancy increases as you age, it’s true that using remaining life expectancy as an estimate for investment horizon is much less accurate at younger ages than at older ages.

Additionally, the examples we were discussing are probabilistically different from this example in that they concern a pre-funding of a future expense. In effect, you’re making a Bayesian inference (e.g. what is the remaining life expectancy conditional on the assumption of living X more years).

In other words two annuities purchased at birth don’t have the same duration if one begins paying out immediately and the other begins paying out at age 65.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Finding Middle Ground on the LMP

Post by vineviz » Sun Jun 28, 2020 8:34 pm

Steve Reading wrote:
Sun Jun 28, 2020 7:55 pm
vineviz wrote:
Sun Jun 28, 2020 7:00 pm
Ben Mathew wrote:
Sun Jun 28, 2020 4:06 pm
vineviz wrote:
Sun Jun 28, 2020 3:04 pm
In principle, the first step is to estimate your life expectancy at age 80. In other words, if you live to age 80 what will be your remaining life expectancy on that date? Let's say it's about 10 years at that point. So add that number (10 years) to the time between now and age 80 (i.e. 20 years) and you get target duration of about 30 years.
If life expectancy is 10 years remaining at age 80, shouldn't the target duration be increased only by around 5 years to age 85? Because the SPIA's payouts start immediately, the averaging for the duration calculation would include year 1 (age 80) payouts, year 2 (age 81) payouts, etc.
No, “remaining life expectancy” is already the weighted average expected number of years remaining for the individual. It’s the point of 50% mortality, in other words, not the point of 100% mortality.
Right so you take half of that, as that's the correct duration for the average person. If you take the remaining life expectancy as the duration, then that only actually works out right for whoever lives twice as much as the expectancy. For everyone else (aka most people), that would've been too long of a duration. Duration = 1/2 expected remaining years means that for half of people, it would've been a little too short and for the other half a little too long. Which I think is what you want.
I’m traveling so I’ll probably need to get home to produce a coherent reply (typing on my phone won’t do it), but the key is that the effective duration of a life-contingent annuity is longer than a capital (ie bond) portfolio.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Finding Middle Ground on the LMP

Post by Ben Mathew » Sun Jun 28, 2020 8:38 pm

vineviz wrote:
Sun Jun 28, 2020 8:11 pm
the examples we were discussing are probabilistically different from this example in that they concern a pre-funding of a future expense. In effect, you’re making a Bayesian inference (e.g. what is the remaining life expectancy conditional on the assumption of living X more years).
It's true that the life expectancy will keep changing as we get older. That argues for updating bond durations and so on, perhaps as part of an annual adjustment. A reasonable estimate for the duration of a bond or annuity that funds consumption starting t years from now might be (t+T)/2 where T is the life expactancy.

But my personal preference is to keep things simple and just plan to live to age 100 without worrying too much about updating conditional life expectancy. If I die early, my heirs get extra!

And if I live beyond 100, they're paying up!

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Re: Finding Middle Ground on the LMP

