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.