The Most Basic Missing Instrument in Financial Markets: The Case for Bonds for Financial Security
16 Pages Posted: 7 Feb 2017
Date Written: December 1, 2016
The move to defined contribution plans has transferred risk to individuals who are least capable of bearing such risk and requires them to make complex decisions for which they are not prepared. Accumulation (investments) and decumulation (annuity purchase) decisions are complex, costly, often with different entities (asset managers and insurance companies), result in illiquid investments (annuities), and still may result in highly uncertain pensions (because of interest-rate volatility). This paper argues that governments globally can address the shortcomings by issuing a new type of bond that matches the needs of investors saving for retirement. This financial instrument is basically an inflation-linked bond that pays coupons when you need it. We call these Bonds for Financial Security (BFFS) and argue that this single instrument can help investors achieve retirement objectives at lower risk, lower cost, and with greater liquidity and greater simplicity than portfolios created through a mix of traditional stocks and bonds followed by annuity purchases. The need for such a bond is simple to understand: A typical saver sets aside resources today to receive a stream of income post-retirement (for a fixed period) and the BFFS is the “riskless asset” because it guarantees the purchasing power post-retirement. The paper goes further to demonstrate that there is a potentially willing supplier of such bonds — governments that need to invest in infrastructure and have a desire to prevent a retirement crisis, thereby completing the market. The cash flows of such a bond are contrasted with those of infrastructure projects to show how such bonds may foster infrastructure financing. The paper also addresses challenges, issues, and opportunities surrounding such an instrument and examines issues relating to the creation of a market for BFFS.
Keywords: Retirement Security, Inflation-Linked Bonds, Bonds for Financial Security, BFFS
JEL Classification: G10, G11
Suggested Citation: Suggested Citation