Primary Reason Why Lifetime Income Products are Generally Better Investments for Retirees than Bonds

We
advocate a Safety First (or Liability-Driven) Investment strategy for
retired households which anticipates the use of relatively low-risk
investments to fund future Essential Expenses (the Floor Portfolio) and
higher-risk investments to fund future Discretionary Expenses (the
Upside Portfolio). The non-risky assets/investments we advocate for the
Floor Portfolio include:

• Social Security benefits
• Pension benefits
• Lifetime income annuities (SPIAs and DIAs)
• Tips ladders, and
• Non-lifetime fixed annuities

The
first three items above (including deferring commencement of Social
Security benefits) can be considered as lifetime income products for the
purpose of this post. 

We are not big fans of using bonds for
funding the household Floor Portfolio as they are generally subject to
interest rate risk. We will also push back on those who argue that bonds
are more liquid than lifetime annuities by noting that if you are going
to fully fund your Floor Portfolio to pay future essential expenses,
you are committing to keeping it funded, so the extent of perceived bond
liquidity may be illusory. 

Lots of our readers disagree with us
and for whatever reason believe that bonds are just fine for funding
their Floor Portfolios. Further, many of our readers would simply never
even consider buying an annuity from an insurance company. We will once
again take this opportunity to remind our readers that we aren’t in the
business of selling any products (nor do we make any money from visits
to our website or from any activity related to our website).

Many,
if not most, of our readers plan to live longer than their life
expectancy. Some even override the 25% probability of survival default
lifetime planning period assumptions in our workbooks (Actuarial
Financial Planner) because they want to assume that they or their spouse
will live to age 100. We have no problem with being conservative and
agree that most retirees should plan to live longer than their life
expectancy. 

If you plan to live longer than your life expectancy
when determining the present value of your essential expenses, however,
you should consider buying or investing in lifetime income products
instead of buying bonds because acquiring lifetime income will generally
increase the present value of your Floor Portfolio assets and your
Funded Status, all things being equal.

We have spoken with readers
(and some experts) who plan to live longer than their life expectancy
when determining their spending liabilities in retirement, but they then
argue that they don’t want to buy an annuity (or other lifetime income
product) because they fear they may die early. This doesn’t make a lot
of sense to us. When planning, you should presumably use the same LPP
assumptions for determining both your assets and your spending
liabilities, and you should presumably select investments that maximize
returns for a given level of risk.

Readers may wish to read Dr. Wade Pfau’s paper, Determining an Efficient Frontier for Retirement Income,
in which he compares the efficiency of various stock/bond portfolios
with various stock/SPIA portfolios. He concludes that the stock/SPIA
portfolios are much more efficient.