No. of Recommendations: 8
But... you're smart. You already know this, and that's why you refuse to balance it out.

All the rest of the narrative is 'hand waving' trying to keep the focus away from the obvious.

When the reserves that are required to survive a naked S&P B&H strategy are employed in the Allianz IUL as designed, so that the field is even, the IUL wins. Doesn't take a math genius to see that a 50% reserve on the straight S&P, or a 30% reserve on the 60/40 blend, drops both below the net 7.76% return, tax free, of the IUL.

Or it could be he disagrees with how you are describing and measuring risk and cost. I do too. I didn't think it was worth getting into it, and I have no illusions of changing your mind, but just in case some poor sod is still following along...

Your formula is fine for illustrating downside volatility and creating equal risk of drawdown for the starting balances, but doesn't credit the upside volatility and then needs to be adjusted every year. For example, as the S&P grows over the IUL value, the correction factor should get smaller and smaller until it gets to zero. That's a lot of extra karate that doesn't help decision making.

From a strategy comparison standpoint, your correction factor isn't useful, because in real life you don't get extra money depending on which strategy you use. You can only use one or the other. You don't get the option of the IUL with a 50% bonus. You have a certain amount of money to invest, that's it. No correction factor in real life.

In short, because correction bonuses don't exist, I have zero interest in including one for purposes of making investing decisions. Same with unicorns. Since I can't incorporate them into my portfolio, it doesn't seem worth discussing them either.

Anyway, I'll use Catherine's spreadsheet to illustrate what I think is a much better way to view risk that is applicable to the real world. Ray's shows the same thing in more detail, but Catherine's is simpler, so I'll just use that. In the period in question, there were four large market draw downs. 1974, 1987, 2002, and 2008. 2012 is included as the final.

If we look at the balances, we see that in fact the IUL saved us in 1974, the first year. But in each of the subsequent events, even at the very bottom of the market, at each of the very worst possible times, the S&P strategy had substantially more money. And of course you wind up with a lot more more money at the end.

Year S&P IUL Difference
1974 1103 1500 -397
1987 72712 46223 26489
2002 437119 191564 245555
2008 525917 328882 197035
2012 938987 501680 437307

After that first year, the S&P balance is higher then the IUL for next 38 years in a row. I'll take those odds to Vegas. If risk is mitigated by having money, 97% of the time the S&P is the way to go.

And on top of that, the IUL only beats the S&P early on. If the S&P investor gets wiped out in Year Three, he has plenty of time to catch up. If a $501,681 personal financial crisis hits in 2012, the S&P guy is wounded but in reasonable financial shape. The IUL guy eats Alpo for the rest of his life. Which strategy is riskier?

Oh, and the cost to reduce the bumpiness? About $440,000. That's a big cost to solve a problem that volatility is willing to fix for you for free after a few years.
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