Join Early Retirement Today
Reply
 
Thread Tools Display Modes
Protect your Nestegg with a 'Retirement Collar'
Old 08-20-2005, 08:05 PM   #1
Recycles dryer sheets
 
Join Date: Jun 2002
Posts: 248
Protect your Nestegg with a 'Retirement Collar'

http://www.ifid.ca/pdf_workingpapers/WP2005JUNE20.pdf

Exhibit #14 provides an example of how this would work for a retirement
portfolio. Imagine that at retirement you decide to allocate your $100 nest egg
(which can arbitrarily be scaled up or down) and consume $4 per year from this
nest egg. If all of the money is invested in equity-based products, the simulation
results suggest that the probability of retirement ruin is 7.3% for a male (and
8.4% for a female, as per Exhibit #15). But, if you or your client purchase a 3-
month put option that is 5% out-of-the-money, which means that the strike price
is initially at $95, and you fund this purchase by selling a call option that is 6.6%
out of the money, the put/call combination will reduce the dispersion of your
portfolio and will reduce the probability of ruin to 1.5% for a male and 2.4% for a
female.

Essentially, we obtain this improvement in probability because we have
removed the very large negative returns from all scenarios, thus increasing the
chances that your initial nest egg is sufficient to maintain your desired standard
of living. We emphasize, though, that this “collar strategy” is not a free lunch
since large negative returns are reduced at the expense of reducing the upside
potential of the portfolio. This is yet another manifestation of the universal tradeoff
between financial risk and return. Thus, although the portfolio's income will
"last" longer by "delaying its date" with zero, the portfolio will not grow or increase
in value as rapidly as the un-collared or unprotected portfolio. A sample path of
the wealth in retirement with and without “collar protection” can be seen in Exhibit
#16.

</snip>


intercst
__________________
***** puts the &quot;hoco&quot; in Hoco-mania
intercst is offline   Reply With Quote
Join the #1 Early Retirement and Financial Independence Forum Today - It's Totally Free!

Are you planning to be financially independent as early as possible so you can live life on your own terms? Discuss successful investing strategies, asset allocation models, tax strategies and other related topics in our online forum community. Our members range from young folks just starting their journey to financial independence, military retirees and even multimillionaires. No matter where you fit in you'll find that Early-Retirement.org is a great community to join. Best of all it's totally FREE!

You are currently viewing our boards as a guest so you have limited access to our community. Please take the time to register and you will gain a lot of great new features including; the ability to participate in discussions, network with our members, see fewer ads, upload photographs, create a retirement blog, send private messages and so much, much more!

Re: Protect your Nestegg with a 'Retirement Collar'
Old 08-21-2005, 11:01 AM   #2
Full time employment: Posting here.
bosco's Avatar
 
Join Date: Jul 2005
Posts: 987
Re: Protect your Nestegg with a 'Retirement Collar'

I have a book called

"Safer Investing in Volatile Markets" by Carolann Doherty Brown

that goes into this strategy in great detail. It also goes into other risk-mitigation strategies such as asset allocation and sector rotation.

IMO, its section on sector rotation is weak.

I am very reluctant to cap my potential returns by selling covered calls. Read the book, and concluded that I'd just ride things out and count on asset allocation and a variable withdrawal strategy to get me through.
__________________
I have an inferiority complex, but it's not a very good one.
bosco is offline   Reply With Quote
Re: Protect your Nestegg with a 'Retirement Collar'
Old 08-21-2005, 11:16 AM   #3
Moderator Emeritus
Nords's Avatar
 
Join Date: Dec 2002
Location: Oahu
Posts: 26,855
Re: Protect your Nestegg with a 'Retirement Collar'

Quote:
Originally Posted by intercst
Essentially, we obtain this improvement in probability because we have
removed the very large negative returns from all scenarios, thus increasing the
chances that your initial nest egg is sufficient to maintain your desired standard
of living. We emphasize, though, that this “collar strategy” is not a free lunch
since large negative returns are reduced at the expense of reducing the upside
potential of the portfolio. This is yet another manifestation of the universal tradeoff
between financial risk and return.
I wonder if this study includes all the investment costs and the taxes incurred if the options are executed.

Seems awful complicated if the goal is just to reduce volatility. Isn't that what diversification & bonds are for?
__________________
*

Co-author (with my daughter) of “Raising Your Money-Savvy Family For Next Generation Financial Independence.”
Author of the book written on E-R.org: "The Military Guide to Financial Independence and Retirement."

I don't spend much time here— please send a PM.
Nords is offline   Reply With Quote
Re: Protect your Nestegg with a 'Retirement Collar'
Old 08-21-2005, 12:40 PM   #4
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
 
Join Date: Mar 2003
Posts: 18,085
Re: Protect your Nestegg with a 'Retirement Collar'

It seems to me that the biggest boost one would get is protection vs. a big downside move in, say the first 5 years after retirement. I don't know how to do this easily, but I wonder if anyone has studied what survivability looks like if a small part of the portfolio is invested in out of the money puts in the first 5 years?
__________________
"All animals are equal, but some animals are more equal than others."

- George Orwell

Ezekiel 23:20
brewer12345 is offline   Reply With Quote
Re: Protect your Nestegg with a 'Retirement Collar'
Old 08-21-2005, 02:04 PM   #5
Thinks s/he gets paid by the post
 
Join Date: Jun 2005
Posts: 1,183
Re: Protect your Nestegg with a 'Retirement Collar'

I took a look at this article and did find it interesting.

