The document discusses strategies for securing retirement income, highlighting the shift from corporate pensions to 401(k)s and various investment approaches, including liability-driven investing and income matching. It provides a case study to illustrate building an income matching portfolio tailored to meet spending needs over time while minimizing risks related to market fluctuations. Additionally, it critiques traditional bond ladders and immediate annuities, emphasizing the importance of targeting predictable cash flows to ensure financial security in retirement.

1. © Copyright Asset Dedication 2011
Build Your Own Pension
Presented By:
Professor Stephen Huxley
&
Brent Burns

2. © Copyright Asset Dedication 2011
The Transfer of Retirement Burden
From Corporate Pensions to 401(k)s

3. © Copyright Asset Dedication 2011
“The purpose of a pension plan is to
provide retirement income security for
the remaining life of the plan member.”
Source: Pensions Institute

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“In short, to eliminate the risk that the
pensioner outlives his/her resources.”
Source: Pensions Institute

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Liability-driven investing (LDI) is
an investment strategy based on
the cash flows needed to fund
future liabilities
Source: Wikipedia

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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

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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

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De-risking Retirement Income
• Reduce uncertainty of funding spending needs
• Reduce sensitivity to market risks
– Interest rate risk
– Equity market risk

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Case Study
• Client age: 65
• Plan Horizon: 30 years
• Portfolio Balance: $2,000,000
• Annual Spending: $100,000
• Expected Inflation: 3%

10. Lifetime Spending Needs
$2MM Portfolio, $100K/Yr, 3% Inflation

11. Initial 8 Years of Spending Needs
Year 1
8 Years of
Income

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Building 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 $889,234
Quotes: 9/6/2011

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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 $889,234
Quotes: 9/6/2011

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Matching 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

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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 $889,234
Quotes: 9/6/2011

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Portfolio Costs
8 Years = $829,656
Total Income = $889,692

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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

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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 resources
Quotes: 9/6/2011

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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. Portfolio

21. Income Growth
Portfolio Portfolio

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Protected Principal
and
Predictable Income

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Protected Principal
and
Predictable Income

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Protected Principal Higher Expected Return
and but
Predictable Income Short-term Volatility

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Protected Principal Higher Expected Return
and but
Predictable Income Short-term Volatility

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Protected Principal Higher Expected Return
and but
Predictable Income Short-term Volatility

27. Lifetime Spending Needs
$2MM Portfolio, $100K/Yr, 3% Inflation

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Portfolio Critical Path®

29. Year 1
8 Years of
22 Years of Uncertainty
Income

30. Year 2
8 Years of
21 Years of Uncertainty
Income
Roll or Don’t Roll?
?
?
?
?

31. Year 2
8 Years of
21 Years of Uncertainty
Income
Above CP → Roll 1 Year

32. Year 3
8 Years of
20 Years of Uncertainty
Income
Above CP → Roll 1 Year

33. Year 4
8 Years of
19 Years of Uncertainty
Income
Above CP → Roll 1 Year

34. Year 5
8 Years of
18 Years of Uncertainty
Income
Above CP → Roll 1 Year

35. © Copyright Asset Dedication 2011
Show above

36. Year 6
15 Years of
10 Years of Income Uncertainty
Well Above CP → Roll 2 Years

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Show above

38. Year 7
9 Years of 15 Years of
Income Uncertainty
Not Above CP → Don’t Roll

39. © Copyright Asset Dedication 2011
Show above

40. Year 8
8 Years of 15 Years of
Income Uncertainty
Not Above CP → Don’t Roll

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Show above

42. Year 9
8 Years of 14 Years of
Income Uncertainty
Above CP → Roll 1 Year

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Why Not a Bond Ladder?
• Cash flows are not tied to actual needs
• Income is more expensive

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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 $1,051,250
Quotes: 9/6/2011

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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
$13,790
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 Greater Total Cash Flow
$106,378 $121,714 $119,405
2019 $101,330 $124,691 $122,987
2020 From Income Portfolio
$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 $1,051,250

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Why Not a Bond Fund
• Volatility around funding
• Sensitivity to rising interest rates

47. 10 Year US Treasury Bond Yields
1800-2010

48. Bond Fund Volatility Revealed
Rising Interest Rates 1950-1981
10-year Treasury Index is the proxy for high quality bond funds

49. Bond Fund Volatility Revealed
Rising Interest Rates 1950-1981
10-year Treasury Index is the proxy for high quality bond funds

50. Bond Fund Income Variability/Shortfall
Comparison Over 8-Year Horizons 1950-1981
Starting 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

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Why Not A Period Certain Annuity?
• Expensive
• Inflexible
Quotes: 9/6/2011 www.immediateannuity.com

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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 $999,808
Quotes: 9/6/2011 www.immediateannuity.com

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Why 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

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The Hidden Risks of Annuities
Since 1991 more that 60 life insurance
companies offering annuities have
become insolvent and come under the
control of the state insurance
guarantee system.
Cost = $2.8 billion
Source: National Organization of Life and Health Insurance Guaranty Associations

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In 2008, AIG was the largest issuer of
fixed annuities.
US Govt capital infusion = $182 billion

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Insurance Company Failures
According to a CitiGroup study of bank
and insurance company failures in the
Great Depression, 14% of life insurance
companies failed and went out of
business between 1929 and 1933.

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Which is safer?
1. FDIC Insured CDs and Government
Agency bonds
OR
2. Insurance companies

58. © Copyright Asset Dedication 2011
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