The Money Mustache Community

Learning, Sharing, and Teaching => Investor Alley => Topic started by: NCGal on June 11, 2015, 01:23:26 PM

Title: Another Kitces Article - Question
Post by: NCGal on June 11, 2015, 01:23:26 PM
I read this one:
I've also heard other advisors mention building your own portfolio to mirror an annuity. I don't quite understand how to achieve this but is it worth investigating as a means to protecting principal after RE?
Title: Re: Another Kitces Article - Question
Post by: bdbrooks on June 12, 2015, 09:01:24 AM
Generally I like what Kitces has to say. You really need to remember that he writes almost exclusively to professionals. So his writing assumes a certain level of knowledge and understanding with what is going on. In terms of buying bonds and letting the interest buy options, that is something that should be reserved only for those that understand how options work. Also this article is geared at those seeking absolute protection of principle. If you are ok taking on more risk, then you will need to tweak his advice.

One downside to his strategies, his principle would be guaranteed (by the US GOV) at the END of 10 years. If interest rates skyrocket, then the bond values will go down in the meantime. So if you are potentially withdrawing before 10 years, then you will actually have some downside risk. Because of this, who is really worried that a balanced stock/bond portfolio will lose value over the next 10 years? I think that stocks are overvalued and I think everyone agrees bonds are overvalued, but I think over the next 10 years that a balanced stock/bond portfolio with rebalancing will at least return your principle (since we are comparing buying and holding for 10 years).

Personally, if I were worried of valuations and a potential crash, I would consider using a trend following system (absolute momentum, 200 day MA, MACD, and Bolinger Bands) to systematically time an exit from the market (yes I know that this crowd is very mixed on timing the market and in general leans away from it). These systems have been shown to reduce volatility (protect principle). Over the long run, they generally don't actually add to returns. For example, they worked SPLENDIDLY in the tech crash and financial crisis, but they got "whiplashed" in 1998 and 2011.  Whiplashed meaning: they got out of the market after a move down (usually about 10%) and then the market rallied about 5-10% before they got back in (costing them 5-10%). I go through the effort of explaining this so that if you do utilize it that you understand the limitations and drawbacks.
Title: Re: Another Kitces Article - Question
Post by: forummm on June 13, 2015, 06:45:23 AM
Thanks for posting. This was an interesting read. Bdbrooks has a great answer.

Another way of thinking about options is that someone has to take the other side of that contract. If you are paying someone to take almost all of the downside risk of the stock market, you have to adequately compensate them for that risk. So, on average, you are giving away some (perhaps significant) portion of your upside to the counterparty. They are betting that stocks will go up (and they are almost certainly right in the long term).
Title: Re: Another Kitces Article - Question
Post by: NCGal on June 14, 2015, 08:35:13 AM
Thanks for your replies. I'm just trying to make sure we're not ignorant of any tried and true strategies before pulling the plug. Thinking about an end to those direct deposit paychecks is a little overwhelming. We've got a year and a half to explore options.