Pensions, Retirement Planning, and Economics Blog

Time Diversification

2012-02-27T11:36:00.001+09:00

This past week I was appointed as the Curriculum Director for the Retirement Management Analyst (SM) Designation Program operated by the Retirement Income Industry Association. I'm quite excited about this opportunity, as it will allow me to help build their curriculum by incorporating the latest research results on retirement planning and retirement income distribution strategies, much as I have been doing here at my blog.

As I have been starting to discuss here recently, there really is more to retirement planning than just deciding on a safe withdrawal rate. We can talk about Monte Carlo simulation with its thousands of trial runs and find a strategy that minimizes the probability of failure. But retirees only get one shot at retirement. If failure is something they view as catastrophic, then the objective becomes to eliminate the chances for failure, not just minimize them.

In considering how to best accomplish this, there are all sorts of tradeoffs that one must consider. Retirees want to maintain control of their assets, but also they want to obtain guaranteed income sources that often require relinquishing control. Retirees want to spend as much as possible to enjoy their retirement, but they also fear running out of wealth later in life.

The research I want to work on, and the research which I want to work hard to more fully incorporate into the curriculum, relates to how one can best balance all of these competing tradeoffs to find the most personally satisfying retirement income path that will work no matter what happens with financial markets during retirement.

The fundamental goal of retirement planning is to “first build a floor, then expose to upside.” If you want to read more about what this means, it is the approach Moshe Milevsky has in mind when he recommends that you “pensionize your nest egg” and it is the way that Zvi Bodie suggests you can “risk less and prosper” in retirement.

Also, over the weekend I read some articles on "Modern Retirement Theory" by Jason K. Branning and M. Ray Grubbs. What they are doing also very much ties in with the ideas in the RMA Curriculum. A brief overview of "Modern Retirement Theory" can be found in this special report supplement from the December 2010 Journal of Financial Planning.

That was a rather long lead-in to today's topic, time diversification, which is something that may have already been discussed to death at other places. But I just wished to run some simulations of my own about it, and I think it could be useful to share.

Consider someone who puts $1 into a portfolio of stocks and lets that dollar sit and grow for 30 years. I will look at 100,000 Monte Carlo simulations for what happens to this dollar over the ensuing 30 years. I'm doing things in real terms, assuming at the average annual real stock return is 7%, but that the standard deviation of annual returns is 20%. This means that the compounded real return for stocks is 5%.

The classic argument about time diversification is that the longer you invest, the more likely your average returns will match the compounded 5% average. The classic picture shown in support of time diversification looks like this:

We can see that in the median case, we get the 5% compounded real return we expect. As time passes, the distribution of average returns also gets narrower to focus in more on the 5% return. I've shown a 90% confidence interval, meaning that 90% of the time we would get an average return falling within the red bands. 5% of the time the average return would be even higher than the top dotted red line, and 5% of the time it would be even less than the bottom dotted red line.

But that is not the whole story. People don't really care about these average returns. What they should care about is the money! How large will this dollar grow over the ensuing 30 years? That is what I show in the next picture. The distribution of wealth accumulations gets wider as time passes, not narrower. And not only that, but the distribution is not symmetric (it is a lognormal distribution). There are chances for extreme wealth, but don't let that obscure anything happening on the downside.

Let's look more at the downside. First, some good news. As more time passes, the probability of experiencing bad outcomes will decrease. Here I show the probability of having less than $1 (in inflation-adjusted terms) as time passes. That implies experiencing negative compounded growth over the whole time period. This probability does decline over time, but still there is about a 7% chance that your accumulated wealth will be less than $1 even after 30 years of experiencing 7% average real returns.

And finally, risk is not just the probability of bad outcomes. It is probability times magnitude. The final picture shows bad news, which is that as time passes, the wealth accumulation in the worst-case scenario falls even further. Even after 30 years of 7% expected growth, there are cases where the person only has about a nickel (5 cents) left. Remember, this is about accumulation and there are no portfolio withdrawals. Those losses are due to stock market losses.

People only get one simulation path for their own life. Despite the extreme potential upside seen in the second picture, people may reasonably wish to protect on the downside. Though I've just shown a simple example about wealth accumulation rather than retirement distribution, this is the basic idea behind "first build a floor, then expose to upside."

This example is also overly simplying in two ways, one that is good news and one that is bad news. First the bad news: I assume that the stock returns are normally distributed in this example, but a common complaint we hear about this is that there are fat tails. That means the chances of getting really bad stock returns are higher than the normal distribution implies. That would make things look even worse on the downside.

But the good news, I think there is some long-term mean reversion that can help protect on the downside. This Monte Carlo simulation assumes that each year has returns independent from the past. There is no notion of market valuations, which may get unrealistically low in some cases. But more generally, there is no notion such bad luck simulations would be met with such widespread social and economic problems (as everyone experiences this bad luck at the same time) that the issue of enjoying retirement may fall by the wayside no matter what. Just for some edification about Monte Carlo simulation, here are the returns experienced by the person who had the lowest wealth accumulation after 30 years out of 100,000 tries. Notice in particular the almost continuous series of negative returns experienced between years 11 and 20. Could things ever get that bad in the real world? I don't know, I can't predict the future.

