I'm Immunizing My Retirement - Here's How
This year I bought my first-ever Treasury note. I’ll outline the reasons in a minute. For the curious, the process was straightforward. I purchased my 10-year TIPS (Treasury Inflation-Protected Security) directly from the treasury through my brokerage at a recent treasury auction. Since it was through an auction, there were no transaction fees. Why did I do this? I’m trying to “immunize” my retirement. Or at least the first ten years of retirement. But first, a little background as to why.
One of the major retirement risks is called: Sequence of Returns risk. This is when you retire during “crappy” times (that’s a technical term). Imagine that you dutifully save and invest; you’ve done everything right. Then you retire, and that year BOOM! There’s a recession and a major market drop. For example, during the 2008-9 financial crisis, the S&P 500 dropped approximately 50% at one point. Even an appropriately diversified portfolio dropped 25-30%. That can be difficult to recover from. And doubly so if you start to make retirement withdraws just as your portfolio collapses. Sequence of Returns is a significant risk, and any sound financial plan will need to take it into account. There are whole cottage industries in finance devoted to managing this particular risk. This brings me to my next thought:
The annuity puzzle. One way to manage this risk is to lay it off to an insurance company. This is what an annuity does. As with anything related to insurance, things can get complicated (and expensive) relatively quickly. But the basic product is simple, relatively cheap, and effective. It is called an Immediate Annuity. You give the insurance company a pot of money, and they give you a monthly income for life. No matter how long you live. You have just purchased a personal pension. The insurance company guarantees your new monthly income.
The payments that the insurance company makes to you are a combination of: 1) a return of principal, 2) interest, and 3) something called “mortality credits.” The insurance company invests your money, with many other annuity owners, in a pot of investments consisting primarily of bonds. Each payment made to you gets some of the bond interest, a small helping of the initial payment you made. Plus, you get some money from any participants who have died earlier than expected. These mortality credits give the annuity a little extra return above just investing in bonds.
Although immediate annuities are a very good solution for sequence of return risk, they are not very popular among retirees. Economists and advisors have puzzled over this for years. It turns out that people don’t like to give their principal away to an insurance company - whatever the benefit. Many retirees want to leave a legacy for their children, are charitably inclined, or hope things work out well for them. So they want to keep their investment principal intact.
I must admit that I am one of the people who would like to keep his investment principal intact. So I’ve decided to self-annuitize my first ten years of retirement. I think of this as “immunizing” the first ten years of spending I need. I just turned 55, and every year from now until 65, I plan on buying a ten-year treasury note. I will do this around my birthday - it’s an easy way to remember when to do it, plus it is a little gift to my future self. A modest amount each year, plus future Social Security payments, should guarantee me a modest yearly income. When I get there, if things look good for my portfolio, I can purchase a new ten-year note to continue my immunization program. Or if the outlook is not so good, I can use the bond principal for spending when it matures.
Compared to an annuity, this will not generate as much income each year for the amount of principal deployed; but I will get to keep control of the principal and re-deploy it if I want. I also feel it will give me a bit of peace of mind to know that I have a minimum spending level guaranteed for the first ten years of retirement. It’s not a perfect solution. But it feels like a good fit for me.