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How to Build a TIPS Ladder Portfolio for Millennials

Active Fund Management in South Africa Continued to Struggle in 2016

How Much Is Your Social Security Benefit Worth?

Alaska Healthcare Profiled

Rieger Report: State G.O. municipal bonds have underperformed

How to Build a TIPS Ladder Portfolio for Millennials

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Peter Tsui

Director, Global Research & Design

S&P Dow Jones Indices

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In his January blog post entitled “Try a TIPS Mixer in Your Equities Cocktail,” Phillip Murphy described the potential benefits of including Treasury Inflation-Protected Securities (TIPS) in one’s portfolio.  In this blog aimed at Millennials, I would like to propose an easy way to build up a 30-year TIPS portfolio for retirement.

Let us assume that Alice, age 25, wants to create her own do-it-yourself TIPS portfolio to be one of her sources of retirement income when she turns 65, 40 years hence.  Without a lot of investment decision-making experience, what would be an affordable way for Alice to accomplish her goal?

To begin with, it may help for Alice to read “Risk Less and Prosper: Your Guide to Safer Investing,” by Zvi Bodie and Rachelle Taqqu, in which the authors argue for accumulating TIPS in one’s portfolio, because TIPS provide inflation protection and hedge against interest rate risk.  In addition, if the TIPS securities were held to maturity, as would be the case for a laddered portfolio, then there shouldn’t be any risk.

Currently, if Alice has a TreasuryDirect account, she can participate in non-competitive biddings throughout the year.  Some key facts about TIPS are as follows:

  1. TIPS are issued in terms of 5, 10, and 30 years;
  2. The interest rate on a TIPS is determined at auction,
  3. TIPS are sold in increments of USD 100, with the minimum purchase at USD 100;
  4. TIPS are issued in electronic form; and
  5. TIPS can be held until they mature or, if desired, they can be sold in the secondary market before they mature.

For more details, please visit the TreasuryDirect website at: https://www.treasurydirect.gov/indiv/research/indepth/tips/res_tips.htm.

As described by Wikipedia: “TreasuryDirect is a website run by the Bureau of the Fiscal Service under the United States Department of the Treasury that allows U.S. individual investors to purchase Treasury securities such as T-Bills, TIPS, and others directly from the U.S. government.  Its website allows money to be deposited from and withdrawn to personal bank accounts, and allows rolling repurchase of securities as the currently held items mature.”

Thus, for Alice, her TreasuryDirect account would be a cost-effective investment account to accumulate TIPS.  From age 25 to 34, at a relatively modest salary, Alice would buy the 10-year TIPS, at USD 5,000 a year.  From age 35 to 44, as her compensation grew, she would roll over the maturing 10-year TIPS into 30-year TIPS each year, and she would buy an additional USD 5,000 of the 30-year TIPS.  From age 45 to 54, she would buy USD 10,000 each year of the 30-year TIPS.  Finally, from age 55 to 64, she would buy USD 10,000 each year of the 30-year TIPS.  As she turns 65, she would have built up a 30-year laddered TIPS portfolio, with USD 10,000 of TIPS securities maturing in each of the next 30 years.  Since these TIPS securities have coupons and inflation-adjusted principal amounts, the nominal amounts would be much different from the face amount of USD 10,000; but in real terms, meaning on an inflation-adjusted basis, each maturing tranche of the laddered portfolio would provide the same purchasing power of a real USD 10,000.

For Alice, having a 30-year TIPS laddered portfolio of USD 10,000 real income each year would be a nice supplement to her other sources of income from Social Security benefits and defined-contribution retirement savings.  If, along the way to her retirement, she could afford to buy more TIPS, then her TIPS nest-egg could be correspondingly larger.

It may not seem like a big deal to have such a USD 10,000 30-year TIPS laddered portfolio available for retirement income when one is ready to retire.  However, bear in mind that the maximum social security benefits one may get (in current U.S. dollars) is around USD 2,800 per month, or USD 32,600 a year.  In this context, an income of USD 10,000 a year would increase one’s social security income by about one-third.

The posts on this blog are opinions, not advice. Please read our Disclaimers.

Active Fund Management in South Africa Continued to Struggle in 2016

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Daniel Ung

Director

Global Research & Design

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Equity markets in South Africa, as measured by the S&P South Africa Domestic Shareholder Weighted (DSW) Index ZAR, increase 5% in 2016.  Aside from the GDP contraction experienced in the last quarter of 2016, conditions were generally improving in the country.  For example, the South African rand strengthened during the year and the municipal elections passed without incident.

However, it appears that active managers were not able to take advantage of these more favorable conditions; 72% of South African equity funds underperformed their corresponding S&P DJI benchmark over the one-year period, and 77% underperformed over the 10-year period.

In regard to active funds invested in global markets, funds in South Africa fared poorly during the year and were the worst performers among the fund categories studied in the SPIVA® South Africa Year-End 2016 Scorecard.

For more details of the report, please click here.

The posts on this blog are opinions, not advice. Please read our Disclaimers.

How Much Is Your Social Security Benefit Worth?