Post by Steve Reading » Sun Jun 28, 2020 9:04 pm

vineviz wrote:
Sun Jun 28, 2020 8:34 pm
Steve Reading wrote:
Sun Jun 28, 2020 7:55 pm
vineviz wrote:
Sun Jun 28, 2020 7:00 pm
Ben Mathew wrote:
Sun Jun 28, 2020 4:06 pm
vineviz wrote:
Sun Jun 28, 2020 3:04 pm
In principle, the first step is to estimate your life expectancy at age 80. In other words, if you live to age 80 what will be your remaining life expectancy on that date? Let's say it's about 10 years at that point. So add that number (10 years) to the time between now and age 80 (i.e. 20 years) and you get target duration of about 30 years.
If life expectancy is 10 years remaining at age 80, shouldn't the target duration be increased only by around 5 years to age 85? Because the SPIA's payouts start immediately, the averaging for the duration calculation would include year 1 (age 80) payouts, year 2 (age 81) payouts, etc.
No, “remaining life expectancy” is already the weighted average expected number of years remaining for the individual. It’s the point of 50% mortality, in other words, not the point of 100% mortality.
Right so you take half of that, as that's the correct duration for the average person. If you take the remaining life expectancy as the duration, then that only actually works out right for whoever lives twice as much as the expectancy. For everyone else (aka most people), that would've been too long of a duration. Duration = 1/2 expected remaining years means that for half of people, it would've been a little too short and for the other half a little too long. Which I think is what you want.
I’m traveling so I’ll probably need to get home to produce a coherent reply (typing on my phone won’t do it), but the key is that the effective duration of a life-contingent annuity is longer than a capital (ie bond) portfolio.
I'm not talking about the bond portfolio at all. What is the expected duration of an immediate annuity that an 80 year old buys today, given we know the remaining life expectancy of this person is 10 years?
I'm arguing it's 5 years and I think you're arguing it's 10 years.

If you think about it from the insurer perspective ("what duration should the insurer aim for to immunize the annuity sold to an 80 year old?"), then I think it's clear. I know for certain many more payments will occur within the first 10 years (when most are alive) than after 10 years (when 50% are dead) so I can immediately tell 10 years can't be it.

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Re: Finding Middle Ground on the LMP

Post by WoodSpinner » Sun Jun 28, 2020 9:13 pm

pascalwager wrote:
Sun Jun 28, 2020 3:07 pm
WoodSpinner wrote:
Thu Jun 25, 2020 8:00 pm
OP,

I am also using a similar approach with a bit of a twist....

I have a cash flow spreadsheet projecting out my expenses (core+discretionary) and income through age 90. Based on this, it seems like once SS begins at 70, I will have minimal need to tap my portfolio. I have built an LMP portfolio (Short (3 years cash-flow)/Intermediate Treasuries (remaining years Cash-flow) ) to cover the years from 58 till start of SS at 70.

Spreadsheet is updated yearly and I rebalance as needed (as expenses change) at least yearly.

I do hold some bonds in the Growth part of the Portfolio as well — this allows me to hit an overall target AA of 55/45. I rebalance this section of the portfolio yearly as well, plus 5/20 bands for shorter term volatility.

The LMP funds are reserved for expenses and are never used for rebalancing.

This slide illustrates my approach (note, I currently have 10 years till start of SS)
Image

WoodSpinner
One thing.

I would replace "Growth" with "Growth/Shrinkage"--or even better, "Risk". Otherwise, why even have an LMP?
Fair enough, certainly Risk is accurate. Not sure I will shift, kinda attached to it now.

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Re: Finding Middle Ground on the LMP

Post by Horton » Sun Jun 28, 2020 9:54 pm

There’s a distinction between the duration of an annuity and the duration of a bond portfolio/ladder that is intended to cover potential expenses beyond life expectancy. The duration of an annuity will be much less than life expectancy - a very rough approximation could be a little less than: (life expectancy - commencement age) / 2.

Think of it this way - the average annuitant will live until life expectancy.

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Re: Finding Middle Ground on the LMP

Post by fatcoffeedrinker » Sun Jun 28, 2020 10:54 pm

Here is our plan for a modified LMP.

I plan to retire at 55 (3 1/2 years from now) and DW and I will both defer SS to 70 (DW and I are about the same age). Assuming a 23% reduction in SS benefits, my SS plus DW spousal benefit will be $50K/year in 2024 dollars (assuming 2% inflation from now until 2024). Our planned expenses are around $175K, but there is a lot of cushion in there. So we are setting up a TIPS ladder (30 years, but through rolling 10 year periods since I am not willing to lock in real rates now beyond 10 years) to cover $100K per year. So the TIPS ladder will cover $100K for 15 years and then $50K for 15 years.

