Update on prelim evaluation of real annuitization with stochastic inflation model

I confused a reader in my last post. In a convention that I did not explain, when I ran different spend rates, and used different asset allocations to a stylized efficient frontier, for a parameterization that was unique to me, and therefore not really generalizable, I used a type of shorthand from a prior post. 

For different spend rates for a nominal and for a real annuity, both modeled using stochastic inflation with an autoregressive feature (and compared to a deterministic baseline), I consolidated my moves and took the max utility for each spend rate across all allocations. Easier for me but also easy to misunderstand.  The original chart from (A prelim look at a real annuity and lifetime consumption utility - with a stochastic inflation model) looked like this

A prelim look at a real annuity and lifetime consumption utility - with a stochastic inflation model

Reason for the Post

This is almost the exact same post as the last one (A *very* prelim look at nominal vs real annuities and Lifetime consumption utility) except that I added the ability to make inflation (drawn from history using a table from inflationdata.com) stochastic and, in addition, the ability to stylistically model auto-regressive inflation using an approach offered by Brown, Mitchel and Poterba [2001] in The Role of Real Annuities and Indexed Bonds in an Individual Accounts Retirement Program. The stylized AR(1) process is described in the note in this post (Model Sensitivity: inflation vs lifestyle).

This post is not really research as such. Since modifying existing software is like updating the electrical in a seven bedroom 1911 house not touched for decades (I know whereof I speak and can tell you how long it took and how much it cost) we can consider this post a "software shakeout" rather than anything conclusive. How's that for sandbagging?

A *very* prelim look at nominal vs real annuities and Lifetime consumption utility

I was updating my software for simulating (expected discounted utility of lifetime consumption) and I thought I might as well make it work for a really basic comparison of nominal vs real annuities. I thought it was in the SW but the original amateurism appalled even me.  The mods were really really annoying, though.  I am totally convinced that I should never ever modify software again but do EVERYTHING from scratch.  It's like remodeling houses.

Now, here, I won't give too much detail cuz I don't want to show my own hand on personal data. Mostly this kind of thing uses personal details, though.  Let's at least assume some of the following

Unknowable vs unknown

This is from Crafting Retirement Income That Is Stable, Secure, and Sustainable by Jason K. Branning, CFP®; and M. Ray Grubbs, Ph.D. [2017 SSRN]

Planning against the unknowable offers a different starting point than simply planning for unknowns. We can know that a client will ultimately die, but it is not just unknown as to when, but individually unknowable. The distinction between unknown conditions and unknowable conditions is an important one for financial planners and clients. Unknown implies that there is something that can be done to provide knowledge on which actions can be taken. Unknowable implies that there is nothing that can be done to add knowledge to a particular client situation. The unknowable aptly describes individual client issues such as longevity and conditions within longevity. Conducting empirical tests requires assumptions or constraints to get a meaningful mathematical solution. Math is useful if conditions can be controlled and limited, as math measures quantity.

Tail Risk Hedging

"The takeaway for investors is that the evidence demonstrates that at least, historically, an allocation to time-series momentum and quality (defensive) stocks would not only have improved returns but significantly reduced tail risk, the kind of risk that can lead to the failure of financial plans."

That was Larry Swedroe writing on tail risk hedging at Alpha Architect. The post is here:
Strategies to Reduce Crash Risk in Stocks.

Fecundity and Long-duration Retirements

I was just reading a paper by James Garland (The Fecundity Of Endowments And Long-Duration Trusts) and was struck by the affinities with early retirements. In fact, since I retired early, I myself have always had an eye on endowments and trusts as a model because -- while today at 61 if I were to abandon my DIY approach and plan on sinking a bunch of money into an annuity at age 80, my planning horizon is only maybe 19 years -- for early retirements the planning horizons can be really long, maybe up to 50 years or more.

While I do not 100% agree with what is implied by Garland's approach, since I do believe in "triangulation," this seems like another worthy way to think things through...it's worth a look. Me personally? I still think that the max "fecundity" of consumption portfolios with very long horizons (say 50 years to infinity) happens at a spend rate that is close to or above the horizon-adjusted expectation for multi-period geometric returns -- which depend on the horizon, realized returns, and volatility.  Maybe we are saying the same thing.  TBD.

Try #2 on a rough validation of a 3.6% break-even inflation rate for a real annuity

Before my vacation to MT, I briefly proffered a post that tried to validate Joe Tomlinson’s guess that the current market (ok, it’s only one company and product) for inflation adjusted annuities suggests that there is a “breakeven rate” of around 3.6% inflation when considering those products (Which Annuities Offer the Best Inflation Protection, June 2019). I happened to retract my post because I thought it looked and sounded innumerate and even if it wasn’t innumerate it was at least mixing quantitative apples and oranges and that, at a minimum, felt embarrassing. I also used the wrong name for the insurance company that offers the inflation adjusted annuity. But, I *am* still interested in things like inflation, lifetime income, and consumption utility over a full lifecycle, especially in the decumulation stage. 

