Easier Investing, Richer Life: TIPS Ladders to Annuities
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Walk in the money for the rest of us. This is a personal financial on money, how IT works, how to invest IT and how to live without worrying about IT. Every host David's dying today is is episode 4 fifty five。 It's titled easier investing, rich your life tips latter's two annuals.

A couple years ago, I read a book titled effortless by greg mckeon. IT was a follow up to his best selling book essentialism. My cun describes essential m as doing the right things wherever fort less is about doing them in the right way.

And he wrote that follow up book because he was doing the right things, the essential things, but was completely burned out. And so then he had to change how he was going about doing things. And there were three main focuses. One, an effortless state, which he called clearing the clutter, just getting rid of the excess effort. Action was focused on simplifying the process and effortless results, taking effortless actions on highlighted activities, so that we get these results that compound over time, like interest.

After reading that book, I spend a lot of time thinking about, is there a similar way to go about doing whatever I am doing? Are there steps that I can eliminate? Is their way just to make things easier? IT reminds me a concept taught by a name, Nicholas tolb, in his books, skin in the game, be an negativity.

It's the idea that by removing things, that act of removing things is more powerful and less airplay than adding things. So I spent a lot of of time thinking about what could I get rid of? What could I remove? How can we make this easier? And this occurred to me when I was the post office the other day, I had sold a sweater online.

The person that bought IT was in canada, the pro, and my daughter had had tried to mail at once. And IT turns out the documentation to send a package to canada was a little more complicated than they had anticipated. And IT was my package.

So I I needed to go send IT. I got there. I waited in line, and there were four, five people, and IT took forever.

And as I was getting ready to mail my package, I realized very few people go to the post office with a simple request. They always ask you, you want to buy stamps. That's not why people go to the post office.

Usually there's some more complicated problem they're trying to solve, which is why IT takes so long. At least that's been my experience in that line. I decided i'm not selling use clothes anymore or i'm going to find a similar way.

I'll use some type of shipping service where I can print the label at home and just drop IT off. But that wouldn't work for canada. But the whole idea is, is there a similar way to do things something more effortless? We've had a discussion on the money for the rest of us plus member forms about A A simper way to invest retirement assets.

And it's a topic we've discussed on the podcast most recently, an episode four or seven worry free retirement investing. And it's the idea of creating a bond letter, a bone. Latter is a series of individual bonds that mature in a given year will go out thirty years, for example.

And then when that bond matures, cash low is received in the idea is that, that cash low is sufficient to meet one's expenses or a portion of their expenses. Bond letters have been around a long time. What has changed recently is interest rates are fire.

We've discussed that in recent episodes, particularly real interest rates, there are over two percent right now going out from one to thirty years. That means that bond letters using treasury inflation protected securities are more viable than they have been in over fifteen years. A member of money for the rest of us, plus who is sixty two and and can quit his job anytime.

I I met him, I won't share his profession, but he approached one of his investment advisors. He is three of them, which I found humorous because he is doing a horse race among advisors, something that I actually have ve had clients to in the past and insurance company and florida decided to hire three bond managers. Each got a chunk of the asset to manage because the committee want to see who did the best job.

This member approached one of the advisors about the idea of doing a treasury inflation protection letter with about twenty percent of the assets would be a twenty five years latter, and those cash list would be complimented by social security and a pension. The advisor didn't really like that idea. He thought bond funds, municipal bonds, tips and treasuries would be a Better choice.

He made the comment that buying tips right now would be like putting on a seat belt after the car crash, implying that now that inflation is high, you miss the boat when I came to tip. Now this members pretty savy about tips because he he studied IT. And we've discussed on plus membership podcast and and there's a lot of good information out there.

And he knew that tips E T S hadn't actually done very well because real rates are negative and now their positive. And as interest rates go up, the value of bonds go down, including tips. If we look at the three year return, for example, of the I shares tips etf T I P, its negative one point seven percent analyst inflation has been running close to four percent the past three years.

A tips etf was not a good investment over the past three to five years, and it's something that we've pointed out on the show. But tips now are more attractive. In fact, they were attractive a year ago when we did up to four or seven on worry free investing and talked about tips, latter's annuity and other options.

We're revisiting IT in this episode de, because there are some things about tips. Letters that aren't straight forward as they seem a tips later seems like a simple problem omy. Just figure out how much to put in the tips, spread them out twenty five, thirty years, collect the cash.

