Tag Archives: Stock Market Volatility

A Reader Asks: SPIA inside of an IRA

Thank you for taking the time to read this blog post.  I recently received a rather complicated question from one of the frequent readers of this blog.  His question was about how he could buy an SPIA inside a Traditional IRA account.

The question came from a reader named Bill.  Bill provided me with a good amount of information about his financial situation.  Since I am not a financial advisor, I told Bill that I do not give financial advice, but would write about his situation on my blog and request feedback from other readers in the comment section.

Bill is 59 years old.  He is going to retire from his career as a truck driver next year when he turns 60 years old.  To fund his retirement, he owns three duplex rental properties that produce a generous income of $7,200 per month.  He has a portfolio of a few dividends paying individual stocks including Johnson & Johnson (JNJ) and Procter & Gamble (PG) worth $200,000.  Bill also has a safety deposit box full of EE Bonds that he has been buying for the past 30 years estimated to be worth about $50,000.  Bill also has a 401K with his long-time employer that has a balance of over $650,000.

Bill told me that the income from his rentals and the dividends that he receives is more than enough to cover all of his living expenses.  Bill is planning on taking Social Security at age 65, but if money gets tight for some unforeseen reason, he will tap Social Security at age 62 instead of 65.  Bill explained that he lives a frugal lifestyle and does not project that happening.

He wants to hold off on taking any money from his 401K that he is going to roll-over into an IRA until he turns 70 years old.  His goal is to grow the value of the IRA until he is required to take RMD’s.  Bill also wants to invest this money in a way that will provide guaranteed income in the future.

The exact phrase that Bill used was creating a growth and income strategy for himself.  He asked me what I thought about taking $600,000 from his IRA and buying a Single Premium Income Annuity (SPIA).  An annuity salesman from a major brokerage house quoted him a monthly payment of $2,800 per month, with 20 years certain, and a minimum payout of $665,000.

Bill does not want to spend the $2,800 per month at this time.  He wants to take the $2,800 per month and have it invested in a balanced mutual fund with a conservative asset allocation within the IRA.  His plan is to do this for 10 years.

At age 70, he wants to spend the $2,800 per month when RMD’s are required.  He projects that a balanced fund of 50% invested in stocks and 50% invested in bonds should return around 5% per year over the next 10 years.  That would provide him with another $440,000 in retirement savings.  Bill estimated his RMD’s to be around 4% and that $440,000 would give him an additional $1,400 in retirement income.

Bill asked me what I thought about his plan.  He was not concerned about receiving the best return on investment.  He was also not interested in any type of variable rate product.  He wants to have a guaranteed income at age 70, but also have some conservative growth over the next 10 years.

I am grateful that Bill took the time to send me an email about his unique idea.  He has set himself up for a comfortable retirement.  He just does not want to have to deal with market volatility and simply wants to buy himself a pension for the latter part of his life.

Bill does not want to put any of the $2,800 per month of future income in jeopardy.  Since he does not need it now, he wants to have it grow and earn a reasonable return. He referred to the extra $1,400 per month as gravy.  My thought was that the extra money could come in handy to offset future inflation.    

Since I am not a financial advisor and am not familiar with annuities, I told Bill that I would post his situation on my blog and ask for readers to comment.  My blog is read by many members of the financial independence community and a few financial advisors.  I will ask their opinion.

The main question that I have about Bill’s plan is can an SPIA be purchased in a traditional IRA?

What about the monthly payments, can they be kept within the IRA and be distributed to a mutual fund until RMD’s are due?

Would the combination of payments from the SPIA and withdrawals from a mutual fund impact the RMD’s when Bill is 70 years old?  

Thanks again for taking the time to read over Bill’s situation and plan.  Bill and I would truly appreciate any feedback about his plan of using an SPIA in an IRA to produce some growth and future income.  Please share in the comments section below if you have expertise or experience with using an SPIA in a Traditional IRA.

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Please be sure to read the Disclaimer page.

Bonds to Reduce Volatility

During the first ten years of my investing career, my asset allocation was solely invested in stocks.  From 1997 until 2007, my portfolio returned 8.5%.  I wrote about that period in my first post of this series 100 Percent Invested in Stocks.  In this post, I will write about how adding bonds to my portfolio reduced volatility during the decade that followed.

By the year 2007, my portfolio had five years of positive returns.  At that time, I was reading a good amount of Jack Bogle’s writings on asset allocation.  He suggested holding (100 – your age) in stocks.

After investing for 10 years, it made sense for me to reduce the volatility of my portfolio.  However, I still was focused on aggressive growth because I had the goal of retiring early.  I felt an asset allocation equal to my age in bonds was too conservative.

Another factor that I had to consider was that I was newly married.  Prior to getting married, my wife and I decided to manage all our finances together.  We sat down and evaluated how we wanted to invest our money after we were married.

At that point, I was 30 years old and my wife was 37.  We decided on adding 25% of our portfolio to bonds.  It was close to equaling (110 – our average age) in stocks.

This is how our new asset allocation looked:

S&P 500 Fund – 43%

Extended Market Index Fund – 13%

Total International Stock Market Index Fund – 19%

Total Bond Market Index Fund – 25%

My second decade as an investor was equally as volatile as my first decade. In 2007, our portfolio was off to a solid start by returning over 10%.  Then 2008 came.  That was the beginning of the great recession that resulted from the subprime mortgage bubble burst.  In 2008, our portfolio had a loss of more than -30%.  If I had my original asset allocation of 100% invested in stocks, we would have lost more than -40%.

