Bond Fund Allocations instead of an annuity

[HadEnuff]

Nothing will be "locked in". It will always be temporary.

Yes, of course. The LT funds have average maturities of 10 years or more. Average "duration" on one fund, for example is 13.4 years, and "average effective maturity" is 23.7 years. (BTW, I don't understand the difference between those two things. But I understand the overall picture which is that the fund is invested in longer maturing bonds),
So, yeah, it's "temporary" but we are looking for some stability over maybe 30 years, after which the temporal nature of my existence will render all of this moot.

 

[HadEnuff]

Seems like you could also do an 80/20 stock to cash AA and achieve your 2.74 percent floor income level just with broad market equity dividends. The 20 percent cash would see you through any anomalies. You would have very solid inflation protection in theory and likely could hit your "lavish" retirement withdraw percentage of 3.2% in most years too.

Your WR is low enough that I'm not sure I would want to trade off equity risk for the risks associated with bonds and/or annuities in this case.

I don't think I have the stomach lining for such an allocation. I'm seeking to reduce the risk associated with heavy stock allocation.

 

[nun]

Right now it seems to me investing in an annuity product is the essence of making a long term investment at historically low interest rates, in historically low interest rates. Unless I'm missing something, which is quite possible.

You don't invest in an annuity (or if you think you can with a VA you are making a big mistake) it's insurance that you buy. You get a guaranteed income based on how much you spend, some prevailing interest rate and mortality credits.

 

[hurricane harry]

it is possible we could see negative interest rates in the US


annuities are not a disaster

 

[nun]

it is possible we could see negative interest rates in the US


annuities are not a disaster

Back in the good ol' days of summer 2015 when the Dow Jones was at 18k I had the opportunity to buy into my state's pension and start income in 2016. Part of my reason for doing it was that the market and PE10 were high and the predictions for the next decade's bond returns were pretty low. I'm not usually a numerologist, but they definitely factored in.

 

[OrcasIslandBound]

I wouldn't be surprised to learn that a state pension retirement plan might be a much better deal than buying an instant annuity on the open market today.

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[nun]

I wouldn't be surprised to learn that a state pension retirement plan might be a much better deal than buying an instant annuity on the open market today.

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You are correct, the numbers made the buy in an easy choice, but with the volatility in both the stock and bond markets I can see insurance companies being able to use that to sell their products. An SPIA might be a useful product to buy in some circumstances, but I hope people don't buy VAs and I still don't think bonds are an alternative to an annuity because they are such different things.

 

[OrcasIslandBound]

On one hand, I probably will never buy an annuity of any kind. On the other hand, I have a small pension which I can take as an annuity from my megacorp. It will pay about 6k a year starting next year. I compared it to instant annuities and found it to be a bit better. So I'll probably do that. I did include it in the Fidelity simulations that I ran and noticed that it will shrink to about 2k by the end. That's OK with me as I need more money earlier anyway.

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[HadEnuff]

You don't invest in an annuity (or if you think you can with a VA you are making a big mistake) it's insurance that you buy. You get a guaranteed income based on how much you spend, some prevailing interest rate and mortality credits.

I think of it as an investment. I may be able to guarantee an income, but I can't guarantee what that income will provide in terms of purchasing power, unless I buy a COLA annuity, which are really really expensive.

So I'm looking at the issue much as I looked at life insurance and disability insurance. There was a time in my life when I needed to buy those products for my and my family's security, but eventually I had enough assets to self insure.

A lot of the possible market /economic scenaria that would make an annuity a good gamble, would also have a positive effect on a balanced bond portfolio. And significant inflation would be no better served with an annuity than with a bond fund, in the current interest rate environment, which IMO makes buying an annuity right now a tough bargain.
Assuming one has enough assets to maintain some flexibility.

 

[nun]

So I'm looking at the issue much as I looked at life insurance and disability insurance. There was a time in my life when I needed to buy those products for my and my family's security, but eventually I had enough assets to self insure.

This is a good point. If you have more than 20x annual income saved up you probably don't need to buy the longevity/income/sequence of return insurance of an annuity. At close to 20x or as you get a bit older the annuity might be useful. If you have less than 20x income you should just keep working or saving or cut your budget.

If you are around 20x and see a bond allocation as a substitute for an annuity that's I think that's a false alternative as their risks are very different.

 

[Trooper]

For example, for the intermediate term Admiral bond funds, the regular fund yields 2.38% and the corporate version yields 3.58%, 1.20% more and the durations are similar (6.5 vs 6.4). Similar story for the short term bond, 1.25% vs 2.29%, a 1.04% difference and the same 2.7 duration.

pb4uski - Are the short and intermediate corporate bond funds you mention VSCSX and VICSX respectively? I noticed that VICSX has a 0.25% front load - I wonder why?

