Build Your Own Pension FPA Webinar

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Slides from the 9/28/2011 FPA webinar "Build Your Own Pension." With the decline of pensions, clients will look to their own accounts to provide predictable retirement income. We show how advisors can create pension-like income using institutional liability driven investing (LDI) strategies.

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Build Your Own Pension FPA Webinar

  1. 1. © Copyright Asset Dedication 2011Build Your Own Pension Presented By: Professor Stephen Huxley & Brent Burns
  2. 2. © Copyright Asset Dedication 2011 The Transfer of Retirement BurdenFrom Corporate Pensions to 401(k)s
  3. 3. © Copyright Asset Dedication 2011 “The purpose of a pension plan is to provide retirement income security forthe remaining life of the plan member.”Source: Pensions Institute
  4. 4. © Copyright Asset Dedication 2011 “In short, to eliminate the risk that the pensioner outlives his/her resources.”Source: Pensions Institute
  5. 5. © Copyright Asset Dedication 2011 Liability-driven investing (LDI) is an investment strategy based on the cash flows needed to fund future liabilitiesSource: Wikipedia
  6. 6. © Copyright Asset Dedication 2011 Income Matching Defined “The income matching approach focuses on minimizing variation in funding status. Through risk-management techniques, asset performance is linked to liability changes with the goal of ensuring that assets are sufficient to pay liabilities at each point in time.”Source: Vanguard Investment Counseling and Research
  7. 7. © Copyright Asset Dedication 2011 Contrasting Total Return “The skeptical view is that total return ignores liabilities. In reality, the total-return approach is an attempt to grow assets at a faster rate than liabilities.”Source: Vanguard Investment Counseling and Research
  8. 8. © Copyright Asset Dedication 2011 De-risking Retirement Income• Reduce uncertainty of funding spending needs• Reduce sensitivity to market risks – Interest rate risk – Equity market risk
  9. 9. © Copyright Asset Dedication 2011 Case Study• Client age: 65• Plan Horizon: 30 years• Portfolio Balance: $2,000,000• Annual Spending: $100,000• Expected Inflation: 3%
  10. 10. Lifetime Spending Needs$2MM Portfolio, $100K/Yr, 3% Inflation
  11. 11. Initial 8 Years of Spending Needs Year 18 Years of Income
  12. 12. © Copyright Asset Dedication 2011Building An Income Matching Portfolio Portfolio Target Cash Cash Year Issue Principal Interest Flows Flows 2012 CD $77,000 $22,905 $99,905 $100,000 2013 CD $82,000 $21,416 $103,416 $103,000 2014 CD $86,000 $20,035 $106,035 $106,090 2015 CD $91,000 $17,818 $108,818 $109,273 2016 CD $98,000 $14,855 $112,855 $112,551 2017 CD $104,000 $11,713 $115,713 $115,927 2018 CD $112,000 $7,455 $119,455 $119,405 2019 Agency Bond $121,000 $2,496 $123,496 $122,987 $889,692 $889,234Quotes: 9/6/2011
  13. 13. © Copyright Asset Dedication 2011 Target Income Stream Portfolio Target Cash Cash Year Issue Principal Interest Flows Flows 2012 CD $77,000 $22,905 $99,905 $100,000 2013 CD $82,000 $21,416 $103,416 $103,000 2014 CD $86,000 $20,035 $106,035 $106,090 2015 CD $91,000 $17,818 $108,818 $109,273 2016 CD $98,000 $14,855 $112,855 $112,551 2017 CD $104,000 $11,713 $115,713 $115,927 2018 CD $112,000 $7,455 $119,455 $119,405 2019 Agency Bond $121,000 $2,496 $123,496 $122,987 $889,692 $889,234Quotes: 9/6/2011
