Reducing volatility risk prior to retirement

bostonerimus

Deleted_User said:

Annuities are not for people enjoying “playing probabilities”… But maybe they are. One could use annuities for the 40% portion of a 60/40 portfolio instead of bonds. With a rate of 0.5% on a 10 year bond, a 5% life annuity looks like a far superior option based on probabilities. 

True enough. If someone can afford to use 40% of their capital to lock in today's low rates and have that eaten away by inflation for the rest of retirement then that's great. If we are going to compare annuities to SWR from a portfolio of equities and fixed income we need to use the 2% of the inflation linked annuity. I'd rather see someone put that 40% into cash today and get 1% interest and then reassess in 5 years time.

[Deleted User]

Its either “2%” or “inflation linked” annuity. The latter is a junk product because very few companies offer it. “2%” is an option but not for people wanting to replace the bond portion of their portfolio. A perfect bond has the exact duration you require. The problem is that humans don’t know our duration.  A bond you buy today isn't going to be linked to future inflation. So, a standard annuity is a far superior option for the FI portion of your portfolio than today’s government bonds: it covers your actual duration and it pays a lot more.

michaels

Deleted_User said:

Its either “2%” or “inflation linked” annuity. The latter is a junk product because very few companies offer it. “2%” is an option but not for people wanting to replace the bond portion of their portfolio. A perfect bond has the exact duration you require. The problem is that humans don’t know our duration.  A bond you buy today isn't going to be linked to future inflation. So, a standard annuity is a far superior option for the FI portion of your portfolio than today’s government bonds: it covers your actual duration and it pays a lot more.

But why would you choose a bond ladder (of anything but linkers) if you were concerned about inflation?

And why is there so little competition in the index linked annuity market that the market leading quote at age 55 is 1.6%?  Perhaps it is because not many want to buy as the cost of underwriting them is so high?  Doesn't mean the price is wrong, just that people's perceptions of what is a fair price are wrong.  WE see the glittering prizes that historic SWRs appear to offer and ignore what the markets are telling us about expected future returns and wait for rates to 'recover'...

Linton

Thrugelmir said:

Linton said:

Thrugelmir said:

Linton said:

Deleted_User said:

If you want to bet then just put everything into equities and take your chances.  Of course then people are talking about “SWR” of 3% rather than guaranteed 5% from an annuity and the 3% isn’t actually “safe”. Thats a massive difference in spending cash. 

The problem with your last scenario is that you keep talking about “most people” and “bets”. Many don’t want to play Russian Roulette when the losers get to beg for food in their twilight years. A 5% chance of that happening is way too high in my book, let alone 45% in your example. And life expectancy for someone who lives to 85 years is 7 years. Thats a nightmare scenario you’ve just drawn for that person. 

Seems to me that a risk averse 65 year old who buys a 5% annuity to cover the delta between his DB income and minimum needs, and still has a sizeable stock portfolio to deal with the inflation, “extras” and legacy might well buy both peace of mind and more spending money than your betting person. He can afford to take lots of risk with the remaining liquid portfolio vs a person who has to worry about providing for his very basic needs. So based on “betting” he might come out ahead as well. An annuity would provide a great value to him/her. 

Agree with the general principle apart from one detail - a 5% annuity would be fixed rate that is 99.9% guaranteed to reduce in real value over time whereas a 3% SWR (3% is lower than most people quote) is by definition 100% inflation linked so the two are not comparable.   Fixed rate income is high risk in my view unless you have a low risk strategy to replace it in later years.

By whose definition?  

For example https://monevator.com/how-to-choose-an-swr-for-your-isa-and-your-pension-to-hit-financial-independence-fast/

Says:

• …SWR strategies enable you to withdraw a consistent, inflation-adjusted income for the duration of your retirement (subject to all-important caveats that you need to understand).

That's based on US historical returns of 15-40 year periods to 2014.  Not very usefull to a UK based investor who will experienced a very different scenario of inflation, interest rates and market returns.  

The fact that the choosen starting point of the data is 1974 at the start of the bond bull market appears somewhat selective. 

Nor does it address the issue of constructing a portfolio today that will perform over the next 40 years. 

I don’t advocate an SWR approach but many people do so it serves as a useful benchmark. People who use SWR generally base it on the results from cfiresim that goes back 100 years or more.

[Deleted User]

michaels said:

Deleted_User said:

Its either “2%” or “inflation linked” annuity. The latter is a junk product because very few companies offer it. “2%” is an option but not for people wanting to replace the bond portion of their portfolio. A perfect bond has the exact duration you require. The problem is that humans don’t know our duration.  A bond you buy today isn't going to be linked to future inflation. So, a standard annuity is a far superior option for the FI portion of your portfolio than today’s government bonds: it covers your actual duration and it pays a lot more.

