Little Book of Safe Money

[kyounge1956]

How to Conquer Killer Markets, Con Artists, and Yourself.

I've just finished reading this, particularly the chapter entitled "You are an Egg"—as in "don't put all your eggs in one basket".

Quote:

"...when you follow the classic and indisputably good advice not to put all your eggs in one basket, remember that you are one of the eggs. You must do everything in your power to ensure that your financial capital and your human capital do not get cracked or scrambled at the same time."

The book divides the things that can scramble your eggs into general risks that just about everyone is exposed to, and risks that are specific to your personal job and circumstances. To determine the latter, "Imagine that it's five years in the future, you company has gone bankrupt, and you have the unenviable task of figuring out what went wrong." It seems to me these risks apply as much to retirees as to people who are still working, if not more so—just substitute "pension fund" for "company".

I have well over half of my retirement eggs in one basket, my city employees' pension. Given the events of the last few years, I can easily imagine what could go wrong with the pension system: another big stock market drop combined with a general economic downturn, which would simultaneously cause big fund losses and prompt more employees to retire (rather than waiting to be laid off). Public pension funds are not covered by the PBGC, so if the retirement system ever failed, more than half of my income would disappear, and since tax revenues also drop drastically in these conditions, the City might be unable to meet its legal obligation to make up the shortfall in retiree benefits. It might be possible for me to squeak by on just my savings plus Social Security, but it would be mighty slim pickin's.

All of this has got me thinking about one of the options available in the pension system, which is to take a reduced benefit plus a lump sum withdrawal of either 50% or 100% of accumulated contributions. What this gives me is a choice between full pension benefit and no lump sum; about 3/4 of the full benefit plus half of my accumulated contributions, which I estimate very roughly would be about half the amount of my portfolio; or about 54% of the full benefit plus a lump sum which would very roughly equal my portfolio. The pension is partly COLA'd, and at full benefit, I could probably live on it alone at least until eligible for early Social Security; if inflation is low, I might make it to full SS retirement age, without needing to tap my portfolio at all. If I took either of the reduced benefits, the lump sum would need to create immediate income, maybe with an SPIA. That would give me state guarantee protection for part of my retirement income. As things stand now, none of it's guaranteed. (Question: is the guarantee provided by the state the annuitant lives in, or the state the insurance company is in? Can you get guarantees from more than one state by splitting annuity purchases between several companies?)

If there's an SPIA that pays as much as the difference in benefits, taking the lump sum would be a no brainer, but I've pulled a few quotes online, and I don't think an SPIA would pay that much if bought at age 57, especially if COLA'd. Even if that's the case, maybe I'd be smarter to take one of the lump sum options. That would divide my eggs between more baskets than they are in now, and I think none of the baskets would have more than half of the eggs in it.

Decisions, decisions....

[donheff]

I have no answer for you since this is a tough issue. I would recommend that you determine first whether with an SPIA (or on your own) you can match a substantial portion of your pension with the lump sum option you zero in on. Also keep in mind that if there is another major crash that crushes your city it may take your portfolio, the SPIA insurer, and the state guarantee agency with it. In other words are the baskets you are considering safe against the black swan you are worried about?

[kyounge1956]

Quote:

Originally Posted by donheff I have no answer for you since this is a tough issue. I would recommend that you determine first whether with an SPIA (or on your own) you can match a substantial portion of your pension with the lump sum option you zero in on.

I think I will have to wait until I get closer to my retirement date to know for sure how much income an SPIA would provide. Employee contributions to the pension fund may go up, but I don't know how much, and that would change the amount of the lump sum. Interest rates may go up, and change the cost of annuities. I don't think I would roll the lump sum into my IRA. That would just redistribute the eggs more evenly between the same number of baskets, but I don't know if doing so would be any more black-swan-proof than the way things are now.

Quote:

Also keep in mind that if there is another major crash that crushes your city it may take your portfolio, the SPIA insurer, and the state guarantee agency with it.

More stuff to think about. I found the answer to one of my questions here: "All insurance companies licensed to sell life or health insurance in a state must be members of that state’s guaranty association. The guaranty association...provides coverage to the company’s policyholders who are state residents (up to the limits specified by state laws...)" So, buying SPIAs from insurers in different states would not give any more of a guarantee than buying them in-state, but it might (?) add safety by having an income source that's outside the regional economy. Maybe I should stash some money in an out-of-state bank for the same reason, or even a Canadian one (Vancouver BC is only a few hours' drive up the road from here.) My portfolio is with Scottrade, and maybe (?) when I retire and roll my 457 to an IRA it should be at a different brokerage, so both accounts couldn't be affected by the failure of one firm.

Quote:

In other words are the baskets you are considering safe against the black swan you are worried about?

That's the $64,000 question, isn't it? If "don't put all your eggs in the same basket" is good advice, does that mean four baskets are inherently less likely to suffer disastrous egg loss than three? That is really the question I am trying to answer for myself. Given a big enough, black enough swan, there is nowhere to hide. It's impossible to know how likely pension fund failure is, or whether the same factors that could cause the pension fund to crash would also be certain death to an SPIA. There are only two things I'm more or less sure of: with no lump sum, pension fund failure=poverty; with lump sum, total income is lower. The question is would I be "buying" more safety with that decrease in income, or not? Maybe it just isn't possible to know, in which case it all comes down to the sleep-at-night factor. Not that I can figure out which one "feels" safer, either. :shrug:

I downloaded the Otar book but haven't read it yet. I wonder if the book includes suggestions on how to make this type of decision.

[MooreBonds]

Quote:

Originally Posted by kyounge1956 I have well over half of my retirement eggs in one basket, my city employees' pension. ... All of this has got me thinking about one of the options available in the pension system, which is to take a reduced benefit plus a lump sum withdrawal of either 50% or 100% of accumulated contributions. What this gives me is a choice between full pension benefit and no lump sum; about 3/4 of the full benefit plus half of my accumulated contributions, which I estimate very roughly would be about half the amount of my portfolio; or about 54% of the full benefit plus a lump sum which would very roughly equal my portfolio. The pension is partly COLA'd, and at full benefit, I could probably live on it alone at least until eligible for early Social Security;

I've always been a big believer in diversification.

If a full pension is partly COLA'd and would give you approximately enough to live on all by its own, I'd say at the very least, take 50% of accumulated contributions in a lump-sum and get 3/4 of your full benefit....or possibly even the 50% of pension benefit and lump sum equal to current portfolio.

That way, you still get roughly 3/4 of your expenses covered, while still jacking up the size of your investment portfolio and being able to somewhat control realization of gains/income/losses (just in case they start more means-testing of income down the road), and avoid the risk of fiscal impacts to your local government.

If your local gov't is in that bad of fiscal shape, I'd lean more towards 50% pension benefit/doubling of your portfolio.

Of course, no need to fine tune the numbers until you're 6 months away from pulling the plug - but I'd recommend at least taking out some of the lump sum value.