          Year       Stock Return
          1.00         -7.90
          2.00        -33.73
          3.00         16.68
          4.00          4.12
          5.00        -21.76
          6.00        -32.96
          7.00         18.28
          8.00         34.97
          9.00         51.02
         10.00          4.68
         11.00        -11.90
         12.00        -12.97
         13.00        -23.53
         14.00        -10.76
         15.00          0.20
         16.00        -17.89
         17.00        -42.85
         18.00        -15.81
         19.00         -4.48
         20.00        -27.38
         21.00         33.42
         22.00        -30.39
         23.00        -26.04
         24.00         -8.59
         25.00         -6.15
         26.00        -16.06
         27.00         -6.19
         28.00          6.63
         29.00        -16.84
         30.00          5.56

Retirement Planning Guidelines: An Alternative to the Trinity Study

2012-02-20T10:45:00.000+09:00

Recently I wrote about the famous Trinity Study for developing guidelines about sustainable withdrawal rates to avoid outliving your wealth. I wrote about their portfolio success rates concept. Their approach results in tables like this:

Today, I'd like to suggest an alternative table for prospective retirees to use instead. The alternative is Table 3 from my article, "Capital Market Expectations, Asset Allocation, and Safe Withdrawal Rates," from the January 2012 Journal of Financial Planning. This table is based on the same data as the Trinity study table, but uses Monte Carlo simulations instead of historical simulations. The table looks like this:

I think this table has several advantages:

* It uses Monte Carlo simulations which count each year of the historical data equally. It is not subject to the bias against bonds in the historical simulations resulting from an overweighting of the middle historical years. (For more on this, see the section "Bias against Bonds in Historical Simulations" here.)

* I think the information is more directly useful: it connects withdrawal rates to acceptable failure rates and shows the optimal asset allocation.

* The results fit better with real world expectations. Stock allocation recommendations tend to be lower than the 50-75% outcome in the Trinity study. The table also shows how a wide range of asset allocations work nearly as well as the optimal. This gives relief for retirees worried about high stock allocations.

* Since it is based on Monte Carlo simulations, the table can be easily customized to a change in capital market expectations. That is, the historical portfolio success rates in the Trinity study may not matter now that bond yields and dividend yields are so much lower than their historical averages. By modifying these return assumptions, users can get results that may better fit their own expectations about the future. For example, here is the same table, but with the real return expectations for each asset class being two percentage points lower than their historical averages:

The Safety-first, Goals-based Approach to Financial Planning

2012-02-15T00:13:00.001+09:00

My new monthly column is now available at Advisor Perspectives. It is, “The Safety-first, Goals-based Approach to Financial Planning.” This column is partly a review of the new book by Zvi Bodie and Rachelle Taqqu called, Less and Prosper: Your Guide to Safer Investing. It is also partly a general discussion about the safety-first, goals-based investment portfolio approach. This column is connected to the discussion in my recent blog entry, “Safe Withdrawal Rates: Have I been barking up the wrong tree?” The intro to my new column is:

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 real-world perspective animates a new book by Zvi Bodie and Rachelle Taqqu that implores advisors and their clients to lock in the funding of their essential expenses before worrying about their discretionary goals.

A few other issues…

While I haven’t had a chance to review all of the other Advisor Perspectives articles yet, one thing I do see that is worth a look is page 2 of the Letters to the Editor. There, Joe Tomlinson explores whether it might be a worthwhile to begin Social Security earlier rather than later, and to then invest the proceeds yourself.

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Kay Conheady, CFP, has created a new website called CAPE Research Catalog. CAPE is another term for what I usually call PE10 here, though CAPE is broader to include cousins like PE5 as well. Be sure to check her research timeline which has a rather extensive collection of research related to the cyclically-adjusted price earnings ratio. She is working to make it comprehensive, and it does look quite complete and detailed to me.

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Finally, regarding my previous post, “Are Annuities (SPIAs) Okay When Interest Rates are Low?” Nords began a discussion of it at the Early Retirement Forum. There, Midpack provided a good critique. For some of his points, it is just a matter that the analysis is still incomplete and not comprehensive. But one really good point in particular is that my graph showing how the annuity payout rate increases with age is not a particularly useful way of looking at the information. Retirees may have in mind a set amount of spending they wish to obtain from their annuity, and so what they care about is how much it will cost to obtain this annuitized income stream as they age. The following figure shows the cost of purchasing $1 of real income for each year that one lives as a function of age:

To understand this, consider a 65-year old male. The cost of obtaining a real annuity of $1 is $18.48. For a 70-year old male, the cost has fallen by $3.35 to $15.13. That’s an 18% drop. But that is assuming interest rates remain constant at 1%. If interest rates change during those 5 years, so would the 70-year old numbers. That might be a wash though, as interest rate decreases would make the annuity more expensive but also boost the returns on your bond holdings. You would also need to consider whether your unannuitized wealth would hold its value or not over those 5-years as you spend it down and experience the unpredictable market returns. After all, you did miss $5 worth of real income from the annuity by waiting, and that presumably needs to come from your portfolio instead. These combined factors would tell you, mathematically and probabilistically speaking, whether it is worthwhile to wait.