That should be around 1/3 of the portfolio. With the other 2/3, we will set aside $750K in bonds (10 years of expenses above the $100K LMP) and the rest in stocks (results in 83/17 RP). The bonds will be used for expenses and rebalancing when stocks are down, but we won't rebalance below 5 years ($375K).

After the TIPS ladder is exhausted, we will use a portion of the RP to buy a SPIA if need be, but the RP will probably be sufficient on its own to cover costs above SS. But if desired, I'd expect a $50K annuity at 85 to cost around $500K.

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Re: Finding Middle Ground on the LMP

Post by grok87 » Mon Jun 29, 2020 6:51 am

fatcoffeedrinker wrote:
Sun Jun 28, 2020 10:54 pm
Here is our plan for a modified LMP.

I plan to retire at 55 (3 1/2 years from now) and DW and I will both defer SS to 70 (DW and I are about the same age). Assuming a 23% reduction in SS benefits, my SS plus DW spousal benefit will be $50K/year in 2024 dollars (assuming 2% inflation from now until 2024). Our planned expenses are around $175K, but there is a lot of cushion in there. So we are setting up a TIPS ladder (30 years, but through rolling 10 year periods since I am not willing to lock in real rates now beyond 10 years) to cover $100K per year. So the TIPS ladder will cover $100K for 15 years and then $50K for 15 years.

That should be around 1/3 of the portfolio. With the other 2/3, we will set aside $750K in bonds (10 years of expenses above the $100K LMP) and the rest in stocks (results in 83/17 RP). The bonds will be used for expenses and rebalancing when stocks are down, but we won't rebalance below 5 years ($375K).

After the TIPS ladder is exhausted, we will use a portion of the RP to buy a SPIA if need be, but the RP will probably be sufficient on its own to cover costs above SS. But if desired, I'd expect a $50K annuity at 85 to cost around $500K.
sounds like an interesting plan. are you buying ibonds as well?
RIP Mr. Bogle.

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Re: Finding Middle Ground on the LMP

Post by vineviz » Mon Jun 29, 2020 3:13 pm

Steve Reading wrote:
Sun Jun 28, 2020 9:04 pm
I'm not talking about the bond portfolio at all. What is the expected duration of an immediate annuity that an 80 year old buys today, given we know the remaining life expectancy of this person is 10 years?
I'm arguing it's 5 years and I think you're arguing it's 10 years.

If you think about it from the insurer perspective ("what duration should the insurer aim for to immunize the annuity sold to an 80 year old?"), then I think it's clear. I know for certain many more payments will occur within the first 10 years (when most are alive) than after 10 years (when 50% are dead) so I can immediately tell 10 years can't be it.
I'm still looking for the analytical solution for the duration of of a lifetime income annuity (it's different from the solution when all the cashflows are know with certainty which is why I referenced the bond portfolio, but I'm struggling to find the actual formula). Nonetheless, I think I did make a mistake in my post.

The duration of the annuity is not the unadjusted remaining life expectancy at the time of the annuity purchase but neither is it half of the remaining life expectancy. In fact, based on calculations I ran this afternoon it looks like it's always going to be between those two estimations. Unfortunately, due to the increasingly non-linear shape of the survival probability curve at higher ages, exactly WHERE "in between" is a complicated function as best as I can tell. I'm trying to figure out the analytical solution, but so far I'm coming up blank.

Using strictly empirical data, for annuities that will be purchased below age 75 or so, 50% of remaining remaining life expectancy appears to be the better estimate o annuity duration. For annuities that will be purchased above age 85 or so, 100% of remaining remaining life expectancy appears to be the better estimate of the annuity duration.
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Re: Finding Middle Ground on the LMP

Post by Steve Reading » Mon Jun 29, 2020 4:03 pm

vineviz wrote:
Mon Jun 29, 2020 3:13 pm

The duration of the annuity is not the unadjusted remaining life expectancy at the time of the annuity purchase but neither is it half of the remaining life expectancy. In fact, based on calculations I ran this afternoon it looks like it's always going to be between those two estimations.
Umh, I'm not convinced. Let me ask you this. If you knew the person who bought the immediate annuity will live 10 years, then do you agree the annuity will have 5 years duration in this case? Not meant to be tricky, just trying to figure out at what point we're disagreeing.