I would be interested if anyone with more knowledge of long term calls and puts could comment on how one would actually put the collar strategy into practice for a 40 year retirement timeline. I wonder how different this strategy would be than putting more money into long term TIPs, which also would bring your returns away from the extremes.

I would think that taxes caused by a collaring strategy would be much less of an issue during the distribution phase as compared to the accumulation phase, so I wouldn't think tax issues would be a deal killer, even if I am skeptical about a the effectiveness of a collar strategy.

Most of us will already have an inflation-adjusted, lifetime annuity in retirement, social security.

The article seemed to focus more on 25-30 year timelines, and not a 40 year ER timeline. Presumably, 40 year timeline means even more sensitivity to returns early in retirement, making a collar strategy potentially more worthwhile.

Thanks,
Kramer
kramer is offline   Reply With Quote
Re: Protect your Nestegg with a 'Retirement Collar'
Old 08-21-2005, 02:08 PM   #6
Thinks s/he gets paid by the post
 
Join Date: Jun 2005
Posts: 1,183
Re: Protect your Nestegg with a 'Retirement Collar'

bosco wrote: "Safer Investing in Volatile Markets" by Carolann Doherty Brown

Thanks for the pointer. Readers on Amazon seem to recommend the book. Would you recommend it?

Kramer
kramer is offline   Reply With Quote
Re: Protect your Nestegg with a 'Retirement Collar'
Old 08-21-2005, 03:49 PM   #7
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
 
Join Date: Mar 2003
Posts: 18,085
Re: Protect your Nestegg with a 'Retirement Collar'

Quote:
Originally Posted by kramer
I took a look at this article and did find it interesting.

I would be interested if anyone with more knowledge of long term calls and puts could comment on how one would actually put the collar strategy into practice for a 40 year retirement timeline.*
Options markets are far more liquid in the shorter term contracts, so to get reasonable execution costs you probably wouldn't want to go farther out than 3 months. That means you would have a rolling collar reconstituted 4 or more times a year. Not that hard to do, especiallt in the case of index options, but definately more labor intensive than rebalancing once a year.
__________________
"All animals are equal, but some animals are more equal than others."

- George Orwell

Ezekiel 23:20
brewer12345 is offline   Reply With Quote
Re: Protect your Nestegg with a 'Retirement Collar'
Old 08-21-2005, 06:28 PM   #8
Thinks s/he gets paid by the post
 
Join Date: Jun 2005
Posts: 1,183
Re: Protect your Nestegg with a 'Retirement Collar'

Thanks, Brewer -- that makes complete sense.

I wonder if there is an insurance premium for protection against downside in the options markets for large indices, similar to the way there is a premium paid by commodity owners to hedge their risk? In other words, you are getting a slightly better deal to bet that the markets go up, rather than betting that they go down, and this would show up in long term results to the detriment of the collaring strategy.

This would have to get captured in any analysis. I suppose historical data would be a good start.

Kramer
kramer is offline   Reply With Quote
Re: Protect your Nestegg with a 'Retirement Collar'
Old 08-21-2005, 10:19 PM   #9
Full time employment: Posting here.
bosco's Avatar
 
Join Date: Jul 2005
Posts: 987
Re: Protect your Nestegg with a 'Retirement Collar'

Quote:
Originally Posted by kramer
bosco wrote: "Safer Investing in Volatile Markets" by Carolann Doherty Brown

Thanks for the pointer. Readers on Amazon seem to recommend the book. Would you recommend it?

Kramer
Yes, I can recommend the book. Although I don't intend to immediately implement the strategies it discusses, it is well written and thoughtful. I would consider it "intermediate" level, not advanced, which made it right for me (in some areas it was a bit too simplistic but I did get quite a bit out of it). I think it has a very good discussion of risk tolerance, how to assess it, and what tools are available to a person to mitigate risk. It is very conscientious about pointing out the tradeoffs in any risk-mitigation strategy.



__________________
I have an inferiority complex, but it's not a very good one.
bosco is offline   Reply With Quote
Reply


Currently Active Users Viewing This Thread: 1 (0 members and 1 guests)
 
Thread Tools
Display Modes

Posting Rules
You may not post new threads
You may not post replies
You may not post attachments
You may not edit your posts

BB code is On
Smilies are On
[IMG] code is On
HTML code is Off
Trackbacks are Off
Pingbacks are Off
Refbacks are Off


Similar Threads
Thread Thread Starter Forum Replies Last Post
Tax Policy Promotes "Early" Retirement REWahoo FIRE and Money 19 07-21-2017 02:10 PM
Retirement Accounts and Early Retirement heebygeeby Young Dreamers 9 03-14-2007 03:56 PM
Predictors of a Happy Retirement Rich_by_the_Bay Life after FIRE 24 07-13-2006 08:59 PM
Social Security Spousal Benefit Elderdude FIRE and Money 52 06-30-2006 07:55 AM
Diversifying My Retirement Funds and Confused Rob Other topics 1 10-31-2005 09:59 AM

» Quick Links

 
All times are GMT -6. The time now is 11:57 PM.
 
Powered by vBulletin® Version 3.8.8 Beta 1
Copyright ©2000 - 2024, vBulletin Solutions, Inc.