Comparing Bond Funds to Their Underlying Index

Comment on “A Fresh Look at Defined-Maturity Bond Funds,” by Charles Rotblut, CFA, in the September 2019 AAII Journal:

Historically how have these types of investments performed on a risk and return basis with the index they are close to?
—Ed from Minnesota

Charles Rotblut responds:
The indexes that the Invesco and iShares funds track are not traditional, widely followed indexes like the S&P 500 index. Rather, they are developed specifically for these funds to track. Furthermore, bond indexes are more difficult to replicate than stock indexes because not all bonds trade frequently.

The bigger issue with these funds is what has happened to them at maturity. The track record on this front has been good.

The Right Place for a Qualified Longevity Annuity Contract

Comments on “Retirees Gain by Using Taxable Assets to Purchase Annuities,” by AAII Staff in the September 2019 AAII Journal:

I assume this study did not consider the strategy of buying a qualified longevity annuity contract (QLAC) within a traditional IRA. Twenty-five percent or $125,000 of your IRA (whichever is less) can be used. The amount used for the QLAC is not included in the amount used to calculate the required minimum distribution (RMD). Would using this strategy make a significant difference in the article’s conclusions?
—Win Schwab from Virginia

It turns out that the premium limit for the QLAC is now $130,000. I did not study the article in detail, but you can download the PDF of the article by clicking on the link in the last sentence. It at least mentions the QLAC.

Personally, I would not buy an annuity inside an IRA if I had a taxable account. I am not convinced that the QLAC would actually help you much with taxes as it only postpones them and doesn’t really get rid of them. By postponing them it will potentially only make them bigger later.

The other underlying principle in this discussion is that the taxable account is the less tax-efficient “wrapper” for holding your assets, so putting a large portion of that into your longevity protection is probably the better choice in my opinion.
—Dave G from Washington

Relying on the Median

Comments on “Clarifying the Purpose of Diversification,” by Craig Israelsen in the September 2019 AAII Journal:

I question using the median result as a figure of merit. High balances are great, but low balances would have a person considering how living in a cardboard box might feel.

By that logic, looking at the low tail of the distribution seems more relevant. Hence, looking at Table 2, I would rank the 100% Large U.S. Stock strategy as the winner.
—Mike from California

In response to Mike, questioning whether median returns should be preferred to average returns in evaluating investment strategies, the median figure is much more indicative of what the typical investor will make utilizing the strategy in question than the average is. Of course, it depends on the underlying distribution in that the more the distribution resembles a normal (Gaussian) bell-shaped distribution, the more likely the average is to be a reliable indicator.

For instance, the most recent information at Career Trend shows that the average PGA golfer makes $2,232,000 a year but the median PGA golfer makes only $628,000 a year—75% less than the average. So, it is pretty clear that in this case the median is much more indicative of what the typical PGA golfer makes than the average is.

Obviously making a career choice as a professional golfer examining the median income rather than the average income helps one make a better choice. I suspect this is also the case for investors, though it is much more difficult to find median figures than average figures.
—Michael E. Ellis from Illinois

Looking Closely at Level3

Comment on “Optimizing Retirement Withdrawals Using the Level3 Strategy,” by John Bajkowski in the September 2019 AAII Journal:

A couple of observations: 1) The Level3 Passive Portfolio has lagged the SPDR S&P 500 (SPY) significantly, 34.2% versus 51.0% since May 2016. 2) Although the four- or five-year defensive fund may not be able to cover a down period exceeding longer periods, it would at least provide cover for those four or five years without the need to sell stocks.
—Richard Shaw from Arizona