If you say yes, then it's fair to say that if you know a person will live n years, then the duration of the annuity will be n/2, correct? Assuming the annuity is immediate.

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Re: Finding Middle Ground on the LMP

Post by Ben Mathew » Mon Jun 29, 2020 5:19 pm

Steve Reading wrote:
Mon Jun 29, 2020 4:03 pm
If you knew the person who bought the immediate annuity will live 10 years, then do you agree the annuity will have 5 years duration in this case?
5 years should be a reasonable approximation. The exact duration would be a bit less, because in PV terms, the initial payouts carry more weight than later payouts. So the exact duration might be more like 4.xx years.
Last edited by Ben Mathew on Mon Jun 29, 2020 5:31 pm, edited 1 time in total.

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Re: Finding Middle Ground on the LMP

Post by vineviz » Mon Jun 29, 2020 5:27 pm

Steve Reading wrote:
Mon Jun 29, 2020 4:03 pm
Umh, I'm not convinced. Let me ask you this. If you knew the person who bought the immediate annuity will live 10 years, then do you agree the annuity will have 5 years duration in this case? Not meant to be tricky, just trying to figure out at what point we're disagreeing.

If you say yes, then it's fair to say that if you know a person will live n years, then the duration of the annuity will be n/2, correct? Assuming the annuity is immediate.
I think my answer is "yes" to both questions: an annuity which a known period will have a duration that behaves like the one you describe. Effectively, an annuity with known period is a bond that has a par value of $0 and so its duration can be calculated in the same way you'd calculate the duration of a bond. With a known (certain) period, the structure of the payouts is known.

The issue I'm struggling to articulate is that a lifetime income annuity has a duration that can't be calculated exactly the same way as a bond, precisely because the cashflows are uncertain.

Maybe this example helps:

Let's pretend we are the insurer, and must build a bond portfolio to match the annuity we sell. In your example, where we know the purchaser of our annuity will live exactly 10 years, we can buy ten zero coupon bonds (one for each known annual payout) with durations of 0, 1, 2, 3, ..., 9 years and a par value of $1,000 each. Average the duration of those ten bonds and we get 4.5 years (we can make it be 5 years if we assume the payout starts in 6 months instead of immediately). No sweat.

Now let's pretend the same annuitant purchases a lifetime annuity but we don't know how long they will live. We can't immunize this risk using the same portfolio of ten equal par value bonds because of the longevity (i.e. mortality) risk. We have to own a progressively smaller amount of each successive maturity: $1,000 of the first bond, $957 of the second bond, $911 of the third bond, $862 of the fourth bond, and so on. This portfolio will include allocations to bonds with 30 years to maturity, albeit very small amounts. I think this makes more sense if you think about an insurance company having thousands of annuities for the same actuarial class. But the upshot is that as the life expectancy decreases (i.e. the mortality credits increase), the duration of the SPIA approaches the remaining life expectancy.
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Re: Finding Middle Ground on the LMP

Post by bigskyguy » Mon Jun 29, 2020 6:04 pm

Ben Mathew wrote:
Mon Jun 29, 2020 5:19 pm
Steve Reading wrote:
Mon Jun 29, 2020 4:03 pm
If you knew the person who bought the immediate annuity will live 10 years, then do you agree the annuity will have 5 years duration in this case?
5 years should be a reasonable approximation. The exact duration would be a bit less, because in PV terms, the initial payouts carry more weight than later payouts. So the exact duration might be more like 4.xx years.
So if that be the case, that an immediate annuity purchased for an individual with a life expectancy of 10 years has a duration of just under 4 years, then a deferred annuity purchased 20 years prior to that same time by an individual with a life expectancy of 10 years would have a duration of just under 24 years. If so, then the equation for a deferred annuity is closer to t + (T/2), where t = deferral period, and T = life expectancy at start of annuity payments. Correct? if not, please help clarify.

