## Thursday, March 1, 2012

### Safety-First Retirements Are Expensive with Low Interest Rates!

I’ve made a table that pretty much speaks for itself. The table provides some idea about how expensive it can be to build a safe retirement portfolio with TIPS. But even this is not completely safe, since the TIPS ladder only lasts for 30 years.
I assume different constant TIPS yields. With no changes in TIPS yields and with TIPS yields the same for all different maturities, this is too simplifying. There is no reinvestment risk or interest rate risk. But it gives an idea. Those yields are shown horizontally.
Vertically, I show different desired withdrawal rates from one’s portfolio. Some relief is that Social Security and other income sources would be added on top. These withdrawal rates (providing inflation-adjusted withdrawal amounts) are only for the part coming from the portfolio.
What the table shows is the percentage of your portfolio assets you would need to dedicate to building your TIPS ladder for different yields and withdrawal rates. Red cells represent the impossible, you would need more than 100% of your portfolio to pull off that spending rate.
Also, you really should have some sort of emergency fund in case of unexpected necessary expenses. This could be at least 10% of your portfolio, making anything in the table above 90% infeasible.
So, for example, with a TIPS yield of 1%, even a 3.5% withdrawal rate is pushing the limits of feasibility, requiring 91% of the portfolio.
With a TIPS yield of 0%, a 3% withdrawal rate is about the best that can be hoped for.
The main message here, for whatever it is worth, is that building an inflation-protected spending floor in retirement can be incredibly expensive in a low interest rate environment!

Since this was a short blog post, for fun, here is the MATLAB code I used to make the table:
r=[-.02:.01:.05] % TIPS Yield
C=[.01:.005:.1]  % Withdrawal Rate
N=30             % Ladder Length

table1=zeros(length(C),length(r));

for i=1:length(r)
for j=1:length(C)
table1(j,i)=100*C(j)*sum((1/(1+r(i))).^[1-1:N-1]);
end
end

### CFPs and RMAs

An issue facing consumers looking for suitable retirement advice is that there has been a proliferation of professional designations, and it can be really hard to tell one from the other. In an ongoing discussion at advisor4advisors, Andrew Gluck has been questioning about what the Retirement Management Analyst (RMA) designation may have to offer.

In discussing this issue now, I don't mean to disparage any designations. I must plead ignorance about what so many designations even mean, before even considering what tools they teach. But I'd like to discuss a bit about what the RMA designation has to offer (last week I became the curriculum director for this designation) in relation to the two most famous and respected designations.

I'm a CFA charterholder, and I naturally gravitated toward that one because it is really the standard bearer for any sort of professional designation in the financial field. Their curriculum is very detailed and teaches many tools about financial analysis and portfolio management. They also place a great and important emphasis on ethics. In making any decisions, the client comes first, then one's employer, and then oneself. This designation is meant particularly for people in the finance and investment fields, and though it does cover some wealth management topics, I don't think the curriculum goes far enough in explaining the unique features and investment considerations in retirement. I must say, though, that there is enough in the curriculum that a CFA charterholder could probably figure out the rest on their own.

For financial planners, the key designation is the CFP. I have some aspirations of one day becoming a CFP, but I haven't attempted to do so yet. And I haven't been following this issue as closely as I should be, but there is a trend now toward making it harder for academics to become CFP designees, which could have an impact on whether I ever become one. For instance, with the CFA program, I could self study the curriculum, but the CFP Board has already changed their requirements so that even with a CFA charter, I would need to pay thousands of dollars to enroll in an online course before being allowed to sit for the exam.

The point being, I'm not a CFP designee, but as I am now looking at a book called Rattiner's Review for the CFP Certification Examination, I can see that their curriculum is missing some important details about retirement distribution. Their retirement planning section contains important material about the various tax-code retirement accumulation vehicles that exist, but doesn't really go further than that. Last year I was surprised in reading a column by a CFP about the updated Trinity Study in the April 2011 JFP. I didn't know how it was possible that a CFP seemingly had no clue that the Trinity study had existed for years already. But I can see why now by looking at this study guide, as I can't find anything about retirement distribution. (Please do correct me if I am missing something). As for investments, the curriculum seems to be a CFA-lite examination of Modern Portfolio Theory.

So what is special about retirement?  Dick Purcell, the creator of PortfolioPathfinder, described what he calls the Two-Bodies problem. I don't know if this is a "problem," but it is just that Zvi Bodie writes material geared for two completely separate audiences. There is no problem for CFPs to know both sides, but there is a problem if they are only learning one side of the story.

The CFA program, naturally [though not completely since Dan Nevins' "Goals-Based Investing: Integrating Traditional and Behavioral Finance" is part of the curriculum], and the CFP program, somewhat more surprisingly, teach along the lines found in the Bodie / Kane / Marcus textbook, Investments. But Bodie and Taqqu's Risk Less and Prosper presents a completely different view about investing. Investments explains how to evaluate whether you are beating a benchmark, but Risk Less and Prosper explains that for personal financial planning, "you judge success by your ability to meet these [personal spending] goals -- rather than by your record in beating some market benchmark." As I began my recent review of Risk Less and Proper at Advisor Perspectives, "Little of what is taught in traditional investment textbooks is of value in personal financial planning. Risk is not standard deviation; it is the probability and consequences of not meeting one’s goals."

That impacts retirement planning. For another way to look at this, here is a paragraph I wrote for an upcoming short piece in the Retirement Management Journal:

Harry Markowitz’s development of Modern Portfolio Theory (MPT) serves as a basis for analyzing and understanding asset allocation for wealth accumulation. In the original MPT framework, a risk-averse investor desires higher expected returns, but dislikes volatility. An efficient frontier for investment choices is calculated as those allocations which provide the highest expected returns for a given level of volatility, or which minimize volatility for a given expected return. While the single period focus of MPT is sufficient for accumulation, the analysis must be extended to deal with the vagaries and complications of planning for a smooth retirement income over an uncertain horizon.

Since I don't know enough about other designations to say that the RMA designation is unique, what I can say about it is that it is special because it teaches the sorts of tools needed to do this. They are focused on what is different about retirement (you no longer worry about maximizing risk-adjusted returns but would like to be able to maintain steady spending power for the remainder of your life). And their curriculum development is an ongoing process. This is still an emerging field, and they have no preconceived conclusions. Everything is fair game. And there are plenty of potential solutions to match the diversity of personal goals, resources, and desires of individuals. With the RMA program, the fundamental goal is to "first build a floor, then expose to upside." They are open to a data-driven research approach to guide the analysis about finding workable retirement income strategies and tools. I'm going to work with others on the curriculum advisory board try to incorporate more of this research into their curriculum. That's why I think the RMA designation merits further consideration.