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Peter Tsui

Director, Global Research & Design

S&P Dow Jones Indices

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Social Security benefits are the gold standard of retirement income.  As Nobel Laureate Robert Merton commented in his article “The Crisis in Retirement Planning,” published in the Harvard Business Review (July/August 2014): “Ask someone what her pension is worth and she will reply with an income figure: ‘two-thirds of my final salary,’ for example.  Similarly, we define Social Security benefits in terms of income.”  In this blog, I will turn it around and try to put a price tag on this stream of retirement income.

This may be timely, as anyone who has read their Social Security statement lately might agree.  As of March 2017, the Social Security Administration includes the following message in the statement received by current and prospective social security benefit recipients: “Your estimated benefits are based on current law.  Congress has made changes to the law in the past and can do so at any time.  The law governing benefit amounts may change because, by 2034, the payroll taxes collected will be enough to pay only about 79 percent of scheduled benefits.”

If we wanted to provide for ourselves the potential shortfall of 21% in our social security benefits in 2034, how much would it cost us?

To answer this question, we consider that the current cost of a single life income annuity paying USD 1,000 per month is around USD 185,000.  Since social security benefits are adjusted for inflation, the cost of such a single life income annuity would be higher.  Without knowing the pattern of inflation changes over time, most annuity providers assume a 2% annual increase in monthly incomes.  With a 2% annual increase option, the current cost of this single life income annuity is about 23% higher, at USD 227,300.

The next step is to determine the monthly social security benefits one would receive.  Assuming the retiree is currently receiving USD 2,500 per month, the projected 21% reduction by 2034 would mean roughly USD 500 less per month.  Thus, since we know it would cost the retiree USD 227,300 to get USD 1,000 per month for life with a 2% annual increase, in order to replace USD 500 a month, the retiree would need to come up with one-half of USD 227,300, or USD 113,650, to get back up to the USD 2,500 monthly income, in current U.S. dollars.

Looking at this another way, if securing USD 1,000 per month costs USD 227,300 now, that means the value of the USD 2,500 monthly income in social security benefits would be worth about USD 568,255 in current U.S. dollars.

The posts on this blog are opinions, not advice. Please read our Disclaimers.

Alaska Healthcare Profiled

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Glenn Doody

Vice President, Product Management, Technology Innovation and Specialty Products

S&P Dow Jones Indices

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According to an April 6, 2017, CNN story titled “High-cost Alaska sits in the eye of health care reform storm,” Alaska currently has the highest healthcare costs of any U.S. state.[1]  In this first profile edition, we look at the state of Alaska and compare just how different the cost profile is for people living in the far North.

To start, we look at the state on a per member per month (PMPM) basis.  As seen in Exhibit 1 and described in the CNN story, healthcare costs are significantly higher in Alaska than any other state in the U.S.  In fact, on average, each Alaska resident spends about USD 525 per month on healthcare as of October 2016, versus a cost of just USD 366 nationally—a USD 160 a month difference, or 43% more.  One could argue that the Affordable Care Act (ACA) is a major reason for this huge cost difference.  However, as Exhibit 1 illustrates, this difference has existed long before the introduction of the ACA.

There Is Hope

There is hope for those in Alaska.  Between August 2015 and October 2016, the increase in healthcare cost trends across the state declined rapidly (see Exhibit 2).  This decline was much more rapid than elsewhere in the country.  In fact, during that same period, change in cost trends in the state of New York continued to increase, peaking at a rate of over 8%.  Even the national trend, which dropped from a high of 5.51% to 4.40%, was not close to the decline in cost increases from 8.84% to 1.71% that we saw in Alaska.  Since October 2014, Alaska has been trending flat.  The average PMPM cost in Alaska between October 2014 and October 2016 was just USD 550, with costs starting at USD 577 per month and ending at USD 525 per month.

[1] “High-cost Alaska sits in the eye of health care reform storm.”

The posts on this blog are opinions, not advice. Please read our Disclaimers.

Rieger Report: State G.O. municipal bonds have underperformed

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J.R. Rieger

Head of Fixed Income Indices

S&P Dow Jones Indices

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Overall, general obligation bonds have underperformed revenue bonds over the last five years  of low rates.   State general obligation bonds have been the sector that is holding back returns as the lower yield and shorter duration characteristics of these bonds have resulted in muted returns in the up market.

While revenue bonds have a larger foot print by par amount outstanding in the municipal bond market, general obligation bonds remain an integral component of the financing of infrastructure.

Chart: Par amount, stated in billions, of municipal bonds tracked in each index:

Source: S&P Dow Jones Indices, LLC. Data as of April 7, 2017. Chart is provided for illustrative purposes. It is not possible to invest directly in an index. Past performance is no guarantee of future results.

Table: Select general obligation and revenue bond indices, their yields, returns and durations:

*Yield represented is Yield to Worst (YTW). Source: S&P Dow Jones Indices, LLC. Data as of April 7, 2017. Table is provided for illustrative purposes. It is not possible to invest directly in an index. Past performance is no guarantee of future results.

More information on the characteristics of each index can be found on:  www.spindices.com or by clicking on the index names below.

S&P Municipal Bond State General Obligation Index

S&P Municipal Bond Local General Obligation Index

S&P Municipal Bond Revenue Index

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The posts on this blog are opinions, not advice. Please read our Disclaimers.