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Re: Finding Middle Ground on the LMP

Post by Steve Reading » Mon Jun 29, 2020 6:05 pm

vineviz wrote:
Mon Jun 29, 2020 5:27 pm
I think my answer is "yes" to both questions: an annuity which a known period will have a duration that behaves like the one you describe.
Perfect. The reason I ask is to figure out when you're placing the annuity payouts. I was placing them at the middle of the year. Based on the above response and this:
vineviz wrote:
Mon Jun 29, 2020 5:27 pm
Average the duration of those ten bonds and we get 4.5 years (we can make it be 5 years if we assume the payout starts in 6 months instead of immediately). No sweat.
I can see we agree there.

Then how about this question: The duration of your fixed-income should not see a "discontinuity" over time. In the ideal scenario, assuming no bequests or a random health emergency, the target duration of your fixed-income should smoothly decrease over time. In other words, the bonds the investor will use to buy the annuity should have the same duration as the annuity, at the time he/she buys the annuity.

Put another way, if the investor is 80 years old and knows they will die at 90, then the duration of the bond portfolio that will finance the annuity should be 5 years on the day he/she buys the annuity at age 80. Does that make sense? It shouldn't be 30 year of duration when they sell to buy the annuity. It shouldn't be in cash. It should be 5 year duration provided he/she knows they will live to exactly 90. Agreed?

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Re: Finding Middle Ground on the LMP

Post by Steve Reading » Mon Jun 29, 2020 6:08 pm

Ben Mathew wrote:
Mon Jun 29, 2020 5:19 pm
Steve Reading wrote:
Mon Jun 29, 2020 4:03 pm
If you knew the person who bought the immediate annuity will live 10 years, then do you agree the annuity will have 5 years duration in this case?
5 years should be a reasonable approximation. The exact duration would be a bit less, because in PV terms, the initial payouts carry more weight than later payouts. So the exact duration might be more like 4.xx years.
Yes, I know. You're getting ahead of me Ben haha.

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Re: Finding Middle Ground on the LMP

Post by fatcoffeedrinker » Mon Jun 29, 2020 6:19 pm

grok87 wrote:
Mon Jun 29, 2020 6:51 am
fatcoffeedrinker wrote:
Sun Jun 28, 2020 10:54 pm
Here is our plan for a modified LMP.

I plan to retire at 55 (3 1/2 years from now) and DW and I will both defer SS to 70 (DW and I are about the same age). Assuming a 23% reduction in SS benefits, my SS plus DW spousal benefit will be $50K/year in 2024 dollars (assuming 2% inflation from now until 2024). Our planned expenses are around $175K, but there is a lot of cushion in there. So we are setting up a TIPS ladder (30 years, but through rolling 10 year periods since I am not willing to lock in real rates now beyond 10 years) to cover $100K per year. So the TIPS ladder will cover $100K for 15 years and then $50K for 15 years.

That should be around 1/3 of the portfolio. With the other 2/3, we will set aside $750K in bonds (10 years of expenses above the $100K LMP) and the rest in stocks (results in 83/17 RP). The bonds will be used for expenses and rebalancing when stocks are down, but we won't rebalance below 5 years ($375K).

After the TIPS ladder is exhausted, we will use a portion of the RP to buy a SPIA if need be, but the RP will probably be sufficient on its own to cover costs above SS. But if desired, I'd expect a $50K annuity at 85 to cost around $500K.
sounds like an interesting plan. are you buying ibonds as well?
I have some iBonds, but I can buy TIPS in my 401(k) through Schwab's PCRA. So that is the major part of the ladder I am building over time. Each January, I buy the next 10-year TIPS and then add to the other years through secondary market. Right now, I own TIPS that mature in 2024 through 2030, but not at the $100K level yet. So next January, I will buy some 2031 10-year TIPS, and then add to 2024 through 2030. Rinse and repeat for the following two years, and then will have TIPS maturing 2024 through 2033 in the amount needed for those 10 years and enough to roll them forward 20 additional years.

