Are you a Stock or a Bond? Create Your Own Pension Plan for a secure Financial Future by Moshe Milevsky

This book addresses some of the more recent thinking and more subtle but critical aspects of financial planning for/in retirement. It is especially useful, not because it tells you how to do things, but it explains what is important, how thing work and what to look out for in a clear and understandable way.

The strengths:

-good introduction to life-cycle investing and financial planning (total capital is the sum of human and financial capital)

-explains why education is an investment not an expense

-value of insurance in the context of life-cycle financial plan

-the value of diversification in time and space; correlation and the fact that one is looking for “imperfect correlation and reasonable chance of making money over time”

-effect of human capital in the asset allocation and leverage decision

-risks in retirement: longevity, inflation, ‘sequence of investment returns’

-inflation: explains CPI-workers, CPI-core (excluding energy and food), CPI-E (elderly/experimental) and then the all important CPI-ME (mine or yours) and how/why these differ from the others (he suggest that you assume 5-8% for elderly- pretty scary!)

-‘sequence of investment returns’- what is it and why it is important when withdrawing large percentage of assets annually (larger than recommended by conservative advisors)

-understanding of longevity- difference between life expectancy at birth, at age 65 or 75 or 85, male/female/joint, and most importantly that any one individual (given that longevity definitions refer to median life expectancy)  may significantly outlive median!

-addresses the difficulty of simultaneously dealing with unknown longevity and unknown return in retirement planning

-criticism of approach used by many advisors, the bucketizing of short-term (three year) cash-flow requirement may be a placebo(?)

-explaining Monte Carlo simulation as a means to deal with uncertainty and providing a formula replacing Monte Carlo calculation

-demonstrates how the marginal improvement in sustainability of portfolios (i.e. decreased risk of running out of money in retirement) is minimal past about 60% equity in the portfolio (i.e. little point increasing risk much beyond 60% equity content). This is done for ‘need-to-wealth’ or withdrawal ratios of 5-9% (it would have been instructive to include what most advisors suggest, a 4% withdrawal target, when the intent is to increase spending annually with inflation as these calculation assumed; also would have been instructive to include the effect of a constant 5% of last year-end  asset annual withdrawal strategy, which is similar to what is done by endowments which try to preserve capital in perpetuity- like Vanguard’s ‘managed-payout’ funds introduced mid-2008, which are now (unfairly) taking a lot of flak  for poor performance.)

-discusses systematic withdrawal products are discussed (though you should consider those which have variable withdrawals tracking assets in your fund as mentioned in the previous comment in brackets (e.g. a fixed percent of previous year-end value- so you get more/less with positive/negative returns on your funds)

-good explanation of annuities (higher returns for survivors due to other/dead people’s money) and annuity shortcomings (inflation, loss of control and credit risk) and longevity insurance (allows you to take more risk); (don’t bother too much with the GMWB-like products mentioned- see criticisms)

-It gets a little confusing in Chapter 10 which discusses (and oversells) ‘product allocation’ as the new ‘asset allocation’ in retirement. The three classes of products discussed are: systematic withdrawal, annuities and guaranteed minimum benefit (called GLIBs in the book- and I seriously question the value of these high cost guaranteed investment products to anyone except those selling them, especially in Canada- see criticism below).

Criticism- only one

-I have yet to be convinced that the advocated GMWBs/GLIBs are a good product for the readers in their currently available form. Return of Premium (RoP) guarantees don’t stack up well even against GICs/CDs or possibly even annuities; certainly they are no match for systematic withdrawal funds- see GMWB II- Guaranteed Minimum Withdrawal Benefit II   . For a GMWB  offering to have  value even at the low 0.6% cost of guarantee, it would have to be an unbundled insurance product or if bundled then it would have to be with very low cost (0.1-0.2%)diversified indexed equity funds or ETFs, not with mutual funds charging 2-3% annually (as charged by the currently available Canadian products). A systematic withdrawal plan (SWiP) with withdrawals tracking assets (rather than blindly increasing withdrawals with inflation) from an asset allocation consistent with retirees’ risk tolerance (e.g. like Vanguard’s managed payout  mutual funds available to Americans only, but Canadians could build their own with ETFs). Such a systematic withdrawal plan coupled with a longevity insurance (i.e. delayed payout annuity now available in the U.S. and when available to Canadians) will meet the majority of retirees’ needs, without high cost bundled investment and minimum payout guaranteed GMWBs. (So GMWB are at best a theoretical maybe, but in reality beware!)