But why would you choose a bond ladder (of anything but linkers) if you were concerned about inflation?

And why is there so little competition in the index linked annuity market that the market leading quote at age 55 is 1.6%?  Perhaps it is because not many want to buy as the cost of underwriting them is so high?  Doesn't mean the price is wrong, just that people's perceptions of what is a fair price are wrong.  WE see the glittering prizes that historic SWRs appear to offer and ignore what the markets are telling us about expected future returns and wait for rates to 'recover'...

…because linkers pay less than today’s inflation so you are locking in a guaranteed loss. Thats because the governments have been buying their own bonds and messing with the market.   You need to be very wealthy indeed to be able to buy linkers and survive on what they pay. 

If you are concerned about inflation and don’t have enough DB income then you need some equities. 

michaels

Deleted_User said:

michaels said:

Deleted_User said:

Its either “2%” or “inflation linked” annuity. The latter is a junk product because very few companies offer it. “2%” is an option but not for people wanting to replace the bond portion of their portfolio. A perfect bond has the exact duration you require. The problem is that humans don’t know our duration.  A bond you buy today isn't going to be linked to future inflation. So, a standard annuity is a far superior option for the FI portion of your portfolio than today’s government bonds: it covers your actual duration and it pays a lot more.

But why would you choose a bond ladder (of anything but linkers) if you were concerned about inflation?

And why is there so little competition in the index linked annuity market that the market leading quote at age 55 is 1.6%?  Perhaps it is because not many want to buy as the cost of underwriting them is so high?  Doesn't mean the price is wrong, just that people's perceptions of what is a fair price are wrong.  WE see the glittering prizes that historic SWRs appear to offer and ignore what the markets are telling us about expected future returns and wait for rates to 'recover'...

…because linkers pay less than today’s inflation so you are locking in a guaranteed loss. Thats because the governments have been buying their own bonds and messing with the market.   You need to be very wealthy indeed to be able to buy linkers and survive on what they pay. 

If you are concerned about inflation and don’t have enough DB income then you need some equities. 

It is not inflation you are worried about but volatility - unexpected inflation = prices volatility just as share prices may over time address inflation risk but are equally (or even more) volatile so the suggestion that one can hedge against price (inflation) volatility via an instrument that also exhibits huge volatility is not really solving the problem....

Thrugelmir

Linton said:

Thrugelmir said:

Linton said:

Thrugelmir said:

Linton said:

Deleted_User said:

If you want to bet then just put everything into equities and take your chances.  Of course then people are talking about “SWR” of 3% rather than guaranteed 5% from an annuity and the 3% isn’t actually “safe”. Thats a massive difference in spending cash. 

The problem with your last scenario is that you keep talking about “most people” and “bets”. Many don’t want to play Russian Roulette when the losers get to beg for food in their twilight years. A 5% chance of that happening is way too high in my book, let alone 45% in your example. And life expectancy for someone who lives to 85 years is 7 years. Thats a nightmare scenario you’ve just drawn for that person. 

Seems to me that a risk averse 65 year old who buys a 5% annuity to cover the delta between his DB income and minimum needs, and still has a sizeable stock portfolio to deal with the inflation, “extras” and legacy might well buy both peace of mind and more spending money than your betting person. He can afford to take lots of risk with the remaining liquid portfolio vs a person who has to worry about providing for his very basic needs. So based on “betting” he might come out ahead as well. An annuity would provide a great value to him/her. 

Agree with the general principle apart from one detail - a 5% annuity would be fixed rate that is 99.9% guaranteed to reduce in real value over time whereas a 3% SWR (3% is lower than most people quote) is by definition 100% inflation linked so the two are not comparable.   Fixed rate income is high risk in my view unless you have a low risk strategy to replace it in later years.

By whose definition?  

For example https://monevator.com/how-to-choose-an-swr-for-your-isa-and-your-pension-to-hit-financial-independence-fast/

Says:

• …SWR strategies enable you to withdraw a consistent, inflation-adjusted income for the duration of your retirement (subject to all-important caveats that you need to understand).

That's based on US historical returns of 15-40 year periods to 2014.  Not very usefull to a UK based investor who will experienced a very different scenario of inflation, interest rates and market returns.  

The fact that the choosen starting point of the data is 1974 at the start of the bond bull market appears somewhat selective. 

Nor does it address the issue of constructing a portfolio today that will perform over the next 40 years. 