What this makes clear to me is that I don’t have any answer about this issue yet. There are now 3 or 4 projects where I need to be using simulations for bond yields rather than simulations for the total returns on a constant-maturity bond fund. I do hope to look at this some more in the not too distant future. Also, this might be something that Moshe Milevsky has already investigated, and so I do need to read his research articles too.

Any reading suggestions or other comments are appreciated. Midpack has earned a spot in the acknowledgments section of any research article I might eventually write about this :)

Are Annuities (SPIAs) Okay When Interest Rates are Low?

2012-02-12T23:59:00.002+09:00

Readers of my last blog entry, Annuities and Delayed Social Security, provided many valuable comments, prompting me to now write a follow-up post. Most of the discussion centered on a chart showing the relationship between annuity payout rates and interest rates. That chart was actually a last minute addition, as I saw the picture on my desktop and decided it might be worthwhile to include.

Now I’d like to discuss more about how annuities are priced and whether it is a good idea to wait to buy an annuity. I will limit the discussion today to inflation-adjusted single premium immediate annuities (SPIAs).

I will provide a modified version of the chart which I showed before. This is an inflation-adjusted SPIA for 65-year olds. For mortality data, I used the Social Security Administration’s Period Life Table from 2007. The interest rates are in real terms (such as the 30-year TIPS yield). Formulas for the calculations can be found below in Appendix 1. I charge a 15.5% overhead charge on the annuity (see more about overhead charges in Appendix 2). Also, before I showed interest rates up to 10%, but since these are real yields, the chances of seeing that are about the same as seeing pigs fly. So I stop at 5% this time. [Nominal interest rates can be higher because they consist of real interest rates plus a premium for expected inflation. Real interest rates do vary over time, but I think the chances of ever seeing long-term TIPS yields above 4% again are very low.] The chart looks like this:

Long-term TIPS yields are currently under 1%, which means that current annuity payout rates for 65-year old males are a little above 5%. Females get lower payouts because they live longer.

Should someone wait for higher interest rates to buy a SPIA?

There can be valid reasons to wait for buying an annuity, which I will address more below, but regarding the issue of whether it is worthwhile to wait specifically for interest rates to rise, I currently don’t think that sounds like a very good idea.

Who knows if TIPS yields will rise? They may continue falling. Even if TIPS yields do rise to 3% or so, this would result in only about a 20% increase in the annuity payout. Only 20%? That sounds like a lot. But as Boglehead dpbsmith argues at "with interest rates so low, are annuities effectively dead?", if you are also investing conservatively like the insurance company, you will probably burn through your assets at a fast enough rate that you really don’t even get any benefit from the increased annuity payout rate since you have less assets by the time you do buy your annuity. He argues as well that, actually, by waiting you miss out on some of the mortality credits available by having had the annuity earlier. In the same thread, Boglehead alec also makes a good point that if you are waiting for interest rates to rise, and then they do rise, you will probably experience capital losses on your bond portfolio and so, again, you don’t get any benefit from the higher payout rate since you have less assets by that time. Joe Tomlinson did point out in the comments at my previous blog entry that this could be counteracted a bit by using shorter term bonds for your bond portfolio.

As well, as Matthew Amster-Burton, Dick Purcell, and others like Boglehead jbaron (at "Rates on annuities") have argued, SPIAs actually become more attractive when interest rates are lower. You don’t buy annuities because they are good investments, you buy them because they provide a guaranteed income for life. This is insurance against living longer than your assets. And you have to compare SPIAs to the alternatives. A bond portfolio will also have more measly returns when interest rates are low. That is basically the alternative for an inflation-adjusted annuity. With low rates, the mortality credit component of the annuity payout becomes even more important, making annuities even more attractive relative to the alternatives like a bond ladder, etc. Another way to say it is, annuities are hurt less by low interest rates than alternative portfolio choices.

So don’t compare annuities to what might have been if interest rates had been higher, compare them to what is possible and available now. Now we are stuck with low rates. Trying to wait for rates to increase is going to eat away at your assets in the mean time, and there is nothing you can really gain from the effort. Low interest rates strengthen, not weaken, the case for purchasing a SPIA.

More generally, should I wait to buy an annuity?

I will now provide another figure which I think explains a lot of the reasoning behind why some argue that it is good to wait as long as possible to buy an annuity. This chart varies annuity payouts by age of purchase, rather than by interest rate. It is made assuming a 1% real yield. Again, these are inflation-adjusted annuities with the same assumptions as before:

As you can see, the longer you wait, the higher is your annuity payout rate. It really starts accelerating in one’s 70s, because that is when mortality rates start picking up and survival rates drop more quickly. Remaining life expectancies start dropping quickly, and so as you do make it longer, you can get a higher payout by waiting to make the annuity purchase.

