R Bonds are a Bad Idea

I have long been a fan of immediate annuities, particularly those that are inflation indexed, as retirement products for seniors. Yet, they do not get bought by retirees. Why? Well, insurance products are sold, not bought, typically, and when the agent sells an immediate annuity, that is his last sale on that money. They would rather sell a less suitable product that offers them another sale down the road. And, people like having flexibility with and control over their investments, even if that leads to less money for them in the long run. Annuitizing a portion of one’s lump sum lowers risk, and takes the place of investing in bonds in the asset allocation.

Most people like the reliability of their pensions, and Social Security, should it be paid, but do not seek the same thing when investing their private money. One would think they would invest that money for growth if they had a strong stream of income elsewhere, but often that money is conservatively invested as well.

People get fooled by yield, and in an environment like this, more so. People try to make their investments do more through targeting higher yields, while ignoring the possibility of capital losses.

Most people can budget, if pressed to do so. Few can manage a lump sum of capital, and know what to invest it in, and how much to take from it per year. Few have the discipline to buy an immediate annuity or limit their withdrawals to 4% of assets per year.

But where there is chaos and confusion, some in our government will seek to create a “solution.” The ill-defined solution that sounds a bit like a Stable Value Fund is what is getting called “R Bonds.” Here’s the idea: for those with 401(k) or IRA balances, if they should retire, and not decide what to do with the money, the assets would get automatically get placed into a Retirement Bond, and for two years, the retiree would receive income. They can opt out before that happens. If after two years they still don’t decide, the income continues. There is nothing mandatory about this program, should it come into existence; people who are asleep about their finances may find themselves trapped in it, at least for a time. [Note: there are scandalmongers alleging out-and-out theft being planned by the US Government. From what I can see that is not true for anyone that keeps his wits about him. All the proposals allow people to “opt out.”]

But let me go further. Scrap the idea of “R bonds.” Issue a limited number of Trills for retirees to use, or create a special variant of TIPS that pays until someone dies. These are easy solutions that do not require a lot of changes to the legal codes, or changes in investment behavior.

Now, there is not just one proposal out there. Let me give the two most comprehensive:

With interest rates so low on the short end, I don’t see how the returns could be that great from “R Bonds.” I would play for higher returns given the risk of inflation. Today that would mean safe stuff that yields little, while waiting for a correction in the fixed income markets, and high quality common stocks with some yield. And, annuitization at present? I would wait for higher rates.

Other posts on the topic worthy of your consideration:

Now, all that said, there is a reason to be politically aware here. Governments have in the past forced people to convert assets that were more valuable for those that were less valuable. And, we have the example of Argentina doing it in the present with pension assets, and also when their currency blew up — most debtors faced a forced conversion to less valuable bonds. With the pension nationalization, it was done in the name of protecting people’s pensions, but ended up benefiting the finances of the Argentine Government.

So, be aware. R Bonds, as currently proposed, are a bad idea. But there are worse ideas not yet proposed that might be proposed in the guise of protecting your future. Let us work to make sure they never get implemented.

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About David Merkel 145 Articles

Affiliation: Finacorp Securities

David J. Merkel, CFA, FSA — From 2003-2007, I was a leading commentator at the excellent investment website RealMoney.com (http://www.RealMoney.com). Back in 2003, after several years of correspondence, James Cramer invited me to write for the site, and now I write for RealMoney on equity and bond portfolio management, macroeconomics, derivatives, quantitative strategies, insurance issues, corporate governance, etc. My specialty is looking at the interlinkages in the markets in order to understand individual markets better. I still contribute to RealMoney, but I have scaled it back because my work duties have gotten larger, and I began this blog to develop a distinct voice with a wider distribution. After one year of operation, I believe I have achieved that.

In 2008, I became the Chief Economist and Director of Research of Finacorp Securities. Until 2007, I was a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. I also managed the internal profit sharing and charitable endowment monies of the firm.

Prior to joining Hovde in 2003, I managed corporate bonds for Dwight Asset Management. In 1998, I joined the Mount Washington Investment Group as the Mortgage Bond and Asset Liability manager after working with Provident Mutual, AIG and Pacific Standard Life.

I hold bachelor’s and master’s degrees from Johns Hopkins University. In my spare time, I take care of our eight children with my wonderful wife Ruth.

Visit: The Aleph Blog

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