A self-frame-of-reference that looks like the hard granite surface of a mountain

While in MT recently with my daughters, I had the chance to watch (Hulu) from a safe distance "Free Solo," the story of an un-roped (i.e., free solo) ascent of El Capitan by Alex Honnold in 2017.   [As an aside, one of the directors went to Carleton College, of which I am an alum.]  The "direct" story of the climbing and the courage necessary to do it is story enough. But there was also a sub-story that I found quite fascinating: that of how Alex holds to his self-defined mission in the face of fairly intense weepy pressure to divert (subvert) it by a committed long-term-relationship girlfriend.

When Retirement Quants Dream...

...when they dream then this, below, in the image (by way of my iPhone last week), is the type of sugar plum fairies that dance in their heads...

In this case we are looking at the Madison Valley in SW Montana. The Madison range (and Ennis, MT) is in front of you, the Tobacco Root range is behind you to the left, the Gravelly Range is behind you to the right. The point of this picture is that it is about :45 from Bozeman. Shit, in south FL it takes me about 45 minutes just to get to the grocery store, about 3 blocks away. An hour of driving and I'm still in Broward county and, if you've ever been to Broward county, you, therefore, know wherefore I dream.

Some thoughts for younger "spenders"

Here is a recent twitter thread on spending....

Bob missed a point right that went right over his head. I wanted to call him a troll after I read this because every once in a while he throws out aggressive tweets of which this is not really one. But nine times out of 10 I totally agree with what he's trying to say. My guess is that he has a point of view developed from working with people that need assertive wealth management help in the Midwest so the trollish-tweets are probably well earned and done in good faith.  At least I'll assume that for now.

In this case the missed point is that sometimes it is not about "spend rates" at all. Spend rates could be all over the place depending on the individual context.  But my guess is that Bob would spend 1M a year without blinking if that was a reasonable construct for a properly constructed age-appropriate decumulation portfolio. I'd maybe agree with that and maybe my own "dream" rate is 1M but my point above was something else entirely.

Let's try this again:

Young people of America. Listen up. Before you even get to the topic of  your future retirement spend rates, make sure that when you complain about spending 150 grand a year, or you complain about having to buy your Porsche used rather than new, you do not do that complaining in front of a family of four that is making 50 or 60 grand a year.  That is somewhere around the median income in this country. And we haven't even gotten to taxes yet.  Your 150k (and I hate to use this next term since it is so loaded these days) is case of privilege.  This has nothing whatsoever to do with whether 3% of 5 mil is "ideal" or a "dream" or not.  I don't really care what your ideal dream spend rate is. This 150 vs 50 thing is a moral position and it is mine. It does not have to be yours. You should be able to make a decent life at 150 in absolute terms. My point still stands. Go find your "dream" but respect others while doing it.

Model Sensitivity: inflation vs lifestyle

In his recent Advisor Perspectives article (Which Annuities Offer the Best Inflation Protection June 2019), Joe Tomlinson, one of the more generous and helpful retirement writers now living, writes:

It turns out by pure coincidence that the 10th percentile for the COLA SPIA almost exactly matches the inflation-adjusted indexed SPIA. So there’s a 90% chance that purchasing the COLA SPIA will generate more real income than the inflation-indexed SPIA and a 10% chance it will do worse. This result is consistent with Blanchett’s findings. The upward-sloping median result for the COLA SPIA indicates that it beats inflation on average; this would be expected given its 3.6% annual increases in payments versus inflation averaging 2.3% overall. The 90th percentile beats inflation by a bigger margin.  

These results look very favorable for the COLA SPIA, but it’s worth cautioning that they are a direct reflection of my particular inflation model, which was built with considerable subjectivity. Higher future average inflation would reduce the advantage of the COLA SPIA and higher inflation volatility would increase the spread between 10th and 90th percentile results. The inflation-indexed SPIA has the unique property of providing a pure hedge against very high inflation, which is a material risk that every retiree must acknowledge and consider. [emphasis added]  

That last sentence is important so the investigations and the conclusions are important as well. Also, if we acknowledge that the inflation-indexed annuity form is the only decent way these days for a retail investor to get access to both a longevity risk pool paired with a pure inflation hedge, it is necessary, imo, to be at least aware of the idea of these products.