But this is not the whole story. For one thing, though the payout rate is higher, you have less time to collect. The life expectancy is getting shorter. That is the big reason why the payout is bigger. There really isn’t anything to be gained in that particular regard.

Another important point made by Dick Purcell is that you may not want to wait too long to make complicated financial decisions like this, because cognitive abilities decline as one ages and it could be easier for one to be swindled by some unscrupulous salesman selling some other type of annuity (not a SPIA) with all sorts of punishing fees.

One other issue is that as you wait longer for the higher payout, you end up using your other assets in the mean time. Boglehead dpbsmith argues that by waiting, you miss out on some mortality credits (though they are quite small before one’s 70s) and so you probably won’t gain from waiting. I’d like to run some further simulations about this point one of these days. It sounds like a good research topic.

And then again, there are valid reasons to hold off buying an annuity, or at least to stagger one’s purchases by purchasing small SPIA chunks over time. Boglehead bobcat2 provided some reasons, such as the possibility that interest rates could increase (though I argued against this reason above), the possibility that one could be run over by a bus the day after buying the annuity, the opportunity to spread annuity purchases across insurance companies to reduce the impacts of a company failure and to help keep annuity purchase amounts under state guarantee limits, and the opportunity to maintain more flexibility and control over ones assets.

In this regard, it does seem quite reasonable to me for one to make multiple annuity purchases over rather than buying all at once. This is probably a case where valid arguments can be made for both sides and there is no one-size-fits-all answer.

Of course another important point to emphasize is that it is probably very rare that the best course of action would be to annuitize all of one’s assets. I’m mostly talking about partial annuitization here.

One other possibility worth mentioning is a deferred annuity. That is, someone aged 65, for instance, who purchases an annuity now which doesn’t begin payments until a later date. This is different from what I discussed previously when someone just waits until later to buy the annuity. The following chart is purely hypothetical since inflation-adjusted deferred annuities don’t exist yet. It is too hard for insurance companies to hedge the long-term inflation risk. But buying an annuity now which doesn’t begin payments until a later date gives a higher payout than waiting to buy the annuity at that date. The difference is just the probability of living that long. You get a lower price today because you may not make it until the time that annuity payments begin. I recently discussed the strategy of combining a TIPS ladder with a nominal deferred annuity as well.

Appendix 1: Formulas for calculating annuity payout rates

The Actuarial Present Value (APV) for an inflation-adjusted SPIA is:

where SURV_t is the probability of still being alive to age t, conditional on having made it to the age in which the annuity was purchased (separated by gender), and r is the expected real return for the annuity company’s investments, which I am representing here as fixed over time at the value of current long-term real interest rates (such as the yield on 30-year TIPS).

When a deferred annuity is purchased (such as a 65 year old purchasing an annuity which begins payments at 85), then I replace SURV with zeros for the years that no annuity payments are made.

The Annuity Payout Rate is then:

where annuitized assets for the charts is $100, and overhead is the overhead charge in decimal form.

Appendix 2: About the Overhead Charge

Insurance companies are businesses. They need to meet their business expenses as well as make a profit. Besides this, there are a couple reasons that they can’t just offer annuities priced using the 2007 Social Security Administration Period Life Tables. First, mortality rates can be expected to improve in the future as they have in the past. For instance, the figure below shows that single-year mortality rates for 75-year old males dropped from about 9% to 5% during the 20^th century:

So people who are 65 today will probably have lower mortality rates when they turn 75 than the 75-year olds in 2007. The insurance companies must adjust for that, though perhaps if they have a life insurance business too then the two business components might hedge one another. But also, insurance companies must deal with adverse selection. That is, the people who buy annuities tend to know they are in good health (people with terminal illnesses have no particular reason to buy an annuity) and may expect to live longer than the average person. Insurance companies must also adjust for this.

John Greaney at the Retire Early homepage has an interesting analysis of these SPIA charges. He compared annuity rates from the Principal Group with actuarially fair annuity rates and found that compared to population averages, it seems that Principal charged an overhead cost to account for all the above factors of about 22-29%. Allowing for corrections for adverse selection (which annuity companies don’t get to keep and it isn’t really a cost for you either… if you expect you might live longer than average then you would need to be making adjustments for this no matter what retirement income strategy you choose), he finds the costs were 9-16%.

I too had played around with those Principal numbers as a way to try to calibrate my annuity pricing program to annuity prices in the real world. I was generally using 10-year Treasury bond yields (compared to higher yielding corporate bonds like John used), and I was usually finding that an overhead charge of 15-20% (compared to John’s 22-29%) would get me a matching annuity price. I’m not sure whether it is better to use Treasury bond yields or corporate bond yields, but at least here is a range of possible overhead charges.