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Re: Finding Middle Ground on the LMP

Post by Steve Reading » Mon Jun 29, 2020 6:29 pm

bigskyguy wrote:
Mon Jun 29, 2020 6:04 pm
Ben Mathew wrote:
Mon Jun 29, 2020 5:19 pm
Steve Reading wrote:
Mon Jun 29, 2020 4:03 pm
If you knew the person who bought the immediate annuity will live 10 years, then do you agree the annuity will have 5 years duration in this case?
5 years should be a reasonable approximation. The exact duration would be a bit less, because in PV terms, the initial payouts carry more weight than later payouts. So the exact duration might be more like 4.xx years.
So if that be the case, that an immediate annuity purchased for an individual with a life expectancy of 10 years has a duration of just under 4 years, then a deferred annuity purchased 20 years prior to that same time by an individual with a life expectancy of 10 years would have a duration of just under 24 years. If so, then the equation for a deferred annuity is closer to t + (T/2), where t = deferral period, and T = life expectancy at start of annuity payments. Correct? if not, please help clarify.
Yes, but the only thing I'll add is that such an annuity will have an expected duration of about 24-25 years. The actual duration will depend on how long you live. If you lived your life over and over again and average the durations of the annuity in each of those lives, it comes out to 24-25 years.

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Re: Finding Middle Ground on the LMP

Post by grok87 » Mon Jun 29, 2020 7:23 pm

fatcoffeedrinker wrote:
Mon Jun 29, 2020 6:19 pm
grok87 wrote:
Mon Jun 29, 2020 6:51 am
fatcoffeedrinker wrote:
Sun Jun 28, 2020 10:54 pm
Here is our plan for a modified LMP.

I plan to retire at 55 (3 1/2 years from now) and DW and I will both defer SS to 70 (DW and I are about the same age). Assuming a 23% reduction in SS benefits, my SS plus DW spousal benefit will be $50K/year in 2024 dollars (assuming 2% inflation from now until 2024). Our planned expenses are around $175K, but there is a lot of cushion in there. So we are setting up a TIPS ladder (30 years, but through rolling 10 year periods since I am not willing to lock in real rates now beyond 10 years) to cover $100K per year. So the TIPS ladder will cover $100K for 15 years and then $50K for 15 years.

That should be around 1/3 of the portfolio. With the other 2/3, we will set aside $750K in bonds (10 years of expenses above the $100K LMP) and the rest in stocks (results in 83/17 RP). The bonds will be used for expenses and rebalancing when stocks are down, but we won't rebalance below 5 years ($375K).

After the TIPS ladder is exhausted, we will use a portion of the RP to buy a SPIA if need be, but the RP will probably be sufficient on its own to cover costs above SS. But if desired, I'd expect a $50K annuity at 85 to cost around $500K.
sounds like an interesting plan. are you buying ibonds as well?
I have some iBonds, but I can buy TIPS in my 401(k) through Schwab's PCRA. So that is the major part of the ladder I am building over time. Each January, I buy the next 10-year TIPS and then add to the other years through secondary market. Right now, I own TIPS that mature in 2024 through 2030, but not at the $100K level yet. So next January, I will buy some 2031 10-year TIPS, and then add to 2024 through 2030. Rinse and repeat for the following two years, and then will have TIPS maturing 2024 through 2033 in the amount needed for those 10 years and enough to roll them forward 20 additional years.
i've stopped buying tips for my tips/ibond ladder but i am continuing to buy ibonds
RIP Mr. Bogle.

