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Building a Personal Pension Like the Professionals

by My Journey to Millions

I think one of the biggest problems that baby boomers are going to encounter is transitioning from accumulation to decumulation.   At 30 I am still young, but it has to be an odd feeling moving from the gathering of assets to partitioning which assets to spend and when.  I recently read an article in Investment Advisor written by Dr. Stephen J. Huxley and Brent Burns, MBA titled “Building a Personal Pension Portfolio” that provided a really straight forward approach to the problem.  It should be noted that I have seen information on this type strategy before and the article written by Dr. Huxley and Mr. Burns while very inspiring is just the tip of the iceberg.

To generate both predictable income and long-term returns, we advocate splitting a portfolio into two sub-portfolios—income and growth. Each sub-portfolio uses asset classes that best suit its purpose. Individual bonds are used to generate the predictable pension-like cash flows in the income portfolio, while stocks and other long-term-growth-oriented assets make up the growth portfolio.

The income portfolio delivers predictable cash flows in the near term, usually eight to 10 years, regardless of what is happening in the stock or bond markets. It also provides a time buffer for the growth portfolio to ride through down markets. The growth portfolio is tasked with driving long-term total return to replenish the income portfolio as it is spent down.

The professional part? The two advisors depend on the concept of Liability-Driven Investing to provide for the income part.

What is Liability Driven Investing?

According to investopedia,

A form of investing in which the main goal is to gain sufficient assets to meet all liabilities, both current and future. This form of investing is most prominent with defined-benefit pension plans, whose liabilities can often reach into the billions of dollars for the largest of plans.

And Wikipedia adds fantastic information about applying LDI to Individuals

A retiree following an LDI strategy begins by estimating the income needed each year in the future. Social security payments and any other income is subtracted from the income needed to determine how much will have to be withdrawn each year from the money in the retirement portfolio to meet the income need. These withdrawals become the liabilities that the investment strategy targets. The portfolio must be invested so as to provide the cash flows that match the withdrawals each year, after factoring in adjustments for inflation, irregular spending (such as an ocean cruise every other year), etc. Individual bonds provide the ability to match the cash flows needed, which is why the term “cash flow matching” is sometimes used to describe this strategy. Because the bonds are dedicated to providing the cash flows, the term “dedicated portfolio” or “asset dedication” is sometimes used to describe the strategy.

The Authors discuss using a very similar structure as Wikipedia describes above.  The authors seem to solely depend on specific bond purchases, but I believe this is a bit shortsighted.

Using Multiple Income Streams During Retirement

The Authors are quick to dismiss REITs and Dividend Producing Stocks as they believe those assets classes are a “lousy source of predictable retirement income in periods of market turmoil.” The authors use the fact that the S&P 500 dividend payments dropped 23.5% from January 2008 to January 2009, but why use that specific index?

I have expressed my obsession with the topic before, but I am not sure why they would ignore the Dividend Aristocrat list?  These stocks have paid increasing dividends for the past quarter century (My first Post on investing with the Dividend Aristocrats and my latest Dividend Investment Portfolio Update).

Notwithstanding that very slight disagreement regarding dividend paying stocks I think they completely miss the boat on the topic of insurance products in retirement planning.  If I had to guess the reason they do this is because it is an investment magazine rather than an insurance based periodical.  At their very core annuities an annuity is an equal stream of payments from an insurance company…what is more guaranteed than that? Of course insurance companies can go out of business but bonds can default.  There are even advance annuities that while they have high fees may guarantee a larger stream of income later on in life (all dependent on specific terms found in various riders such as Guaranteed Minimum Income Benefits or Withdrawal Benefits).

While I may disagree in the application the strategy is phenomenal in my humble opinion. Imagine if it was a bit supercharged with multiple streams of income?

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LaTisha 10/26/2011 - 8:31 am

I like the idea of liability driven investing. We actually deal with this at work with Nuclear Decommisioning Trusts. Matching the expected outflows with investments today would be interesting to use as a personal strategy. I have to admit that my current plan is just to make as much as possible. As far as a personal retirement plan, I haven’t gone much further than knowing what I need based on a few present value calculations and how much I need to save at what rate to get there.