This was a calibration exercise for me to match my results to some existing numbers, and I used 15.5% here because it happens to be the overhead charge that gave me a match for whatever was the last example I had looked at. That is the charge taken by the insurance company when they sell the SPIA, relative to the actuarially fair numbers. John is much more critical about these charges than I am and makes good points about corporate greed and excess, but I think that SPIAs are more transparent and understandable than many of the other types of annuities out there. If you want a guaranteed income for life in addition to the best deal out there (which is waiting to 70 to start Social Security), then you must understand that you’ve got to pay something for it. SPIAs seemingly provide the best possible actual option available.

Annuities and Delayed Social Security

2012-02-11T00:11:00.000+09:00

Today I’d like to feature Joe Tomlinson’s February 7th column for Advisor Perspectives, “An Innovative Solution to Retirement Income.”

He looks at two strategies which deserve more attention than they get: single premium immediate annuities (SPIAs) and delaying Social Security until age 70.

Though you must give up control of your assets, he notes that the current quotes for inflation-adjusted SPIAs are $446.95 per month for a $100,000 payment. That works out to $5,363 per year. That means you are locking in a 5.36% inflation-adjusted withdrawal rate for life. You’ve got to compare that with the alternatives for a systematic withdrawal plan based on safe withdrawal rates research. There’s the 4% rule, but if you think that is optimistic, you may be thinking more in terms of 3% or 3.5%. In this case, it may really make sense to consider some partial annuitization (no one says you have to annuitize everything).

Annuities may sound too good to be true, but very simply the reason that they work is because the insurance company can pay you assuming that you will live to your life expectancy. That is because they can average the uncertain lifetimes of individuals across a very large group of customers. Sorry for the crassness of this sentence, but those who die sooner end up subsidizing those who live longer. If you are planning only for yourself (and/or spouse), you sort of need to assume that you will live quite a bit longer than your life expectancy (you have a 50% chance of living longer than your life expectancy) in order to make sure you don’t run out of funds. That means you should be withdrawing less than possible if you knew exactly when the end would come. The insurance company can take advantage of these averages (their average customer will live to the expectancy, at least after making adjustments for the fact that there is some self-selection so that annuity buyers end up living longer than the general population) to be able to pay you more.

About the issue of whether it is a good idea to buy annuities when interest rates are low, I did make a figure which I hope can contribute something. I wrote a program to calculate annuity payouts. Insurance companies certainly use more sophisticated mortality data than me (I’m just using Social Security mortality data) and they also have more complicated ways to deal with investment returns (I just assume an interest rate) and that may mean the level of the line in this figure is not right. Perhaps it should be shifted up or down. But I do think the slope is basically okay. And so it shows you how the annuity payout relates to the interest rate. Again, these numbers may not be super accurate, so while I show that a 0% interest rate has an annuity payout of 5% and a 4% interest rate has an annuity payout of 7%, what is important is that the payout of an annuity is 40% higher when the interest rate is 4% than when it is 0%. I think this can give some idea about the tradeoffs with buying an annuity now or with waiting (and hoping) that interest rates increase before buying an annuity:

Actually, I made that figure while on a business trip to Boston in October. I saved the figure then, but later I had some computer problems and lost the computer code for making it. So I can't remember all the assumptions I used in that figure. I think it is an inflation adjusted annuity, perhaps for a 65 year old male. There might be an overhead cost built in. But I'm not sure. This is something I will come back to again with more clear explanations at some future time once I re-program it.

Meanwhile, the other important issue Joe discusses is the financial benefits from delaying Social Security. It reminds me of a chart I made once for an article, but never ended up using. This was based on a large sample of Social Security recipients in 2004. For these recipients of retirement benefits, I looked at everyone’s initial age for benefit receipt. The distribution looked like this:

Half of the recipients began at the earliest possible age of 62. Only about 3% of recipients began at age 66 or higher. Joe explains why it makes a lot of financial sense to delay receipt to age 70. It’s a great deal, the best inflation-adjusted annuity that money can buy. Yet people just don’t seem to be willing to do it.

Finally, he also discusses an innovative plan that would call for the government to make inflation-adjusted annuities available through Social Security offices.

Definitely have a look at his column for more about these helpful strategies.

If you are interested in annuities, Bob Seawright also recently wrote a very good column called “The Annuity Puzzle” for Research magazine. Mike Piper at the Oblivious Investor also wrote a good column about annuities in low-interest rate environments. Also make sure to read the set of comments started off with a good point made by Matthew Amster-Burton about how annuities could be even more attractive in low interest rate environments.

Finally, I was part of a student fieldtrip to Kyoto when it happened and then forgot to mention it, but I would like to thank the Finance Buff for making my blog into his “blog of the week” last week. As I owned a copy of his highly worthwhile book, Explore TIPS, before I knew about his online presence, it is a nice honor for me.