  14. 14. © Copyright Asset Dedication 2011Matching Cash Flows to Spending Needs Portfolio Target Cash Cash Year Issue Principal Interest Flows Flows 2012 CD $77,000 $22,905 $99,905 $100,000 2013 CD $82,000 $21,416 $103,416 $103,000 2014 CD $86,000 $20,035 $106,035 $106,090 2015 CD $91,000 $17,818 $108,818 $109,273 2016 CD $98,000 $14,855 $112,855 $112,551 2017 CD $104,000 $11,713 $115,713 $115,927 2018 CD $112,000 $7,455 $119,455 $119,405 2019 Agency Bond $121,000 $2,496 $123,496 $122,987 $889,692 $889,234 Quotes: 9/6/2011
  15. 15. © Copyright Asset Dedication 2011 Timing The Cash Flows Portfolio Target Cash Cash Year Issue Principal Interest Flows Flows 2012 CD $77,000 $22,905 $99,905 $100,000 2013 CD $82,000 $21,416 $103,416 $103,000 2014 CD $86,000 $20,035 $106,035 $106,090 2015 CD $91,000 $17,818 $108,818 $109,273 2016 CD $98,000 $14,855 $112,855 $112,551 2017 CD $104,000 $11,713 $115,713 $115,927 2018 CD $112,000 $7,455 $119,455 $119,405 2019 Agency Bond $121,000 $2,496 $123,496 $122,987 $889,692 $889,234Quotes: 9/6/2011
  16. 16. © Copyright Asset Dedication 2011 Portfolio Costs 8 Years = $829,656Total Income = $889,692
  17. 17. © Copyright Asset Dedication 2011 Portfolio Costs 8 Years = $829,656 (60/40) 10 Years = $1,035,495 (50/50) 30 Years = $2,753,814 (0/100)Quotes: 9/6/2011
  18. 18. © Copyright Asset Dedication 2011 Portfolio Costs 8 Years = $829,656 (60/40) 10 Years = $1,035,495 (50/50) 30 Years = $2,753,814 (0/100) 30-year portfolio exceeds resourcesQuotes: 9/6/2011
  19. 19. © Copyright Asset Dedication 2011 Partial Income Matching• Best of Income Matching – Predictable cash flows protected from interest rate risk• Best of Total Return – Higher long term expected return
  20. 20. Portfolio
  21. 21. Income GrowthPortfolio Portfolio
  22. 22. © Copyright Asset Dedication 2011Protected Principal andPredictable Income
  23. 23. © Copyright Asset Dedication 2011Protected Principal andPredictable Income
  24. 24. © Copyright Asset Dedication 2011Protected Principal Higher Expected Return and butPredictable Income Short-term Volatility
  25. 25. © Copyright Asset Dedication 2011Protected Principal Higher Expected Return and butPredictable Income Short-term Volatility
  26. 26. © Copyright Asset Dedication 2011Protected Principal Higher Expected Return and butPredictable Income Short-term Volatility
  27. 27. Lifetime Spending Needs$2MM Portfolio, $100K/Yr, 3% Inflation
  28. 28. © Copyright Asset Dedication 2011Portfolio Critical Path®
  29. 29. Year 18 Years of 22 Years of Uncertainty Income
  30. 30. Year 28 Years of 21 Years of Uncertainty Income Roll or Don’t Roll? ? ? ? ?
  31. 31. Year 28 Years of 21 Years of Uncertainty Income Above CP → Roll 1 Year
  32. 32. Year 38 Years of 20 Years of Uncertainty Income Above CP → Roll 1 Year
  33. 33. Year 48 Years of 19 Years of Uncertainty Income Above CP → Roll 1 Year
  34. 34. Year 58 Years of 18 Years of Uncertainty Income Above CP → Roll 1 Year
  35. 35. © Copyright Asset Dedication 2011Show above
  36. 36. Year 6 15 Years of10 Years of Income Uncertainty Well Above CP → Roll 2 Years
  37. 37. © Copyright Asset Dedication 2011Show above
  38. 38. Year 79 Years of 15 Years of Income Uncertainty Not Above CP → Don’t Roll
  39. 39. © Copyright Asset Dedication 2011Show above
  40. 40. Year 88 Years of 15 Years of Income Uncertainty Not Above CP → Don’t Roll
  41. 41. © Copyright Asset Dedication 2011Show above
  42. 42. Year 98 Years of 14 Years of Income Uncertainty Above CP → Roll 1 Year
  43. 43. © Copyright Asset Dedication 2011 Why Not a Bond Ladder?• Cash flows are not tied to actual needs• Income is more expensive
