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Zvi Bodie on Stocks and Annuities in Retirement

August 10, 2010

by Dan Richards

You are well known for your recommendation that investors, if they can possibly do so, should hold exclusively inflation-protected bonds when they retire.  They should sell their stocks and shift to bonds.

I'm glad you're giving me an opportunity to correct that statement.  I may have said it, but I certainly didn't mean it.  Or if I did mean it at that time, I'm changing my mind.

What I really meant to say is the logical place to start thinking about what you want to hold when you retire is a portfolio that is as free as possible of risk.  It is one that gives you the most complete protection against inflation risk, market risk, and other forms of risk, and then you can see how much income that produces.  That's you're starting point.  It's not the ending point.  You may decide, given that level of income, that you’re willing to go for more risk.  But you must recognize that if you shift some of your money into equities, then you want to take risk, and you could wind up with less.

Let’s say you are willing to put 10% of your money at risk.  You could lose it.  That means you're only going to have 90% of what you would've had.  There's no way of getting around that.

So you're starting point is the income you could get with an absolutely safe portfolio.

Correct, although no portfolio is absolutely safe, so a portfolio that is as safe as possible.

So you begin with inflation-protected government bonds, and then you start making trade-offs along the way.

Right.  It's not just and inflation risk, it's also the risk of outliving your money.  So you'd want to start with a life annuity as well, and see how much it costs to lock in an income that is going to last forever.  As it turns out, you can actually wind up getting more income out of a given amount of retirement savings by annuitizing it (by buying a life annuity) than if you tried to manage it yourself.