Harvesting Gains from a TIPS ladder

2012-02-08T12:36:00.000+09:00

I received this question as a comment to a past blog entry:

Very interesting discussion. One of the assets you mention for constructing the "floor" is a ladder of TIPS. A question about that:

What do you do when the TIPS you are holding increase significantly in value, as they would have done in 2011 for no particular reason (certainly not inflation)? Do you continue to hold them till maturity, or do you do something to harvest your good fortune?

Charlie B

Here is my answer (and please feel free to add comments):

Let me preface this with: I am not a financial planner, so this is just my opinion, and also you may have some unique circumstances which call for another answer...

But generally, I would advise against trying to harvest gains from your bond ladder.

You must have created a TIPS bond ladder because you wanted to safely protect a floor of spending.

By selling it off and not keeping it until maturity, you expose yourself to risk. If you sell and interest rates go up, then you will benefit from the move. But if you sell and interest rates go down, then you will lose from the move. That's because, you still want to protect your income floor, and rebuying the bond ladder after further interest rate declines will become even more expensive and you will be ensured a reduction to your future spending.

I think TIPS yields are just as likely to continue going down, as to go up. That's not a prediction, I'm just saying I wouldn't be surprised if TIPS yields continue decreasing. I wrote about this in a column at Advisor Perspectives:

Are TIPS Really Safe and Worry-Free?

When you talk about harvesting gains, you still have to buy something. TIPS have gained, but likewise any other fixed income product that you might switch to will also be rather expensive, so you don't get any particular benefit from the move.

You are just adding risk when you don't need to.

You were specifically talking about a TIPS ladder. If you own a TIPS mutual fund and it has grown to represent a higher percentage of your assets than you desired to have, then rebalancing some by selling some of the TIPS fund is no problem. But I don't think you were talking about this.

The Trinity Study and Portfolio Success Rates

2012-02-08T11:24:00.000+09:00

The other main retirement planning study from the 1990s to enter the retirement research canon came four years after William Bengen’s initial work. The Trinity Study, a nickname for the article, “Retirement Spending: Choosing a Sustainable Withdrawal Rate,” by Philip L. Cooley, Carl M. Hubbard, and Daniel T. Walz (all professors at Trinity University in Texas), appeared in the February 1998 issue of the Journal of the American Association of Individual Investors. The innovation introduced in the Trinity study is ‘portfolio success rates.’ The authors updated their findings from time to time, most recently in the article, “Portfolio Success Rates: Where to Draw the Line” from the April 2011 Journal of Financial Planning.

Before proceeding any further, something must be clear. I will be discussing many different studies, each of which tends to come up with slightly different numbers. This is simply because they use different data sources or make different assumptions.

The only difference in assumptions between William Bengen’s work and the Trinity study regards the choice of bond indices. While Mr. Bengen’s original research combined the S&P 500 index with 5-year intermediate term government bond returns, the Trinity Study used long-term high-grade corporate bond returns instead. The different choice for bonds explains why the worst-case scenario for Mr. Bengen (his SAFEMAX) was a withdrawal rate of 4.15%, but why the original Trinity Study found that a 4% withdrawal rate only had a 95% success rate (with more volatile corporate bonds, the sustainable withdrawal rate dipped below 4% in 1965 and 1966).

Since keeping volatility low is just as important as obtaining high returns, I do think it makes more sense to use intermediate term government bonds than to use corporate bonds. So my re-creation here will follow Mr. Bengen’s choice and will also include the assumption that withdrawals are made at the start of the year rather than the end of the year.

William Bengen’s research gave us the SAFEMAX, which he defined as the highest sustainable withdrawal rate in the worst-case scenario from rolling periods of the historical data. The Trinity Study went a step further by tallying up the percentage of times that withdrawal rates fell below or above certain lines.

They calculated these portfolio success rates for different withdrawal rates (between 3 and 12 percent, both on a fixed and inflation-adjusted basis) and for different time horizons (15, 20, 25, and 30 years) and for different asset allocations (stock allocations of 100, 75, 50, 25, and 0 percent large-capitalization stocks, with the remainder in high-grade long-term corporate bonds).

To understand what they did, again consider Figure 2.1:

What is the success rate for a 5% inflation-adjusted withdrawal rate over a 30-year period with a 50/50 asset allocation? Well, there are 56 rolling 30-year periods starting between 1926 and 2010. These rolling 30-year periods begin in the years 1926 through 1981. Nothing is known yet for the 30-year results of more recent starting periods. Of these 56 rolling periods, we can count up in Figure 2.1 the number of times that the withdrawal rate is above 5%. It is 37 times. That means the portfolio success rate is 100 x 37 / 56 = 66%. I’ve highlighted that number in yellow in the following Table 2.1, which shows the results for many other cases as well. And that is the Trinity Study. I’m not sure how particularly useful this table is for planning future retirements (more on that later), but enjoy looking at Table 2.1 nonetheless:

William Bengen's SAFEMAX

2012-02-07T10:33:00.001+09:00

If the long-term average real return from the stock market is 7%, does that mean one can safely use a 7% withdrawal rate from a 100% stocks portfolio without worrying about running out of wealth or even dipping into the original principal? The answer is No. But answering yes is a common mistake; one which William Bengen set out to dispel.