Evan 11/01/2011 - 4:02 pm

What are Nuclear Decommisioning Trusts?

I do like the strategy of just saving a shitload!

LaTisha 11/02/2011 - 6:08 pm

It’s basically a trust that winds down the operations of a nuclear facility.

The government requires it and nuclear plants have to plan to have enough money to pay for proper disposal and potential clean up. So we help them manage that. (That’s about as much as I know lol)

Jeff 10/26/2011 - 11:53 am

IT’d be quite the strategy if there were multiple income streams involved, but it’s still a pretty sound strategy for those involved just the same.

Evan 11/01/2011 - 4:07 pm

At the very least it is an interesting one to think about!

AverageJoeMoney 10/26/2011 - 2:34 pm

Awesome topic. One of my favs.

I’m always a fan of beginning with the end in mind. You take less risk and eliminate asset classes that don’t meet the goal. This leaves the average investor with more time to pick appropriate investments within the few asset classes that actually matter.

While I’m excited about GMWB annuities for a conservative investor, it’s important to remember that you get what you pay for…and these riders often cost TONS of money. That said, for many with neither the time nor acumen to pick a less costly strategy, annuities are appropriate.

For an investor looking to accumulate enough to fund their lifetime goals and leave a legacy, investments that spin off high dividends are a fantastic form of attack. The problem with dividend producing strategies is that the average investor doesn’t have enough capital to create a machine large enough to keep up with inflation throughout retirement and still put food on the table. The “spend it down” strategy illustrated in your article above is more efficient.

Fun as always!


Evan 11/01/2011 - 9:49 pm

I am glad I can entertain! I used to love GMIBs but they are no longer available for most AAA companies since they are too risky for the insurance companies.

krantcents 10/26/2011 - 2:50 pm

There are anumber of products like annuities that have guaranteed income streams, but they are at a cost. Dividend portfolios provide a steady income as well. There are risks and costs to these choices.

Suba 10/26/2011 - 5:40 pm

Have you heard of Finance Engines? They offer a service that sort of converts assets into income producing stuff (annuities?) as the retirement draws closer.

I have not given much thought about how we are going to use our assets after retirement. We should…

Evan 11/01/2011 - 9:50 pm

Never heard of Finance Engines…Have a link? I’d love to check it out.

UltimateSmartMoney 10/26/2011 - 7:02 pm

Dividend investing could work out but keep in mind that dividend paying stocks can also be volatile and could lost its value very quickly. As a retiree, having too much money in any stock could turn disastrous. Always diversify your portfolio and start saving as soon as possible. Utilize 401K as much as possible.

Squirrelers 10/27/2011 - 11:58 am

This is quite an interesting topics. Actually, what jumped out at me was the observation on how it must be odd to move from accumulating assets to using them. Wow, that seems tough to do when looking at it through the eyes of someone not near retirement. But true, it’s something to think about when considering what the future might be like.

Evan 11/01/2011 - 9:52 pm

Has to be tough, right? You accumulate assets for 40 years then all of a sudden you are supposed to reverse.

Hunter 10/27/2011 - 1:52 pm

I think it’s an excellent strategy to diversify income streams during retirement. It’s prudent, defensive, and smart. Even multiple annuitues within your required annuity allocation is a smart idea…insurance companies go out of business ALL THE TIME.

Evan 11/01/2011 - 9:56 pm

not the big ones:
MetLife – 140 Years Old
MassMutual – 160 Years Old
Guardian – 150 Years Old

Sandy 10/28/2011 - 5:34 am

My goal is similar. I kind of picture my retirement is a kind of endowment fund where you manage to live off the interest or earnings and not touch the principal. I’ve been dealing with a lot of charities lately and that seems like the most sustainable solution if you can get to that point.

Evan 11/01/2011 - 9:57 pm

There are some cool charitable techniques you can use also – ever think of them?

Amanda L Grossman 10/28/2011 - 11:40 am

Very interesting thought about having a psychological problem with decumulation after spending an entire life accumulating.

Perhaps at that point in life (I am 28, so do not know), you would feel like there is no more point in accumulating? Or maybe you would want to accumulate as much as possible for your grandchildren and children…not sure.

Evan 11/01/2011 - 9:58 pm

Only 30 here…has to be hard.


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