 

[Gone4Good]

I think of it as an investment.

It's certainly a financial product with a variable return. It's just that in this case your ROI is determined by how long you live . . . and that is something you have a bit of direct control over**. You also have an asymmetric information advantage relative to the seller.

There's not many financial products in the world with those features, whether we call them investments or something else.



** Some health care studies have found that offering small monetary rewards can have large impacts on people's healthy lifestyle choices. Maybe that's a possible benefit of buying annuity - an incentive to do whatever you can to increase your ROI and take the insurer to the cleaners.

 

[Lsbcal]

If I were to proceed on a non-standard allocation, I would like to see how it performed in the past environments. I would try to construct a model portfolio. Actually I'd try to compare a few portfolios to see how they did in various good and bad periods. Without this information all you have is other's opinions here. Not something to hang onto in a crisis.

At the bare minimum, I would look at how that LT bond component did in the rising rate period starting around 1953. The Fed data is probably available. You will have to convert yields to returns. I know some of the data for the 2yr Treasury and 5yr Treasury is available.

If this all seems too much, ask yourself "do I really want to go into this not knowing the past?". BTW, I've done this for my investment approach which is highly non-standard.

 

[OrcasIslandBound]

Lsbcal, Excellent idea to back test model portfolios! I have done this for a simplified investment mix of VTI and BND a few years back when I did so badly during the 2008 crash. I used yahoo finance to get all the values and dividends. I then used Matlab to simulate it all. That process helped me to define my strategy of staying at about 45% stocks going forward. But I don't know how to get raw data for LT bonds going back to the 50's. Also, I believe that BLV will be similar to a single bond in that after the duration has passed, subsequent to an interest rate rise, it will reach the same value it started at when including dividend reinvestment. This becomes a judgment and the 4% vs 2.2% is compelling.

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[pb4uski]

pb4uski - Are the short and intermediate corporate bond funds you mention VSCSX and VICSX respectively? I noticed that VICSX has a 0.25% front load - I wonder why?

Yes, those were the two I was referring to. Dunno why the 0.25% front-end fee but the ER is really low 0.10% so that might have something to do with it.

The webpage says "The fund assesses a 0.25% fee ($2.50 per $1,000) on purchases. The fee is paid directly to the fund and therefore is not considered a load." I guess it is technically different from a front-end load since the money goes into the fund and therefore increases the NAV (but not noticeably).

As a long term investor the 0.25% fee would not concern me especially since the ER is only 0.10%.

 

[Lsbcal]

Lsbcal, Excellent idea to back test model portfolios! I have done this for a simplified investment mix of VTI and BND a few years back when I did so badly during the 2008 crash. I used yahoo finance to get all the values and dividends. I then used Matlab to simulate it all. That process helped me to define my strategy of staying at about 45% stocks going forward. But I don't know how to get raw data for LT bonds going back to the 50's. Also, I believe that BLV will be similar to a single bond in that after the duration has passed, subsequent to an interest rate rise, it will reach the same value it started at when including dividend reinvestment. This becomes a judgment and the 4% vs 2.2% is compelling.

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Here is one source for LT Treasury data: https://research.stlouisfed.org/fred2/series/GS20

Here is the chart:

We see that the rates are at levels of the 1950's. Where will it head? Nobody knows but the valuation story is not compelling. I would want to convince myself that I would have enjoyed the ride in the 1950's and 1960's compared to, say, 5 year Treasuries. Taking this data and using a spreadsheet should answer that, maybe.

I really don't know the answer. I'm betting on intermediate bonds and my strategy involves a bit of market timing between credit risk and Treasuries which is off topic.

 

[Lsbcal]

I looked up BLV and the duration is 15 years. For someone in their 60s that is too long. ... at least for me.

 

[Gone4Good]

Here is one source for LT Treasury data: https://research.stlouisfed.org/fred2/series/GS20

Here is the chart:

We see that the rates are at levels of the 1950's. Where will it head? Nobody knows but the valuation story is not compelling. I would want to convince myself that I would have enjoyed the ride in the 1950's and 1960's compared to, say, 5 year Treasuries.

The biggest threat to model here is inflation rather than interest rate sensitivity.

A 20 year bond with a 3% coupon has a duration of about 15 years. From 1950 to 1970 it looks like interest rates climbed from 3% to something a bit under 7.5%. That's an increase of about 20bp each year which would result in an annual principal loss of about 3%.

But that 3% loss in principal is offset by the 3% coupon on your bond. So you're really looking at 0% total return in year one. Each subsequent year, though, your interest rate sensitivity declines so you actually start earning a bit of money in year 2 and beyond on a nominal basis.

The big problem is that when you get your initial investment back at maturity in 1970 that money buys a whole lot less than it did in 1950. If you don't model that too, you miss the big story.