Stocks do not earn their average real return each year. Some years they go up, and some years they go down. For a retiree who is withdrawing from their savings, the sequence of returns matters. If the market value of one’s assets falls in the early retirement period, then withdrawals will dig a further hole. Climbing out of this hole becomes increasingly difficult even if a subsequent recovery arrives. This is the sequence of returns risk.

William Bengen’s seminal study in the October 1994 Journal of Financial Planning, “Determining Withdrawal Rates Using Historical Data,” helped usher in the modern area of retirement withdrawal rate research by codifying the importance of sequence of returns risk. The problem he set up is simple: a new retiree makes plans for withdrawing some inflation-adjusted amount from their savings at the end of each year for a 30-year retirement period. What is the highest withdrawal amount as a percentage of retirement date assets that with inflation adjustments will be sustainable for the full 30 years?

To answer this question, he obtained a copy of Ibbotson Associates’ Stocks, Bonds, Bills, and Inflation yearbook, which provides monthly data for a variety of U.S. asset classes and inflation since January 1926. He decided to investigate using the S&P 500 index to represent the stock market and intermediate-term government bonds to represent the bond market.

His exceedingly clever trick was to construct rolling 30-year periods from this data. He could consider a retirement lasting from 1926 through 1955, then 1927 through 1956, and so on. This technique is called ‘historical simulations.’ For each rolling historical period, he could calculate the maximum sustainable withdrawal rate. Though he did not produce the following illustration for his article, what he would have been looking at in his spreadsheet is something like this:

To bring greater realism to the discussion of safe withdrawal rates in retirement, he then focused his attention on what he called the SAFEMAX. It is simply the highest sustainable withdrawal rate for the worst-case retirement scenario in the historical period. With a 50/50 allocation for stocks and bonds, the SAFEMAX was 4.15%, and it occurred in 1966. That is the impact of sequence of returns risk. 4% turned out to be a much more realistic number than 7%. It was from these humble origins that the world of financial planning received the 4% rule.

[Note: I am following the same assumptions as in Mr. Bengen’s original research, except that I deduct withdrawals at the start of each year rather than the end of each year. I do think this is more realistic, and since it results in less time for assets to grow, withdrawal rates are slightly less with this assumption. My SAFEMAX is 4.04%.]

One other important issue coming out of William Bengen’s original study is asset allocation. In particular, Mr. Bengen recommended that retirees maintain a stock allocation of 50-75%. More specifically, he wrote, “I think it is appropriate to advise the client to accept a stock allocation as close to 75 percent as possible, and in no cases less than 50 percent.”

I will have a lot more to say about asset allocation (as well as about the 4% rule), and this stock allocation does sound rather high with respect to what we usually hear is reasonable for retirees. It is particularly poisonous to the ears of advocates of a safety-first retirement planning approach such as Zvi Bodie. But for now, let’s understand from where the 50-75% stock allocation recommendation comes.

One starting point to think about this is to consider Figure 2.2, which shows the time path of maximum sustainable withdrawal rates for different asset allocations. It’s hard to see exactly what is going on in the 1960s, but the general idea is that higher stock allocations tended to support higher withdrawal rates with little in the way of downside risk. I mean, the SAFEMAX does not appear to be that much lower with higher stock allocations.

This point can be seen more clearly in Figure 2.3, which shows the SAFEMAX across the range of stock allocations. Low stock allocations resulted in lower SAFEMAXs, with an all-bonds portfolio even falling below a 2.5% SAFEMAX, but there appears to be a sweet spot between about 35% stocks and 80% stocks in which higher stock allocations have no discernable impact on the SAFEMAX. A 4% withdrawal rate tended to work no matter what stock allocation is chosen in this range. On the downside, retirees would have been just as well off with 80% stocks as with 35% stocks.

So why then did William Bengen recommend 50-75% stocks? The answer lies in Figure 2.4, which shows the median remaining real wealth after 30 years as a multiple of retirement date wealth. In this figure, we can see a general upward trajectory in remaining wealth as the stock allocation increases. In the average case, retirees using at least 45% stocks would have found that their entire initial principal had remained intact, even after adjusting with inflation! And with higher stock allocations, wealth tended to continue to grow more and more in the average case. So while Figure 2.3 showed that there was little in the way of downside with higher stock allocations, Figure 2.4 shows that there was a whole lot of upside available with higher stock allocations. This is the source of Mr. Bengen’s recommendation.

Finally, one other way to look at this is found in Figure 2.5. For different stock allocations, I plot not only the SAFEMAX, but also the median sustainable withdrawal rate and the best-case scenario sustainable withdrawal rate. This is another way to see the same point: with higher stock allocations, sustainable withdrawal rates tended to rise, but even the worst-case scenario held their ground even with a more volatile stock allocation.

