Frequently Asked Questions
- Is Social Security a type of bond?
Social Security is not a bond, however like a bond it provides a
periodic source of income. This means for retirement planning purposes
it needs to factored in very similarly to bond holdings. The greater
the value of your defined benefits the more risk you can take with
liquid investments. What makes defined benefits different from bonds
is they can not be sold. This means if stocks do poorly, and you only
have stocks and defined benefits it isn't possible to rebalance by
selling defined benefits and buying more stocks. Simulations suggest
the importance of preserving the ability rebalance is very minor, and
for the most part Social Security can be treated as like a bond.
- Why recommend inflation-indexed income annuities rather than nominal income annuities?
Nominal annuities are priced using a yield curve somewhere between the
Treasury nominal yield curve and a corporate bond yield curve, while
inflation-indexed annuities are priced with a similar Money's Worth
Ratio using the Treasury real yield curve. This makes nominal annuities
appear more attractive in simulations using a random inflation model.
The problem is inflation isn't random, but is sticky. If inflation is
6% one year, it is likely to be 5, 6, or 7% the next. This could have
a devastating impact on the value of nominal annuities. Unfortunately
it is difficult to simulate this in order to know for sure. So we play
it safe and recommend inflation-indexed annuities despite their being
slightly more expensive.
- What is utility?
Utility is a concept in economics that assigns a number indicating the desirability of a consumption level or sequence of consumption levels. This relationship need not be linear; consuming $20k less per year may be many times worse than consuming $10k less year.
- How many years does the analysis of AACalc.com provide for?
Rather than a fixed number of years AACalc.com uses a stochastic lifespan, and analyzes for all ages (up to 120) with decreasing emphasis placed on later years when the performance of the portfolio becomes less critical. If equal emphasis was placed on all years there would be a perhaps 50% reduction in consumption to handle the very small chance of living to 120. The loss in well being from doing this would exceed the loss in well being from the small chance of living to 120 and having insufficient funds available.