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vineviz
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Re: Finding Middle Ground on the LMP

Post by vineviz » Mon Jun 29, 2020 8:33 pm

bigskyguy wrote:
Mon Jun 29, 2020 6:04 pm

So if that be the case, that an immediate annuity purchased for an individual with a life expectancy of 10 years has a duration of just under 4 years, then a deferred annuity purchased 20 years prior to that same time by an individual with a life expectancy of 10 years would have a duration of just under 24 years. If so, then the equation for a deferred annuity is closer to t + (T/2), where t = deferral period, and T = life expectancy at start of annuity payments. Correct? if not, please help clarify.
You've got the basic equation correct, with the small correction that the "2" in your "T/2" isn't PRECISELY right.

That divisor will be less than 2 usually, and possibly close to 1 .
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Horton
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Re: Finding Middle Ground on the LMP

Post by Horton » Mon Jun 29, 2020 9:36 pm

You can calculate the duration of an annuity using this calculator:

https://afc.soa.org/

The duration of an annuity for a 65 year old male assuming a 3% discount rate (and no changes to any of the other inputs) is 10 years.

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Horton
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Re: Finding Middle Ground on the LMP

Post by Horton » Mon Jun 29, 2020 9:41 pm

You can calculate the life expectancy using this calculator:

https://www.longevityillustrator.org/

The median life expectancy for a 65 year old male in excellent health is 23 years.

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Ben Mathew
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Re: Finding Middle Ground on the LMP

Post by Ben Mathew » Mon Jun 29, 2020 10:40 pm

bigskyguy wrote:
Mon Jun 29, 2020 6:04 pm
Ben Mathew wrote:
Mon Jun 29, 2020 5:19 pm
Steve Reading wrote:
Mon Jun 29, 2020 4:03 pm
If you knew the person who bought the immediate annuity will live 10 years, then do you agree the annuity will have 5 years duration in this case?
5 years should be a reasonable approximation. The exact duration would be a bit less, because in PV terms, the initial payouts carry more weight than later payouts. So the exact duration might be more like 4.xx years.
So if that be the case, that an immediate annuity purchased for an individual with a life expectancy of 10 years has a duration of just under 4 years, then a deferred annuity purchased 20 years prior to that same time by an individual with a life expectancy of 10 years would have a duration of just under 24 years. If so, then the equation for a deferred annuity is closer to t + (T/2), where t = deferral period, and T = life expectancy at start of annuity payments. Correct? if not, please help clarify.
Yes, that's correct. If your wife is 60, and life expectancy is 10 years left at age 80, the duration of the TIPS she'd want would be about 20+10/2=25 years based on what we said. But if vineviz is correct that the uncertainty of the annuity increases its duration compared to that of a bond ladder, then you'll want to add to that. Based on the calculator Horton linked to above, I see the duration of an annuity for an 80 year old female @ 2% discount rate listed as 6.38 years, a bit more than the 4 to 5 years we came up with. So maybe go with that instead. i.e. Your wife would hold TIPS with a duration of 20+6.38=26.38 years. I wouldn't worry about getting this exactly right. It's likely small potatoes compared to most other aspects of a financial plan.

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Re: Finding Middle Ground on the LMP

Post by grayfox » Tue Jun 30, 2020 7:43 am

Horton wrote:
Thu Jun 25, 2020 3:33 pm
I recently re-read "Viability of the Spend Safely in Retirement Strategy", a paper by Wade Pfau, Joe Tomlinson, and Steven Vernon that follows up on their original paper on the Spend Safely in Retirement Strategy (SSiRS). I like the follow-up paper more than the original because it focuses specifically on the SSiRS strategy and contains a variety of practical information.
From the paper: (page 6)
The strategy has two basic components:
1. Develop “retirement paychecks” that are guaranteed for life (and the spouse if married), and are not subject to investment risks. Use these paychecks to pay for basic living expenses, such as housing, medical premiums and costs, utilities, food, and regular transportation.
2. Retirees retain full control over a portion of savings that they invest to pay themselves periodic “retirement bonuses” with the potential for growth in income if investment returns are favorable, but carry investment risk. Use these bonuses to pay for discretionary living expenses such as hobbies and travel. Presumably these expenses can be reduced if investment experience is poor.
This sounds like Floor+Upside, which means you have floor income for basic living expenses from guaranteed income sources (pensions, annuities, SS, TIPS/Treasury ladder, etc) and upside income from a risk portfolio. They also included the "bridge to Social Security". i.e. a LMP of TIPS, bonds or CDs that provides payment that you will get from SS.