Playing around with inflation, part 2

Joe Tomlinson tipped me off to another way to model inflation and sent me the paper that explained it (The Role of Real Annuities and Indexed Bonds in an Individual Accounts Retirement Program [2001] Jeffrey R. Brown, Olivia S. Mitchell,and James M. Poterba).  Also, since the last post I realized I had made an error in the historical inflation model and I wanted to correct that here.  Since I'm goofing around on this and have so few readers, I'm hoping the error did not affect anything anyone does. Doubtful it did.

Starting to play around with inflation...

Note: 

I had an error below where I inadvertently goosed the historical inflation with the extra 1.3% period standard dev. This makes the historical inflation exaggerate a bit. Rather than fix it here I'm moving on and will correct it in the next post (Playing around with inflation, part 2). In that post we see a more reasonable historical inflation effect but when I add on an autoregressive model AR(1) we get back all the multi-period-time-driven vol and then some.  

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The Point

I just finished 12 posts on lifetime consumption utility and full and partial annuitization. That month-long effort involved, by my estimate, over 100 million iterations of some software I wrote.  That's a lot.  It also put the issue of nominal annuities front and center. While there are many proxies for inflation protected income out there in the market there is evidently only one insurer that writes a true inflation protected annuity.  Nominal annuities, and even the pseudo-protected ones, are an explicit bet on inflation; effectively one is partially or completely short inflation where in extreme inflation it might be better to be long...or employed...or living someplace else.

Most of the models I build factor in inflation a bit but mostly I ignore it or gloss over it.  I wanted to think about it some more. I do not have a sophisticated view. I am, as in my other posts, capable with a spreadsheet or R-script but more or less I am naive most of the time. Nothing has changed in that area yet.  But let's take a preliminary look-see.

Fitness after 60: Intermittent Fasting was Not Enough

The Point

The point of this post is to describe a recent breakthrough in a recalcitrant fitness goal, a breakthrough that was achieved via some hard discipline along with a little encouragement from a few Twitter connections. The other point is to describe some of the how, why and when involved in getting there.

Another point here is that while intermittent fasting and proper diet, along with resistance training of course, is now an important and permanent part of my routine (see this TedX talk by Cynthia Therlow; follow Alex at foreveralphablog.co.uk or on Twitter @TheForeverAlpha; or follow PD Mangan @Mangan150 or roguehealthandfitness.com) it was not, in the end, enough for me. Alcohol elimination (temporary) and calorie counting were necessary to push me all the way to my goal.

Nominal annuity allocation vs deferral - supplement to last post

This is an addendum to Annuity Allocation and Immediate vs. Deferral in a Lifetime Consumption Utility Context (the very last post).  I couldn't not throw in a 3D.

Without too much comment, this is a representation of the max value function (across all spend rates and allocations to risk) for each combination of (a) allocation to a nominal (fake, in-model) annuity between 10 and 50%  and (b) deferrals including: none(SPIA), to-70, 75, and 80. I skipped 85 since the numbers were not great at that age.

As before, this is not terribly universalizable and was made using some personal and fairly rigid choices for a set of parameters. You'd have to know those parameters and why I used them to get some more intuition on the output.  The link to the last post contains links to all of the past posts.

As before there is a overall maxima area around 30% allocation and deferral to 75 with the edges favoring a direction towards 20%/age75-80 and 40%/age70. The chances, however, that I will annuitize anything this year is still approaching zero.

Annuity Allocation and Immediate vs. Deferral in a Lifetime Consumption Utility Context

The Point of the Post

In two previous posts, using my rigid and personally particular parameters and a custom coded lifetime-consumption-utility simulator (i.e., you need to have a certain amount of skepticism present in your brain starting now) I determined two things among several attempts to try to see this:

1. At a 10% allocation to a nominal SPIA for a 61 year old using current interest regime assumptions, that allocation delivered demonstrably better lifetime utility than no use of a risk pool,

2. At a 0% allocation to a nominal SPIA for a 61 year old deferring to no later than age 80 produced higher econ. lifetime utility than the SPIA,

3. When trying to allocate to an SPIA between 10% and 80% of initial wealth, a 60% allocation to an SPIA seemed to work the best, and

4. Deferring the 60% allocation did not seem to do much good, utility wise.

So, the question today is whether some combination of allocation between 10 and 60% and some degree of deferral produces a utility-driven outcome that is better than either #2 (10% allocation, defer to age 80) or #3 (allocate 60% to an SPIA).

I'll look at the following allocations to annuities to try to answer the question above:

• 10% - 50% in 10% increments
• Deferral to 0(spia), 70, 75, and 80. 85 proved in a past post to be a non-starter for me.