New Here? Get the Free Newsletter

Oblivious Investor offers a free newsletter providing tips on low-maintenance investing, tax planning, and retirement planning. Join over 11,000 email subscribers:

Articles are published Monday and Friday. You can unsubscribe at any time.

Retirees: Should You Get Rid of Your Bonds?

Retirement researcher Wade Pfau recently released a paper titled “An Efficient Frontier for Retirement Income” (summary here) in which he compared different allocations of stocks, bonds, fixed lifetime annuities, inflation-adjusted lifetime annuities, and variable annuities with “guaranteed lifetime withdrawal benefit” riders to see how each combination plays out in terms of meeting two competing retirement goals:

  1. Minimizing the shortfall between desired spending and actual spending, and
  2. Maximizing the amount of money you leave to your heirs.

The results were rather shocking. So shocking, in fact, that there’s a good chance you’ll read about it elsewhere (which is why I’m hoping to prepare you for what you’ll hear).

What Wade found was that, given the assumptions he used, the ideal allocations for retirees involved only stocks and fixed lifetime annuities. That is, the ideal allocations included no bonds, no inflation-adjusted lifetime annuities, and no variable annuities (although I don’t think many people will find that last part to be particularly shocking).

What’s important to understand, however, is that Wade’s paper is not about showing you how to allocate your money — at least not directly. Rather, it’s about creating a new method for analyzing various allocations — by looking at how well each allocation meets those two goals above, rather than looking at, say, the allocation’s probability of running out of money within 30 years.

The specific results that Wade provides in his paper are only an example of one such analysis. And they use a very specific (though mostly reasonable) set of assumptions (about stock and bond returns, correlations between them, rates of inflation, and so on). When those assumptions are changed, the results might look very different.

In other words, for individual investors, the takeaway is not that you should dump all your bonds in favor of stocks and/or fixed lifetime annuities. Rather, the takeaway is simply that a portfolio completely eschewing bonds in favor of lifetime annuities might not be completely-off-the-wall-crazy. And, given how far such a portfolio would be from conventional retirement recommendations, that’s very interesting.

I hope we’ll see more research along these lines in the near future.

Retiring Soon? Pick Up a Copy of My Book:

Can I Retire Cover

Can I Retire? Managing a Retirement Portfolio Explained in 100 Pages or Less

Topics Covered in the Book:
  • How to calculate how much you’ll need saved before you can retire,
  • How to minimize the risk of outliving your money,
  • How to choose which accounts (Roth vs. traditional IRA vs. taxable) to withdraw from each year,
  • Click here to see the full list.

A Testimonial from a Reader on Amazon:

"Hands down the best overview of what it takes to truly retire that I've ever read. In jargon free English, this gem of a book nails the key issues."

Comments

  1. Mike,

    In his studies what % of the portfolio was allocated to fixed lifetime annuities?

    -Rick Francis

  2. He tried combinations anywhere from 0% to 100%. In total, he tested just over 1,000 possible combinations.

  3. Mike,

    Thanks for the excellent explanation. I just posted a new entry showing the frontiers for 1%, 3%, and 5% withdrawal rates too.

    Also, I quoted your last paragraph, as it is excellent and articulated very well.

    Thanks, Wade

  4. I’m wondering if the fact Bonds are historically expensive is a part of the study? I think there are many good reasons to not own bonds right now!

  5. On an intuitive level, I think Wade’s study makes a lot of sense. The purpose of bonds, in the conventional retirement strategy, is to provide a stready stream of income. The purpose of annuities, in a similarly conventional strategy, is to provide a steady stream of income WHILE also pooling longevity risk. It’s this pooling that creates outsized returns and are thus theoretically a better option. The key is the fees on annuities – which would be make or break for this strategy.

Disclaimer: By using this site, you explicitly agree to its Terms of Use and agree not to hold Simple Subjects, LLC or any of its members liable in any way for damages arising from decisions you make based on the information made available on this site. I am not a financial or investment advisor, and the information on this site is for informational and entertainment purposes only and does not constitute financial advice.

Copyright 2014 Simple Subjects, LLC - All rights reserved. To be clear: This means that, aside from small quotations, the material on this site may not be republished elsewhere without my express permission. Terms of Use and Privacy Policy