Wednesday, June 13, 2012

Retirement Income Newsbeat #1

Steve Vernon and the Oblivious Investor are both established as leading providers of basic education about investing and retirement income strategies, and Joseph Tomlinson is working at the cutting edge of theorizing about retirement income. They've all checked in this week with worthwhile new columns.

First, in "Should Asset Allocation Change with Age," the Oblivious Investor provides an intuitive explanation for why it is reasonable to reduce one's stock allocation with age. But he also notes that in the post-retirement period, a wide variety of asset allocations do almost just as well in terms of minimizing the failure rates of different inflation-adjusted withdrawal amount strategies.

Second, in "How to Recession-Proof Your Retirement," Steve Vernon at CBS MoneyWatch provides an interesting example of his own mother's retirement and how she has done well with a strategy that establishes a basic retirement income floor first, and then seeks greater upside with remaining assets. Another column by him from this week, "Do-it-yourself retirement income" also provides a good introduction.

Finally, Joseph Tomlinson's new column at Advisor Perspectives, "Investing for Retirement: SPIAs, TIPS, Stocks, and the 4% Rule," is a rather significant and important presentation of new research. He and I both tend to agree on basic issues, though we take a different approach with how we simulate retirement income strategies. I rely much more on brute computing power, which allows me to now investigate strategies with more variable spending amounts, which in turn requires more sophisticated evaluation tools. 

But in the context of constant inflation-adjusted spending amounts until wealth depletion, Joe's column moves the ball forward quite a bit by proposing a more sophisticated measure that incorporates both the probability and magnitude of failure. The fact that failure rates ignore when the failure happens (1 month or 15 years before the end of the retirement period count the same) really diminishes their usefulness. Joe has provided a very intuitive and simple measure to correct for this by multiplying failure rates by the magnitude of failure (how far into the hole one's desired spending would take them).

In addition to Monte Carlo simulations for financial market returns, Joe's analysis also allows for simulated ages of death, rather than assuming a fixed retirement period. This highlights the dangers lurking behind bond ladders for when retirees live longer than the planned end date for their ladder.

Joe also incorporates current market conditions, which are what will be faced by new retirees, rather than basing the simulations on historical averages.

In my view, he has several important findings about the allocation between stocks, TIPS, and SPIAs:

-While partial annuitization has little impact on failure rates, it does help to dramatically reduce the magnitude of failure. Expected bequests are also reduced. The proper choice depends on how a retiree weighs the tradeoff between their ability to leave a bequest and their fear of running out of money.

-A TIPS ladder is quite exposed to longevity risk.
-SPIAs act as "turbo-charged" bonds. This suggests that there is not much room for bonds in a retirement portfolio. Instead of stocks and bonds, you may wish to instead be thinking more in terms of stocks and SPIAs.

-This final point is something I am still thinking through and don't have any clear opinion of my own yet. Conventional wisdom is that it is a bad time to annuitize when interest rates are low. Rather, wait for rates to rise. But I believe that Joe is essentially arguing that the overall case for partial annuitization (relative to the alternatives) becomes stronger precisely when interest rates are low.


  1. Hi Wade.

    Thanks for including my article in your roundup.

    And thanks too for pointing out Tomlinson's article. I look forward to reading it in full tomorrow. Looks very interesting.

  2. Wade –

    Regarding your last paragraph, SPIA vs. Bonds when interest is low -- In a prior discussion we were involved in partly in Bogleheads, months ago, it seemed to me a conclusion came out that when interest rates are low, Bonds are hurt more than SPIAs, and therefore SPIAs are RELATIVELY attractive. And per your paragraph Joe Tomlinson sees it that way. Could you summarize your current view, or the competing views, of the low-interest SPIA/Bond comparison?

    If in low interest SPIAs beat Bonds, that’s a very big deal for the present, and maybe for times ahead . . .

    Dick Purcell

  3. Thanks Mike for including so many of my articles at your blog!


    I'm reviewing my column for Advisor Perspectives next week, and I'm finding that the reporting I'm doing on other views is leading more toward the wait to annuitize said.

    I guess the issue that is holding me up on forming my own opinion is about the issue of waiting. I'd like to see with Monte Carlo simulations that allow bond yields to slowly rise to a more typical level, how the strategies perform: annuitize now, or hold bonds and wait to annuitize later. Also there is the issue of getting upside potential from holding stocks and holding off on the annuitization decision. Joe may be right, but I would just like to explore it some more before committing to a viewpoint.

  4. Wade, Good discussion of mine and the other articles. Re: waiting and SPIAs, it will be worth expanding on what I did and looking at strategies like buying at 65 vs. waiting until 75. Perhaps there isn't that much mortality pooling benefit in the early retirement years so maybe it makes sense to retain the flexibility until 75 or so. That said, I think that a lot of SPIA reluctance is, indeed, behavioral bias rather than rational on the part of both clients and advisors, perhaps status quo bias. It's not easy to recommend that a client make an irrevocable decision with a major hunk of money.

  5. Like others, I'm very interested in the analysis of waiting vs SPIAs now. I currently view it as a form of diversification -- scaling into a SPIA in 3-4 separate purchases over a few years will average out the interest rates and not make a single bad timing decision permanent.

    But I'm more concerned with the statement about stocks+SPIAs vs stocks+bonds. Stocks regularly get smashed, and when this happens it is important to have a portion of the total portfolio that can be "rebalanced" to replenish the stock portion and allow the subsequent stock recovery to impact the total. This rebalancing is not possible with a SPIA.

  6. Joe and Bill,

    Thanks for the comments.

    Bill, that's an interesting point. It's another reason why all of this needs to still be tested more systematically before coming to any firm conclusions.

    But Joe, I guess this point would show up with your simulations. Any thoughts about it? I suppose that the longevity protection from the SPIA was more than making up for this rebalancing effect.