May 10, 2018

I am my own behavioral case study on annuitization

Everything I've ever done here at RH -- that is, if I were to want "funded contentment" (Portnoy in The Geometry of Wealth which I have not read) or an almost fully defeased retirement goal-set or an optimized utility of lifetime consumption...or whatever -- invariably leads me to the logical conclusion that I should do (must do?) something like create a TIPs ladder for a "floor," hedge longevity risk with a deferred annuity or at least a plan to layer into income annuities as a displacement to my bond allocation, and then go up the investing risk spectrum with what's left.  No proof here, just trust me for now. 

And yet...I don't.

This tension is obvious and has been nagging me in my annoying little inner voice for a long time.  What, exactly, is holding me back?  It's time to take a look. This is not a hard analytical look, just a preliminary warning shot across the bow-of-self to pay attention to this in the front of mind rather than the back. Here is my starter list to which I will hopefully add some analytical insights as the future months unfold:

What do I think holds me back?

1. Lethargy.  Who doesn't like the status quo or have some vague anxiety about change? I do.  I like my risk-based set up for now and have enough risk capacity to not worry...yet. I need some kind of catalyst. And then hope I am not too late.

2. Upside Foregone.  Basically the plan above is more or less like an option collar. Some upside is forsaken, in addition to the cost of hedging, for the benefits of the downside hedge.  Forget for the moment that the unhedged (prospect-theory) downside would be horrifying and the un-abridged (utility theory) upside would be diminishing in its meaning to me.  Ignoring that, then there is in fact probably at least some option value to not hedging everything out yet.  That, of course, assumes an absorbing barrier that is still below where I am by which I mean I still have balance sheet capacity to get off the merry-go-round of risk by buying my way out via annuity products. If I was at or below that barrier, this would be a different story.  It's just I know that I'll have to monitor this carefully going forward if I don't want to lose the game by not watching my risk vs barrier.

3. Cost and product choices. I have not done my research but I get the sense that there is an imperfect market in annuity products these days. And I know it will be difficult to match an "income product set" to a fully understood, custom, optimal, adaptive, random, shock-prone, lifetime consumption plan.  For now anyway. And even if they (income products) existed to match that consumption plan (good luck), they would not come cheaply as far as I can tell.  But then again access to "the longevity pool" can do things I can't so that cost is something that I can at least comprehend as a potential the future. Perhaps a Tontine might do something for me here were they available.

4. Inability to collateralize and self-lend. This is a relatively minor point but I now have the ability to use my assets as collateral for self-lending. This kind of thing sometimes gets a bad rap in the press but it has been very very useful to me over the last 10 years.  Certainly there are one-off circumstances like a bridging loan when buying and moving households.  But in addition to that, I know from experience and my 10 years of collected data that spending is not only random but a fat-tailed distribution to boot.  Conventionally, this is common sense: there is a set of predictable recurring expenses and then also a pile of other discretionary stuff along with some unknown expenses over time.  In the language of a past post I could maybe also represent this kind of thing as a type of "Gaussian mix+" : (1) one spending distrb that has a lower mean and narrow standard deviation, plus (2) another spending distribution with higher mean and wide distribution, plus (3) the unknown.  If I weren't so gun shy about showing my personal data online I could demonstrate this easily enough on my monthly spend series.  The point here is that borrowing capacity can be useful in smoothing spending when income is constant and/or sequence risk looms.  Not sure how much real benefit there is but it feels like it is there. Full annuitization can certainly solve the lifetime income side of the equation but has little to say about fat-tailed spending.

5. Legacy and default risk.  These issues are common in the lit.  For example, I worry that, in the case of the annuity, handing capital to the insurer means that death on day 2 of the contract feels unfair to me and my heirs. Intellectually I realize, of course, that this is answerable in several ways such as: (a) acknowledging this is part of the risk pooling game and is necessary to make the insurance work, or (b) there are now some (still imperfect) products that can assuage some of this worry like GLWB riders and their ilk. Beyond that, like everyone else, I am also aware of the idea of the risk of insurer default.  While saying this I should also acknowledge that a default scenario would also likely put an uninsured portfolio at risk.  There'd have to be some serious financial anarchy for that kind of thing to unfold I think.  But I still pause.

6. Other because there is always other.  There are probably other things I am not thinking of here.  With a google search of "annuity pardox" it'd probably take 3 minutes to flesh out the list.  Either way, I'll think about this some more and see if I can either get off my wait-and-see chair or provide some more analytical support for my inertia. 

No comments:

Post a Comment