Friday, August 26, 2011

How Long Might Retirees Spend with No Remaining Wealth?

What the following figure shows for a couple both aged 65, is the probability that at least one of them will experience at least so many years at the end of their retirements with no remaining wealth. A note about the methodology and data is included at the end. This information is more detailed than just knowing the probability of failure, which is actually just the probability of spending at least 1 year of retirement with no wealth.  Now we can see further than that. For instance, using a 5% withdrawal rate, a couple can expect that at least one of them will spend at least 1 year at the end of retirement with no remaining wealth in 15% of cases, at least 4 years of retirement with no wealth in 10% of cases, at least 8 years with no wealth in 5% of cases, and so on. I do realize that real retirees would start cutting back on spending before their wealth is gone, but at least we can see about the patterns for the necessity of accepting a lower standard of living later in retirement.  Though using life expectancies did start pointing to the possibilities of using a higher withdrawal rate, these figures suggest caution about doing this because it may result in a long period of time with no wealth. 

Single males and single females would have lower probabilities for having no wealth, since they do not live as long. I forgot to save the figure for females, but the results for females would be somewhere in the middle between those for males and those for joint couples. Here is the figure for males:

Note: In the real world, actual results might be more pessimistic than this, either because people continue living longer and longer in the future (which is great of course, but in this context it will increase the failures), or because future market returns will not be as high as in the past, or because retirees will also have fees deducted from their portfolios. The above results really should be interpreted as a best case scenario.

Methodology: These figures are made using a 40% stock and 60% bond asset allocation strategy built from random combinations of the historical returns data. Simulations are bootstrapped using real annual 1926-2010 data from SBBI for large-cap stocks and intermediate-term government bonds. Withdrawals are taken at the start of year and are adjusted for inflation. The portfolio is rebalanced annually and there are no taxes or fees.  Mortality data is from the 2007 Social Security Administration Period Life Tables.

Safe Withdrawal Rates and Life Expectancy, Part 3

The other day I wrote about safe withdrawal rates and life expectancy.  I've been working on this some more, and have many half-finished bits and pieces right now. I hope to write more about this in the coming weeks.  But I do have one more figure that fits in nicely with the story from the earlier post.

On the matter of failure rates, people are probably not only interested in the probability they can expect to run out of wealth during retirement.  They probably are also curious to know how long they might live without any remaining wealth.  If they only have to endure one year on just Social Security benefits, it might not be so bad as having run out with another 15 years left to live.  The following figure may be a bit confusing and I should try to think about how else I might present the info.  But what it shows on the x-axis are numbers of years.  And on the y-axis, it shows the probability that you will spend that many years of your retirement without any remaining wealth.  This version is for couples.  It is for a 40% stock allocation, and it is based on the same data as described in the previous entry linked above. I just included the numbers for the zero year case, to keep the scale nice.  Let me just describe the 9% withdrawal rate case to show how it works.  Then you can see about the rest.

With a 40% stock allocation, the failure rate is 85%. That means, 15% of retirees can enjoy making it through their whole retirement without running out of wealth.  As this is based on lifespans, though, unfortunately, most of that 15% are not so lucky after all, really, because probably both members of the couple died just shortly after retiring.  Then, just eye-balling it, you can see that about 2.5% of retirees should expect one year with no remaining wealth, about 2.8% with 2 years of no remaining wealth, and so on.  You can see, there are lots of cases with no wealth left for even 20 or more years.

I thought this figure is kind of interesting.