You get the majestic principal value over time and you're set the chAllenge is, is figuring out how much do we put in that particular tips in order for IT to grow on a real basis. And we will take a look at some ways to do that. In this episode, I first became aware of the power of using treasury inflation protected securities as a way to to have more worry free investing.

From my book I read over twenty years ago by sv body and Michael clouds, it's called worry for investing a safe approach to achieving lifetime financial goals. And in the book, body and clouds point out that many people and estimate the risk of the stock market. We discuss this back in episode three seventy four on life cycle investing.

We're used to thinking of the stock market at looking at an expected or return and arranger returns. The volatility, the volatility of the stock market in any one years around eighty percent. But the volatility, the range of expected returns, if we look at five years or thirty years, will be narrowed.

We're not going to see a twenty percent differential in the tenure analyzed returns for the stock market. It's much narrower. But the problem is as individuals, as retirees, we don't spend average returns.

We spend dollars or whatever currency. As mark spit snag, the hetch fund manager, points out in his books, safe haven investing principle number one is that investing is a process that happens sequentially through time. We get one shot as we go through time with our investment. And as a result, investing in risk, he points out, is a multiple od problem. Returns are iterated, returns compound.

And so the outcome, the wealth outcome width as time passes, risk doesn't decrease the longer you're in the stock market because of this compounding effect, because of volatility drag, which we we've talked about the fact that the greater the volatility, the more difficult IT is to recoup losses. And so the average outcome is greater than the median out outcome with the middle person experiences because some people get very lucky and going to have very high returns. That brings up the average body points out in his book that we we know.

This is the case based on the Price of options, the formula for option to the black sholes model. The longer you hold an option, the more expensive is, for example, a put option where you protected on the downside. For the S M P, five hundred IT might cost four percent a year to protect against losses greater than five percent.

But if our time horizon is fifty years, then IT might cost fifty percent of assets. And that's how that formula works. Because the formula, the math, recognizes this volatility drag, this multiyear problem of risk, the compounding and how risk increases as we go through time. The dollar outcome, the compounding outcome, how much we have at the end of the day. And that's why using something like a tips latter or an anuwa, these more safety first approaches can be very powerful because it's a way to lock in these cash flows and reduce some of the diversion risk body in his book, recommended tips.

And I remember twenty years ago thinking, well, I just do that, except that for many years, the yield on tips has been close to zero and it's been negative at times, which made IT much more expensive to implement the strategy you needed to have more saved to put in the tips letter. There is a relatively new tool that a number of listeners and members have recommended. Its at tips latter not come.

And he had a really dig to see who created this thing. And his name is Kevin esler from mass accuses. And that's all I know about him. There's an email and an name, and I spent close to two hours trying to understand the math at tips letter dot come IT will tell you which particular tips the cusip to buy for each year of your bond letter going out thirty years, which is kinda cool. And IT tells you how many of each particular bond purchase and how much.

And IT seems super simple until you start to think about how do we know the math is correct and not knowing who created IT, at least we know their name, but nothing about their background. I wanted to make sure the math was correct. When you buy an individual treaty inflation protection security, there are two things that determine the Price you pay.

The first is the adjusted principle baLance on the tips. The way that tips work is there is a set coupon rate or interest rate that is used to calculate the interest payment. So for example, last month, october twenty and twenty three, I bought at auction the newly issued five year treasury inflation protected and security IT has a coupon rate of two point three seven five percent that two point three seven five percent is multiply by the principal amount over time to figure out what that interest payment will be.

The adjusted principal amount is increased by the rate of inflation. There is an index ratio. That's known as the inflation factor that the U.

S. Treasury calculates. And there's one for every month based on the nine seasonally adjusted U S, city or items, consumer Price index C, P, I, U.

That index factor is then used to calculate the adjusted principal men and are linked to, in the show notes, the investment guide we have on money for the rest of us on investing in tips and eyeball es. And we go through an example of this principal adjustment using this index factor. What we pay on on, on a tips depends on how long that tips had been outstanding.

And if it's been out for twenty years, the index factor is going to be much higher as well. The adjust the principal mount. The second thing that determines how much you pay for the tips is what current interest rates are relative to the state of interest rates, the coupon rate, and when and if current real interest rates are higher than the coupon rate, then the Price paid for the bond will be less.