Just as during the dot.com bubble and the three years of negative returns that followed, we just kept investing and moving forward.  We stuck to our normal schedule of dollar cost averaging.  We also stuck to our plan of semi-annual re-balancing.

Fortunately, the market bottomed out in March of 2009 and one of the greatest bull markets began.  By the middle of 2010, we had recovered all of our losses. From 2009 to 2016, our portfolio averaged over 10.5% annually.

That 10.5% return did not occur without volatility.  During this period, there were peaks and valleys along the way.  There were budget crises, polarizing politics, debt-ceiling debacles, federal government shutdowns, and threats of austerity.

Over the course of those ten years, our portfolio had an average return of 5.24%.  If we were invested in 100% stocks the average return would have only been 5.58%.  By adding 25% in bonds, there was almost zero impact on growth.  The bonds did help to reduce volatility.

If you are not comfortable with having 100% of your portfolio invested in stocks, consider adding some bonds to your allocation.  Bonds are susceptible to interest rate increases, currently have low yields, and do not hold up as well as stocks during periods of inflation. Bonds do, however, reduce volatility when the stock market is in decline.  That is the main reason why they have an important role in our asset allocation.

Please keep an eye out for Part-3 in my series on asset allocation.  In Part-3, I will write about the balanced-growth asset allocation that we will hold until we reach early retirement (FIRE).

Please remember to check with a financial professional before you ever buy an investment and to read my Disclaimer page.

100 Percent Invested in Stocks

Do you think you have the risk tolerance to invest 100% of your portfolio in equities?  I had an asset allocation of 100% invested in equities for over 10 years.  At this stage in my life, However, I no longer have the need or desire to have that asset allocation.  That was how my portfolio was invested when I reached my first milestone of Saving $100,000 by age 30.

This is the first of a 4-post series about my asset allocation.  This series on asset allocation is about my asset allocation at different points in my investing career.  The series is based on where I started, what happened, where I am at now and where I will be heading based on age and risk tolerance.

My investing career began in 1997.  This was a time Alan Greenspan referred to as a period of irrational exuberance.  The stock market was soaring.  The S&P 500 had an average return of over 15% per year from 1989 to 1999.  If a person invested $100 in the Vanguard 500 Index Fund (VFINX) in 1989, it would have grown to $692 by 1999.

In 1997, I purchased my first mutual fund.  My first fund was the Vanguard 500 index fund (VFINX).  This was the only investment that I owned from 1997 until 2000.  I would purchase at least $500 worth of this funds shares per month.  Over that 3-year period, the Vanguard 500 averaged a return of nearly 20% per year.

In 2000, as the result of my savings and market returns, my portfolio was large enough to add more funds.  To improve my diversification, I wanted to add small caps and international stocks to my asset allocation.  I added the Vanguard Extended Market Index Fund (VEXMX).  By adding the Vanguard Extended Market Index fund to my portfolio, I could replicate the total stock market because I already owned the Vanguard 500 Index Fund.  The third fund that was added was the Vanguard Total International Stock Market Index Fund (VGTSX) for international exposure.

My asset allocation was:

Vanguard 500 Index Fund – 60%

Vanguard Extended Market Index Fund – 15%

Vanguard Total International Index Fund – 25%

As far as equities are concerned, my new portfolio was diversified.  It contained every major publicly traded U.S. and international stock.  In my mind, I was ready for the new century and another decade of 20% annual returns.

It did not take long for the economy to change for the worse.  In March of 2000, the dot.com bubble burst.  On September 11, 2001, New York City and Washington D.C. were attacked by terrorists.  By 2003, the U.S. was fighting two wars in Afghanistan and Iraq.  Those unfortunate events drove the U.S. economy into an extended recession.

As the result of those events, the stock market posted losses for three consecutive years.  The average annual return on my portfolio was a loss of -16%.  In other words, if you invested $100 in January or 2000, it was worth $61 by January of 2003.

How did I handle the prolonged recession and market contraction of the early 2000s?  I stayed the course.  I dollar cost averaged the same amount of money into my investments every month.  My goal was to reach financial independence, so I rode out those volatile markets and took advantage of buying equities at a reduced price.  I would, however, feel unnerved when I paid attention to the media.  Fortunately, I was too busy working and going to college to become obsessed with the media.  I honestly do not remember ever feeling overly fearful during this period.

My patience did ultimately pay off.  By sticking with my allocation, I was rewarded handsomely between 2003 and 2007.  Over the course of those next five years, my portfolio had an average return of more than 16% per year.

During my first 10 years as an investor, my portfolio returned slightly more than 8.5% per year.  This asset allocation, however, was extremely volatile.  The best year returned 34% and the worst year had a loss of -20%.

An asset allocation of 100% invested in stocks is not suited for every investor.  It worked for me because I was young and able to dollar cost average when the market was both up and down.  This type of volatility does cause many investors to sell low and buy high.  That is a losing game if you want to reach financial independence.  If you cannot honestly handle a -40% drop in the value your portfolio, then a portfolio made up of 100% stocks might be too aggressive for you.

There is a simple solution if the volatility of a portfolio invested in 100% stocks causes you to feel insecure.  Add a percentage of bonds to your portfolio that matches your risk tolerance.  In my next post, I will write about how adding bonds to my asset allocation reduced the market volatility of the next decade.

Please remember to check with a financial professional before you ever buy an investment and to read my Disclaimer page.