I don’t advocate an SWR approach but many people do so it serves as a useful benchmark. People who use SWR generally base it on the results from cfiresim that goes back 100 years or more.

Global equity markets haven't existed for a 100 years though. That's manufactured data. Markets are efficient at the micro level and inefficient at the macro level. Doing what everybody else does, is a sure way of being disappointed at some point in time. 

[Deleted User]

michaels said:

Deleted_User said:

michaels said:

Deleted_User said:

Its either “2%” or “inflation linked” annuity. The latter is a junk product because very few companies offer it. “2%” is an option but not for people wanting to replace the bond portion of their portfolio. A perfect bond has the exact duration you require. The problem is that humans don’t know our duration.  A bond you buy today isn't going to be linked to future inflation. So, a standard annuity is a far superior option for the FI portion of your portfolio than today’s government bonds: it covers your actual duration and it pays a lot more.

But why would you choose a bond ladder (of anything but linkers) if you were concerned about inflation?

And why is there so little competition in the index linked annuity market that the market leading quote at age 55 is 1.6%?  Perhaps it is because not many want to buy as the cost of underwriting them is so high?  Doesn't mean the price is wrong, just that people's perceptions of what is a fair price are wrong.  WE see the glittering prizes that historic SWRs appear to offer and ignore what the markets are telling us about expected future returns and wait for rates to 'recover'...

…because linkers pay less than today’s inflation so you are locking in a guaranteed loss. Thats because the governments have been buying their own bonds and messing with the market.   You need to be very wealthy indeed to be able to buy linkers and survive on what they pay. 

If you are concerned about inflation and don’t have enough DB income then you need some equities. 

It is not inflation you are worried about but volatility - unexpected inflation = prices volatility just as share prices may over time address inflation risk but are equally (or even more) volatile so the suggestion that one can hedge against price (inflation) volatility via an instrument that also exhibits huge volatility is not really solving the problem....

I am worried about my portfolio being severely depleted just before or after retirement. Unexpected inflation is one of the risks. Companies have been good  at dealing with unexpected inflation. They jack up the prices faster than salaries. Short term volatility in stocks isn’t problematic as you have your fixed income to fall back onto.  Long term, equities are the best tool for dealing with inflation. Hyperinflation is another story. 

The reality is that no approach eliminates the risk entirely.  I just disagree with people suggesting axiomatically that “annuities are poor value”.  They seem like a really good option for a youngish retiree to replace bonds. Government bonds today are a poor product because of “quantitative easing”. 

Thrugelmir

michaels said:

Deleted_User said:

michaels said:

Deleted_User said:

Its either “2%” or “inflation linked” annuity. The latter is a junk product because very few companies offer it. “2%” is an option but not for people wanting to replace the bond portion of their portfolio. A perfect bond has the exact duration you require. The problem is that humans don’t know our duration.  A bond you buy today isn't going to be linked to future inflation. So, a standard annuity is a far superior option for the FI portion of your portfolio than today’s government bonds: it covers your actual duration and it pays a lot more.

But why would you choose a bond ladder (of anything but linkers) if you were concerned about inflation?

And why is there so little competition in the index linked annuity market that the market leading quote at age 55 is 1.6%?  Perhaps it is because not many want to buy as the cost of underwriting them is so high?  Doesn't mean the price is wrong, just that people's perceptions of what is a fair price are wrong.  WE see the glittering prizes that historic SWRs appear to offer and ignore what the markets are telling us about expected future returns and wait for rates to 'recover'...

…because linkers pay less than today’s inflation so you are locking in a guaranteed loss. Thats because the governments have been buying their own bonds and messing with the market.   You need to be very wealthy indeed to be able to buy linkers and survive on what they pay. 

If you are concerned about inflation and don’t have enough DB income then you need some equities. 

It is not inflation you are worried about but volatility - unexpected inflation = prices volatility just as share prices may over time address inflation risk but are equally (or even more) volatile so the suggestion that one can hedge against price (inflation) volatility via an instrument that also exhibits huge volatility is not really solving the problem....

High inflation historically has resulted in higher interest rates. Higher interest rates have a negative impact on share prices. Borrowing costs increase for companies, yields on fixed interest instruments rise, likewise the rates of interest available on cash deposits for savers increase. All of which diminish the attraction for holding the same level of equities. 

[Deleted User]

Delayed Income Annuities are worth considering as well. I don’t have UK payout rates, but a 65 year old female in the US buying a DIA to pay from 85 gets a payout ratio of 12.35% (2 year old data).  Thats longivity insurance paying over 12k in perpetuity at the cost of 100k.  

The general idea is similar to delaying state pension.