Guarding Retirees From Interest Rate Risk With The Help Of CoRI

Last time, we discussed how DFA’s target-date retirement income funds can help guard retirees from interest rate risk. Today, I want to look at another example of a bond fund used as a safeguard against interest rate risk: BlackRock’s series of CoRI Retirement Indices.

The CoRI Retirement Indices are gauged to help retirees understand the cost of $1 of cost-of-living adjusted (COLA) income for the remainder of their lives. They provide the indices for those aged fifty-five to seventy-four.

Click here to download Wade’s fact sheet, “What Is a Bond and How Does It Work?”

For the fifty-five to sixty-four indices, the goal is to put together a collection of bond investments that can track the evolving cost of purchasing a single premium immediate annuity (SPIA) with a 2.5% COLA at age sixty-five.

After sixty-five, the indices are meant to track the evolving cost of purchasing a SPIA.

These indices provide retirees with a clear way to understand how much sustainable income they could expect to obtain with their savings.

For instance, on January 3, 2017, the CoRI Index for a fifty-six-year old planning to retire at sixty-five was $14.96. Someone who saved $100,000 and invested in this fund could expect to obtain $6,684[1] in cost-of-living adjusted income for life starting at age sixty-five should they sell the fund at that time and buy an annuity.

For a sixty-five-year old, the CoRI index was priced at $20.91. One divided by this number gives us a spending rate, which in this case is 4.8%. This reflects the median price of commercial SPIAs with unisex mortality assumptions (as required for ERISA qualified retirement plans) and the 2.5% COLA.

The CoRI index is priced higher for the sixty-five-year old because there is no deferral period for the investment to earn interest before income begins.

After sixty-five, the index value decreases because the present value of a lifetime income shrinks in relation to the remaining time horizon at more advanced ages.

The planning notion is that assets in the CoRI index could be used to purchase a SPIA at sixty-five, and the investments track the cost of this SPIA.

The investment comes with no guarantees as the fund managers are essentially using bonds to track the hypothetical cost of a deferred-income annuity.

By properly matching the duration of the bond investments with the duration of the underlying projected income, the index should be immune to interest rate risk and should do a good job tracking its objective.

Eliminating this interest rate risk hedges the costs of retirement, which should reduce the impact of sequence risk as retirement nears.

It provides an alternative option to purchasing a deferred-income annuity in the years leading up to retirement for those seeking to take market risk off the table.

The BlackRock indices also aim to shift the focus to lifetime income rather than wealth maximization. The ultimate goal of individual investors is to fund retirement spending.

The CoRI indices let retirees get a better feel for how an income annuity works, but without actually locking in the purchase. Retirees can test drive a SPIA through age seventy-five before making an irrevocable commitment to annuitize or not.

CoRI provides an effective and intuitive way for individuals to think about the cost of retirement and about how they can translate their savings into sustainable spending. Again, this is a second practical example of a strategy to use bond funds to immunize interest rate risk for retirement liabilities.

[1] 100,000 / 14.96 = $6,684
 

McLean Asset Management Corporation (MAMC) is a SEC registered investment adviser. The content of this publication reflects the views of McLean Asset Management Corporation (MAMC) and sources deemed by MAMC to be reliable. There are many different interpretations of investment statistics and many different ideas about how to best use them. Past performance is not indicative of future performance. The information provided is for educational purposes only and does not constitute an offer to sell or a solicitation of an offer to buy or sell securities. There are no warranties, expressed or implied, as to accuracy, completeness, or results obtained from any information on this presentation. Indexes are not available for direct investment. All investments involve risk.

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