  44. 44. © Copyright Asset Dedication 2011 Why Not a Bond Ladder? Bond Income Target Cash Year Ladder Portfolio Flows 2012 $133,636 $103,297 $100,000 2013 $131,428 $108,750 $103,000 2014 $130,452 $111,082 $106,090 2015 $122,982 $113,612 $109,273 2016 $121,468 $116,438 $112,551 2017 $113,690 $119,099 $115,927 2018 $106,378 $121,714 $119,405 2019 $101,330 $124,691 $122,987 2020 $104,576 $127,180 $126,677 2021 $96,636 $130,502 $130,477 Total Cash Flow $1,162,576 $1,176,366 Cost $1,052,363 $1,051,250Quotes: 9/6/2011
  45. 45. © Copyright Asset Dedication 2011 Why Not a Bond Ladder? Bond Income Target CashYear Ladder Portfolio Flows2012 $133,636 $103,297 $100,0002013 $131,428 $108,750 $103,000 $13,7902014 $130,452 $111,082 $106,0902015 $122,982 $113,612 $109,2732016 $121,468 $116,438 $112,5512017 $113,690 $119,099 $115,9272018 Greater Total Cash Flow $106,378 $121,714 $119,4052019 $101,330 $124,691 $122,9872020 From Income Portfolio $104,576 $127,180 $126,6772021 $96,636 $130,502 $130,477Total Cash Flow $1,162,576 $1,176,366Cost $1,052,363 $1,051,250
  46. 46. © Copyright Asset Dedication 2011 Why Not a Bond Fund• Volatility around funding• Sensitivity to rising interest rates
  47. 47. 10 Year US Treasury Bond Yields 1800-2010
  48. 48. Bond Fund Volatility Revealed Rising Interest Rates 1950-198110-year Treasury Index is the proxy for high quality bond funds
  49. 49. Bond Fund Volatility Revealed Rising Interest Rates 1950-198110-year Treasury Index is the proxy for high quality bond funds
  50. 50. Bond Fund Income Variability/Shortfall Comparison Over 8-Year Horizons 1950-1981Starting value = cost of 8-year Income Portfolio for each year. Target cash flows = $100,000/year plus 3%inflation. 10-year Treasury Index is the proxy for high quality bond funds
  51. 51. © Copyright Asset Dedication 2011 Why Not A Period Certain Annuity? • Expensive • InflexibleQuotes: 9/6/2011 www.immediateannuity.com
  52. 52. © Copyright Asset Dedication 2011 Why Not A Period Certain Annuity? Year Period Certain Income Portfolio 2012 $95,400 $98,235 2013 $98,262 $104,183 2014 $101,210 $105,590 2015 $104,246 $108,236 2016 $107,374 $110,222 2017 $110,595 $113,056 2018 $113,913 $115,887 2019 $117,330 $118,115 2020 $120,850 $120,837 2021 $124,475 $124,385 Total Cash Flow $1,093,654 $1,118,746 Cost $1,000,000 $999,808Quotes: 9/6/2011 www.immediateannuity.com
  53. 53. © Copyright Asset Dedication 2011Why Not A Period Certain Annuity? Year Period Certain Income Portfolio 2012 $95,400 $98,235 2013 $98,262 $104,183 2014 2015 $25,092 $101,210 $104,246 $105,590 $108,236 2016 2017 Greater Total Cash Flow $107,374 $110,595 $110,222 $113,056 2018 $113,913 $115,887 2019 From Income Portfolio $117,330 $118,115 2020 $120,850 $120,837 2021 $124,475 $124,385 Total Cash Flow $1,093,654 $1,118,746 Cost $1,000,000 $999,808
  54. 54. © Copyright Asset Dedication 2011 The Hidden Risks of AnnuitiesSince 1991 more that 60 life insurance companies offering annuities havebecome insolvent and come under the control of the state insurance guarantee system. Cost = $2.8 billionSource: National Organization of Life and Health Insurance Guaranty Associations
  55. 55. © Copyright Asset Dedication 2011In 2008, AIG was the largest issuer of fixed annuities.US Govt capital infusion = $182 billion
  56. 56. © Copyright Asset Dedication 2011 Insurance Company Failures According to a CitiGroup study of bank and insurance company failures in theGreat Depression, 14% of life insurance companies failed and went out of business between 1929 and 1933.
  57. 57. © Copyright Asset Dedication 2011 Which is safer?1. FDIC Insured CDs and Government Agency bonds OR2. Insurance companies
  58. 58. © Copyright Asset Dedication 2011 Questions?Email info@assetdedication.com for more information on Asset Dedication white papers

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