As literates go up to value, bonds go down and IT works the same way for tips. The lower the tips coupon rate relative to real rates, the market rates, the bigger discount, the lower the Price. So a tips that as a coupon rate of point one percent versus one that has a coupon rate of one percent, if they have the same maturity right now, real yields are around two point three percent.

So they'll be a greater discount, a greater Price drop for that tips with a point one percent coupon rate. As an example, in february twenty and twenty to the us. Jury y issued a tips that had a coupon rate of point one two five percent.

IT was a thirty year tips. IT matures in twenty fifty two. The index factor is around one point one o three. You can multiple that index factor times the original principle count, and we get basically a Price and adjust the principal value of that bond of one thousand, one hundred and three dollars.

But if we go out into the marketplace and buy that because real yields are higher than the coupon rate of point one two five percent, we can buy that bond for six hundred and eleven dollars. When we think about building a tips letter, the reason why they're more attractive right now is the higher the real yields, the cheaper IT is to purchase tips and create a bond latter. Before we continue, let me pass and share some words from this weak sponsors, knowing where moneys going and how it's being spent.

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The only way to get twenty percent off is to go to join delete me dot com slash David twenty and enter code David twenty a checkout that's join delete me that comes less David twenty code David twenty here's a dirty little secret when IT comes to tip latter's that people all mention I ve got some videos on IT and you really need to understand the bond math or how bond math works with the principal mount. So let's say we we paid six hundred dollars for that bond and tips that expires in two and fifty two. Now over time, the principle will be increased as inflation increases and are return on the principle because we've bought IT at such a discount, IT increases in Price over time so that the the return on just the principal peace, if we look at what we paid versus what will get in twenty and fifty two, that equal the yell to maturity, the real yet to maturity of two point three percent plus whatever the inflation rate us to the principal value is, is protected from inflation and and we will get that starting yelled the maturity.

excEllent. That's what we want. However, tips are paying in interest in my annually. And in order for our latter to work, we have to reinvest those interest payments and they need to be reinvested at that starting ulto maturity when that tips was bought, in this case, two point three percent that say real rates go back to negative again. And we're getting all this cash flow from these interest payments on our tips latter or that i'll be broken unless we find some other way to invest those interest payments at at least that starting yet the maturity, in this case, two point three percent, if it's less than that, then we actually will not have the right inflation adjusted cash flow when the tips bonds mature. And I don't see people talking about that, took me out to figure that out.

And it's not necessarily even clear on tips letter that IT tells you which bond to buy and IT says you've got the write amount at the end, but you can have to dig into the math of the spread sheets that you can download to realize, oh, this is actually the embedded assumption, which is the emda assumption of all bonds. All bonds assume that if if you're going to earn the yield to maturity when you purchase the bond, that you you're reinvesting the interest payments at that same year to maturity. But if mark rates of change, if the lower than IT becomes more difficult to do because of this reinvestment risk, ideally, for tips, we want high real yield ds, but we would prefer the tips to have low coupon rates, to be more season, to have a higher inflation adJusting value.

But because we won't have as much reinvestment risk because we we're receiving less cash loss in my annually. Now we don't really get that choice because there's not that many tips outstanding, and we're going to have to take what we're given in the tips latter dot com can help with that to figure out which cusip to buy. But reinvestment risk is one of the chAllenges with tips or tips letter.

A benefit of tips letters, though, is we could spend a higher amount then we would if we were just doing sort of a traditional asset allocation, let's say, a fifty percent stock, fifty percent bond portfolio. We're using a four percent spending rules of spending four percent in our first year retirement and adJusting IT for inflation, the benefit of of tips and iran, this through our retirement spending calculator, money for the rest of plus. We have a million dollar portfolio.

And if we sum inflation, average three percent over the next thirty years, and the starting real yield is like IT is today, two point three percent, so combined, our real yield less inflation that any returns five point three percent. That calculator shows that we can have a spending rate, a starting spending rate of basically four and and a half percent instead of four because we have the security of the inflation protection. And that starting real yield.

Again, though, IT assumes we're able to overcome the investment risk in our investing. Those interest payments at least two point three percent real. You can go through really any online calculator and see that the assets with last thirty years using that four and a half percent spending grades to that, that's helpful.

Although the other downsides of tips for the government could default and not make good on those principal payments, that seems unlikely, very unlikely, incredibly unlikely. But IT could happen more unlikely that politicians will just make sure they spend the money not to default, which could lead to higher inflation, which were protected from with our tips letter. Now the chAllenge that would tips is we're not sure how long will live.