That's basically what I do, and I approve their message.
Sic transit gloria mundi. [STGM]

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Re: Finding Middle Ground on the LMP

Post by bigskyguy » Tue Jun 30, 2020 8:35 am

Ben Mathew wrote:
Mon Jun 29, 2020 10:40 pm
bigskyguy wrote:
Mon Jun 29, 2020 6:04 pm
Ben Mathew wrote:
Mon Jun 29, 2020 5:19 pm
Steve Reading wrote:
Mon Jun 29, 2020 4:03 pm
If you knew the person who bought the immediate annuity will live 10 years, then do you agree the annuity will have 5 years duration in this case?
5 years should be a reasonable approximation. The exact duration would be a bit less, because in PV terms, the initial payouts carry more weight than later payouts. So the exact duration might be more like 4.xx years.
So if that be the case, that an immediate annuity purchased for an individual with a life expectancy of 10 years has a duration of just under 4 years, then a deferred annuity purchased 20 years prior to that same time by an individual with a life expectancy of 10 years would have a duration of just under 24 years. If so, then the equation for a deferred annuity is closer to t + (T/2), where t = deferral period, and T = life expectancy at start of annuity payments. Correct? if not, please help clarify.
Yes, that's correct. If your wife is 60, and life expectancy is 10 years left at age 80, the duration of the TIPS she'd want would be about 20+10/2=25 years based on what we said. But if vineviz is correct that the uncertainty of the annuity increases its duration compared to that of a bond ladder, then you'll want to add to that. Based on the calculator Horton linked to above, I see the duration of an annuity for an 80 year old female @ 2% discount rate listed as 6.38 years, a bit more than the 4 to 5 years we came up with. So maybe go with that instead. i.e. Your wife would hold TIPS with a duration of 20+6.38=26.38 years. I wouldn't worry about getting this exactly right. It's likely small potatoes compared to most other aspects of a financial plan.
Thx. Very much appreciated. The entire concept of duration has been mystifying, but having explained the concept of immunizing against interest changes is clarifying. And applying it to TIPS, which immunize against inflation, makes utilizing them for future targeted expenses so much more understandable.

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Ben Mathew
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Re: Finding Middle Ground on the LMP

Post by Ben Mathew » Tue Jun 30, 2020 1:38 pm

bigskyguy wrote:
Tue Jun 30, 2020 8:35 am
The entire concept of duration has been mystifying, but having explained the concept of immunizing against interest changes is clarifying. And applying it to TIPS, which immunize against inflation, makes utilizing them for future targeted expenses so much more understandable.
Yes, risk reduction through inflation protection and duration matching are the free lunches of bond investing, just like diversification is the free lunch in stock investing. Holding bonds as TIPS ladders makes a lot of sense for that reason.

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Re: Finding Middle Ground on the LMP

Post by grok87 » Tue Jun 30, 2020 2:00 pm

Ben Mathew wrote:
Tue Jun 30, 2020 1:38 pm
bigskyguy wrote:
Tue Jun 30, 2020 8:35 am
The entire concept of duration has been mystifying, but having explained the concept of immunizing against interest changes is clarifying. And applying it to TIPS, which immunize against inflation, makes utilizing them for future targeted expenses so much more understandable.
Yes, risk reduction through inflation protection and duration matching are the free lunches of bond investing, just like diversification is the free lunch in stock investing. Holding bonds as TIPS ladders makes a lot of sense for that reason.
agree.
RIP Mr. Bogle.

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