Posts
Wednesday, July 1, 2009
Monday, June 29, 2009
Pure Annuities
In a comment to June 19’s post, Anonymous asked what I mean by “pure” annuity. “Pure annuity” is not a term of art, I’m afraid. I made it up. Forgive me for not defining my terms.
What I meant by “pure” annuity is an annuity that pays an agreed annual payment, beginning at an agreed starting date, either for your life, or for the life of you and your spouse. It is “pure” in the sense that it does not contain the following features:
• Payment does not vary with the performance of some asset class, such as with the S&P 500 index; that’s called a “variable” annuity. In my mind, however, an annuity that varies with an inflation index is an acceptably pure annuity.
• Payment is not guaranteed for a minimum period, such as 10 years, should you not live that long. It’s purely for your life. In my mind, however, an annuity that continues for the life of your spouse, should he survive you, is pure enough. Most couples properly view themselves as a single economic unit.
I’m no expert on annuities. I know what I like about them in concept, but I don’t know enough about them to know when they’re a good deal or a rip-off. For a good informative website about annuities, go to AnnuityDigest.com.
What I meant by “pure” annuity is an annuity that pays an agreed annual payment, beginning at an agreed starting date, either for your life, or for the life of you and your spouse. It is “pure” in the sense that it does not contain the following features:
• Payment does not vary with the performance of some asset class, such as with the S&P 500 index; that’s called a “variable” annuity. In my mind, however, an annuity that varies with an inflation index is an acceptably pure annuity.
• Payment is not guaranteed for a minimum period, such as 10 years, should you not live that long. It’s purely for your life. In my mind, however, an annuity that continues for the life of your spouse, should he survive you, is pure enough. Most couples properly view themselves as a single economic unit.
I’m no expert on annuities. I know what I like about them in concept, but I don’t know enough about them to know when they’re a good deal or a rip-off. For a good informative website about annuities, go to AnnuityDigest.com.
Sunday, June 28, 2009
TIPS and Losses
In a comment to June 24’s post, Paul asks a good question: Can “investing in TIPS lead to zero possibility of losses over any and all time periods?”
I think the answer is “no,” but perhaps it depends on the way you look at it. Here are the dangers of TIPS.
Treasury Inflation Protected Securities, or TIPS, are issued by the U.S. government and backed by the full faith and credit of the United States. That means the likelihood of default is close to zero. Not zero, but close to zero. We think of default by the U.S. Treasury as inconceivable, but perhaps it’s more accurate to characterize it as inconceivably bad, rather than inconceivable.
Another obvious danger of TIPS derives from the manner in which it is adjusted for inflation. The Treasury increases the principal value each year to reflect changes in the Consumer Price Index. But the CPI is an imperfect measure of inflation. It’s made up of changes in the prices of a typical basket of goods and services. But a “typical” basket ain’t your basket. The goods and services in the CPI are not necessarily those that you need; nor are they necessarily measured in your part of the country. I don’t foresee the day when the Treasury starts publishing “CPI-Paul.”
Perhaps the most important point to recognize about TIPS and losses is this: Like other bonds, TIPS can gain or lose value in the marketplace. You likely won’t lose principal, but you can lose value. Those are two different things. TIPS are subject to the same laws of supply and demand as other securities. With the government backing of their principal, and their inflation protection, TIPS ought to be less volatile than stocks or other bonds. And I imagine they are, although I have not confirmed that. (Maybe someone reading this post has looked at this. Anyone?) Less volatile, perhaps, but somewhat volatile nonetheless. The market value of TIPS is determined by millions of purchasers and sellers, each acting based on his own financial needs, opinions, and prejudices. So if you have to sell some TIPS to meet your need for cash, you will find that their value has gone up or down, notwithstanding their rather conservative nature. So there is quite a distinct possibility of losses.
You could minimize that possibility by buying TIPS with staggered maturities, so you never have to sell them; just wait around to collect the proceeds as they mature. But your ability to do that is limited by both the impossibility of predicting your future spending needs, and the fact that you simply can’t get TIPS of any maturity in any denomination you wish. They’re not that fine-grained.
So the bottom line is there is no hiding from the possibility of real losses, even with TIPS.
Besides, you would pay a steep price for that low probability of losses in the form of measley returns.
I think the answer is “no,” but perhaps it depends on the way you look at it. Here are the dangers of TIPS.
Treasury Inflation Protected Securities, or TIPS, are issued by the U.S. government and backed by the full faith and credit of the United States. That means the likelihood of default is close to zero. Not zero, but close to zero. We think of default by the U.S. Treasury as inconceivable, but perhaps it’s more accurate to characterize it as inconceivably bad, rather than inconceivable.
Another obvious danger of TIPS derives from the manner in which it is adjusted for inflation. The Treasury increases the principal value each year to reflect changes in the Consumer Price Index. But the CPI is an imperfect measure of inflation. It’s made up of changes in the prices of a typical basket of goods and services. But a “typical” basket ain’t your basket. The goods and services in the CPI are not necessarily those that you need; nor are they necessarily measured in your part of the country. I don’t foresee the day when the Treasury starts publishing “CPI-Paul.”
Perhaps the most important point to recognize about TIPS and losses is this: Like other bonds, TIPS can gain or lose value in the marketplace. You likely won’t lose principal, but you can lose value. Those are two different things. TIPS are subject to the same laws of supply and demand as other securities. With the government backing of their principal, and their inflation protection, TIPS ought to be less volatile than stocks or other bonds. And I imagine they are, although I have not confirmed that. (Maybe someone reading this post has looked at this. Anyone?) Less volatile, perhaps, but somewhat volatile nonetheless. The market value of TIPS is determined by millions of purchasers and sellers, each acting based on his own financial needs, opinions, and prejudices. So if you have to sell some TIPS to meet your need for cash, you will find that their value has gone up or down, notwithstanding their rather conservative nature. So there is quite a distinct possibility of losses.
You could minimize that possibility by buying TIPS with staggered maturities, so you never have to sell them; just wait around to collect the proceeds as they mature. But your ability to do that is limited by both the impossibility of predicting your future spending needs, and the fact that you simply can’t get TIPS of any maturity in any denomination you wish. They’re not that fine-grained.
So the bottom line is there is no hiding from the possibility of real losses, even with TIPS.
Besides, you would pay a steep price for that low probability of losses in the form of measley returns.
Subscribe to:
Posts (Atom)