Retirement Portfolios: Theory, Construction, and Management

Preface xiii

Acknowledgments xxi

PART ONE Framing the Problem

CHAPTER 1 Portfolio Focus and Stage of Life 3

A “Balanced” Portfolio Approach May Not Last Through Retirement 4

Retirement Saving versus Retirement Income: An Illustration 10

Products versus Solutions 11

Summary 12

CHAPTER 2 The Top-Down View

A Short Primer on Economic Models of Retirement Income 13

An Overview of Economic Models of Retirement Income 14

Reconciling Retirement Income Portfolio Construction with Accumulation 15

The Dynamics of Risk Aversion 19

Separation between Flooring and Upside 21

Fully Funded versus Underfunded Flooring 22

Monetizing Mortality 23

Taking Market Risk 23

Risk Is Risk, Is It Not? 24

Risk, Uncertainty, and Risk Aversion 25

Summary 25

CHAPTER 3 The Importance of Lifestyle Flooring 27

Amount of Flooring: A Balance Sheet View 28

Retirement Requires Outcomes, Not Just Expectations 30

Consumption Needs 32

Yes/No Planning 33

The Window for Maintaining Lifestyle 34

The Bedrock Floor 36

The Aspirational Floor 37

The Finished Floor 38

Nominal versus Real Flooring 38

Types of Flooring 42

Choosing a Flooring Type 45

Summary 48

CHAPTER 4 Monetizing Mortality Annuities and Longevity Insurance 49

Risk Pooling 50

Pure Longevity Insurance 50

Annuities 52

Complex Annuities 54

Credit Risk and Insurance 55

Summary 57

CHAPTER 5 Flooring with Capital Markets Products 59

Government-Issued Securities 60

Creating a Floor of Strips 61

TIPS 63

Municipal Securities 65

Corporate Securities and Other Financial Products 66

Summary 67

PART TWO Adapting Portfolios for Retirement Income

CHAPTER 6 Building Retirement Income Portfolios 71

Portfolio Sleeves for Retirement Income 72

Portfolio Intuition 76

Basic Portfolio Constructs 77

General Accumulation Plans for Retirement Income 81

Taxes and Retirement Income Portfolios 81

Summary 85

CHAPTER 7 Creating Allocations for Constructing Practical Portfolios by Age and Lifestyle Needs 87

Flooring Allocations 88

Longevity Allocations 93

Precautionary Allocations 96

Discretionary Equity Allocations: Assets with Risk 97

Summary of Allocations 99

Summary 103

PART THREE Managing Portfolios for Retirement Income

CHAPTER 8 Rebalancing Retirement Income Portfolios 107

Rebalancing the Discretionary Wealth Subportfolio 108

Rebalancing the Functional Components 109

Raising the Floor 111

Summary 112

CHAPTER 9 Active Risk Management for Retirement Income Portfolios 115

Static Example 118

The View from the Capital Markets Line 121

Risk Management and Expected Returns 122

Simple Rules: For Passive and Active Risk Management 122

An Inelegant but Simple Plan 124

High-Water Mark Flooring 125

The Cushion 126

Risk Rules: Periodic Rebalancing 128

Risk Rules: More Active Rebalancing 130

CPPI and Volatility 132

Taxation and Active Management 133

Locking in Flooring: Long End versus Short End 134

A Quick Note on Usability, Scalability, and Approaches Other Than Liability Matching 135

Playing with Fire in a Retirement Income Portfolio 135

Summary 138

PART FOUR Making It Happen

CHAPTER 10 The Transition Phase 141

What the Transition Is About 142

The Order of Transition 144

A Diffi cult Transition 146

When to Transition 148

Making the Transition Seamless 150

Creating a Business Model that Includes a Natural Transition 152

Sudden Transitions 153

Summary 153

CHAPTER 11 Putting Together the Proposal 155

Laying Out Client’s Assets to Show Current Status 156

Minimally Invasive Surgery: Reconfi guration Proposal 158

Lifestyle and Flooring Types 160

Accumulation Plan Types 160

Allocations 161

Passive Versus Active Risk Management 163

Summary 165

CHAPTER 12 Market Segmentation 167

Segmentation for Traditional Portfolios 168

Segmentation for Retirement Income Portfolios 169

Summary 175

CHAPTER 13 Products and Example Portfolios 177

Overview of Products Offered 177

Managing Expectations around Outcomes 184

Example Portfolios 185

Summary 202

CHAPTER 14 Preparing Your Client for a Retirement Income Portfolio 203

Know Your Resources 207

Lifestyle and Life Cycle 210

Risks to Your Retirement Lifestyle 212

Lifestyle and Flooring Types 214

What the Adviser Needs from the Client 221

Summary 221

CHAPTER 15 Salvage Operations, Mistakes, and Fallacies 223

Mistakes and Fallacies 224

How to Dig Out of a Hole 228

Summary 233

APPENDIX A

History of Theoretical Developments in Life-Cycle Planning 235

The Model 235

Rising Lifestyles and Habit Formation 238

Empirical Studies of Life-Cycle Behavior 241

APPENDIX B

How Professionals Can Maximize the Usefulness of this Book 243

Transaction-Oriented Salespeople 243

Asset Gatherers 245

Insurance Planners 246

Financial Planners 247

Portfolio Managers 248

Notes 251

Glossary 265

References 271

Index 275