Pfau's Article on Insurance vs Investing

[Trooper]

Looking for your thoughts on this article. I am generally a fan of Wade Pfau's work, and I like how he breaks down retirement finances into 4 "L's"...lifestyle, longevity, liquidity, and legacy.

He essentially says that bonds have no place in a retirement portfolio; instead they should be replaced by income annuities (SPIAs I would imagine).

Thanks in advance.

Evaluating Investments versus Insurance in Retirement

 

[fritz]

Looking for your thoughts on this article. I am generally a fan of Wade Pfau's work, and I like how he breaks down retirement finances into 4 "L's"...lifestyle, longevity, liquidity, and legacy.

He essentially says that bonds have no place in a retirement portfolio; instead they should be replaced by income annuities (SPIAs I would imagine).

Thanks in advance.

Evaluating Investments versus Insurance in Retirement

I seem to recall ans old saying (might not be exactly right) - "Always remember who's telling you"...

 

[samclem]

It's a good conceptual paper, he didn't present data to back it up, but it wasn't designed for that.

The audience is financial advisors/planners, and I'm sure many will be happy to have the verbal ammunition he provides to help convince clients to buy high-commission insurance products. And some clients probably need them--but many of those people will never know if they really needed them or were sold them.

I'd say he probably sees a role for bonds--but investors should get their benefit indirectly, through insurance companies (via annuities). Insurance companies own the bonds, retirees get the pooled returns from them through insurance companies--which also covers longevity insurance by use of the mortality credits from those who check out early.

I think I can self-insure for sequence of return risk (by being flexible on spending, having a pension, and having some bonds/cash), so I can save a lot by not buying that insurance (an immediate annuity). On the distant end, we'll probably use deferred SS as longevity insurance. Those are the two big reasons to annuitize, so we'll probably be skipping those costs and staying largely in the market.

 

[urn2bfree]

Pfau seems to really be pushing annuities a lot and it makes me react the same way I do when strangers get close to me on a subway or in a crowd- I become acutely concerned that someone may be planning to pick my pocket. The insurance company is investing in the same stuff I can invest in, so I am supposed to give up my principle and pay fees to let them do what I can do myself?
Add in the effect of inflation on "regular" annuity payments and I have a hard time seeing the advantage of annuities.

For those with smaller nest eggs, things may be too uncertain. With Social Security and the size of my nest egg, I feel we have enough that I feel we can self insure. I would rather not pay an insurance company for the privilege. As Jack Bogle says about investing, "you get what you don't pay for."


Sent from my iPad using Early Retirement Forum

 

[ERD50]

I think "annuities" become the answer for two reasons:

1) If you ignore all the behind-the-scenes issues (cost, default risk, inflation), it's very simple. You pay $X, you get $Y income stream for life. Probably easier to explain this to the general public than how bonds react to interest rate changes, default/quality considerations, etc.

2) Commissions.

It's a powerful combination. The salesperson makes more with a product that is easy to explain (if you don't dig too deep, and most people don't?).


-ERD50

 

[Chuckanut]

Pfau did a study years ago in which he claimed that stocks and annuities were superior to stocks and bonds.

In my mind the use of annuities in retirement planning has the same big advantage as the use of balanced funds such as Wellesly or Wellington - That is as one ages and becomes less mentally capable of managing various investments the fund or annuity will do it for you. As Pfau says:

With longevity, one must also plan for how declining cognitive abilities will hamper the ability to manage investments.

In other words, you are buying some brains.

Of course, if one has a good SS benefit and/or a decent DB pension then one already has a fall back position when the time comes that managing investments is no longer possible.