The longest maturity we can purchase is thirty years, but if we want to plan for a thirty five year retirement IT IT adds a little more complications. We can compare tips to another option. And we were discussing this in the member forms and immediate unit ity.

This same member that was discussing tips latter's with his advisor was also getting quotes on immediate annuities, which you make a one time principle payment and then you get lifetime income for yourself or you can do a joint one for yourself and your house of whoever lives the longest and the rate that he was getting for immediate unit I was about six point two percent of the principal amount. And he he gets that every year. The benefit of immediate unity is IT is lifetime income.

You build a tip slater for thirty years with all your money, and you live to be thirty five years that there is a problem as social security and a pension plan. But with an immediate, I knew that you get what are called mortality credits with a tips latter or any time of retirement we have assume we're going to live to be ninety five. An immediate annuity is an insurance product.

You buy IT from an insurance company which pulls the risk with the immediate annuities. They don't have to plan for everyone living to be ninety five. They can assume the average life expectancy of the pool, which will be, let's say, in the low eighties, and as a result, because the average will be closer to low eighties as opposed to age ninety five.

A new audience that that lived to be ninety five, they make IT out well. But IT also means. The amount paid out, the yields on immediate annuity are higher because of this risk pooling impact, which is called mortality credit.

And so you you will get more cash low investing with any media, anybody. What you won't IT is inflation protection. Now there are some immediate annuities that, that do offer inflation protection, but those pants are much, much lower, even lower than tips.

The other chAllenge we with immediate annuities is you don't have the liquidity. You give the principle, there can be guaranteed that you can get the principle back. Your ears will get IT back if you die early, say in the first five years or it's it's guaranteeing for ten years.

But the I knew IT IT doesn't get IT once you make that decision that moneys gone, which is fair but with tips, if you decide, oh, I don't, anna, keep with my tips latter. Maybe you find that you have an incurable cancer and you need the funds to to pay for health care or something like that. Well, you you can access the tips letter.

So we have two options here. We have a tips latter. The prose are you get true inflation protection, you have liquidity, and you typically can spend more than you would just using a traditional four percent rule.

The cons to a tips letter is they can be complex. They're going out which tips we buy, how much we buy. They only go out thirty years. If you're going to do a thirty five year tips latter in year and five, you're going to have to buy another thirty year tips.

A big con is the reinvestment risk of of the interest payments recognize you have to reinvest those coupon payments of interest payments at whatever yield to maturity was baked in to your tips letter when you initiated IT. And if you're not able to earn that much, then then the tips letter won't meet the objective. There will not be enough cash in year twenty five for your year thirty.

Another context, pes, there's not necessarily always a bond, our tips that fits the year maturity that you want, so you can't get the necessary the perfect match of the cash flows to when you want me to spend them. The benefit of immediate unity is, is that is true lifetime income for the rest of your life, they're simpler er you choose a highly rated insurance company. I recommend a mutual insurance company like a new york life for example.

Northwestern mutual been around for very, very long time, low risk and you get the true lifetime income and you get a higher pay out and you would with with bonds due to the mortality. Credit is a proven model. But the contest, you do give up the principle and you you can access for liquidity and you don't get the inflation protection.

So what works best is a combination like this member was considering. The member has social security, the member has a pension plan, the members is considering a tips letter. We have other members that have have done tip letters with half their assets and invested the rest in stocks and other asset class.

So having a combination works best. There can be some simplification to IT IT. We'll take off some risk.

But as we try to simplify, simplify the process that that's different than saying it's dead simple, investing can be complicated. There's always some type of risk. There's new answers, which is why we do a sure like this to help point these things out.

There's ways to simplify them and immediately IT when individuals that I know that I bought them have gotten great piece of mind, not having to worry about whether they would get cash low every month for the rest of their life, still have to worry about inflation. wherewith. Tips, you don't have to worry about inflation, but there worry.

So there's always some tradeoffs. So use a combination. And that's a discussion then.

Tips, latters versus annuities. That's episode four fifty five. Thanks for listening. I have loved teaching you about investing on this podcast for over nine years.

Some topics, though, I just Better explained in writing or with a chart. And that's why we have a weekly free email newsletter to insider guide. In that news letter, I share charts grasped and other materials that can help you Better understand investing.

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