Safe Retirement Income with TIPS and a deferred annuity

2012-01-26T11:46:00.001+09:00

Coincidentally, a message I've been seeing repeatedly from many sources during the past week is the reminder that a strategy of using a bond ladder to provide one's retirement income is still exposed to longevity risk. That is, using TIPS to provide retirement income needs over 30 years may have a very low failure rate, for instance, but with principal exhausted after 30 years the failure rate jumps up to 100% should you happen to live into a 31st year past retirement.

In the new January/February 2012 issue of the Financial Analysts Journal (the research journal for the CFA Institute), authors Stephen C. Sexauer, Michael W. Peskin, and Danield Cassidy propose a solution of building a TIPS ladder for 20 years and buying a deferred annuity which kicks in after 20 years to provide income for the rest of one's life. Their article is called, "Making Retirement Income Last a Lifetime."

Before getting to the substance of the article, just a brief note that this article would have surely not been published had someone along the line (authors, referees, editor) done a bit of homework. First, it is rather odd that this article has the same title as one of the most famous studies on sustainable retirement spending, the December 2001 article by John Ameriks Robert Veres and Mark Warshawsky in the Journal of Financial Planning. Second, the message and contents of this new article are nearly identical to S. Gowri Shankar's article, "A new strategy to guarantee retirement income using TIPS and longevity insurance" from a 2009 issue of Financial Services Review. In a number of ways, Professor Shankar's article is actually superior for a do-it-yourself retiree as it explains more detail about how to construct the TIPS bond ladder, and separately the article provides details about how a financial company may go about packaging and selling this product. The only difference for the new article is that it talks about making this strategy the benchmark whereby to consider alternative strategies. The numbers in each article are also a bit different because Prof. Shankar assumes the strategy is implemented in April 2008, whereas Sexauer et al. assume an implementation date of September 2010.

That being said, what is the strategy being discussed, and is it a good idea?

The other day I included this picture at my blog:

Both articles start with a premise that inflation-adjusted annuities (SPIAs) will be non-starters for most people. Retirees seem to just not want to give up control of their assets for the purposes of getting a guaranteed income.

So the objective of the articles becomes: how can you get guaranteed income with as little annuity as possible? Also, both articles look for strategies which are much safer than the diversified portfolios of classic safe withdrawal rate studies. As Sexauer et al. say in a footnote, "we do not want to minimize the probability of shortfall -- we want to eliminate it."

In looking for alternatives, these articles move us into the center circle of my diagram: less inflation protection, but more control over assets. At the September 2010 prices, Sexauer et al. determine that a 65 year old retiree could spend 12% of their assets to purchase a deferred annuity, and then use the other 88% of assets to construct a bond ladder of TIPS to provide precisely 20 years of inflation-protected withdrawals. Anyone then living past 20 years would have no assets to bequest because they've spent the 88% of their wealth already and the deferred annuity represents a non-refundable payment. Sexauer et al. determine that this would support a safe real withdrawal rate of 5.118% over the first 20 years of retirement. Things get more dicey after that.

This is a viable strategy to be considered by retirees. I'm not so convinced that this strategy is going to be better for most people than using inflation-adjusted immediate annuities instead. I'm getting closer to the point where I am going to be able to make a detailed comparison between different strategies, and so I don't know the answer yet, but I wonder if something like using 50% of assets for an inflation-adjusted annuity and using 50% of assets in a diversified portfolio may be able to provide more satisfying outcomes for many retirees while still leaving sufficient control over assets to satisfy that aspect of the issue.

Though I think it is a viable strategy, as you consider retirement income let me just provide what I think are two important concerns for this particular strategy that you should consider:

1. Extending from the comment made by my wise friend Bob Seawright about my above illustration, this particular strategy really is only providing an illusion of control over those assets used to purchase the TIPS ladder. It is true that if you die early, the remaining assets can be left to an heir. But you don't exactly have all that much control over potential emergency needs to increase spending in one year. You can spend more in an emergency, but the way the TIPS ladder is constructed, it means you are spending what you needed in the future and you are going to have a gap of lower spending until you hit the 21st year when the deferred annuity kicks in. The TIPS ladder is constructed to exhaust your portfolio after 20 years. You could construct it differently to have more wealth left at the 20 year point for emergencies, but this would obviously lower the withdrawal rate you are able to use.

2. There are two problems with the deferred annuity both related to the fact that it is a nominal annuity. The amount of deferred annuity you buy is such that you are "expected" to have a smooth real income flow from year 20 to year 21. Both articles calculate this using the breakeven inflation rate implied by the difference in yields for 20-year nominal and TIPS bonds. For Sexauer et al, the assumed 20-year average inflation rate is only 1.91%. To the extent that the actual average inflation rate over those 20 years may be more or less than that, the amount of spending you get with the deferred annuity is really unclear. For instance, if inflation follows its historical average of 3% over those 20 years, instead of 1.91%, then your spending power will drop by almost 20% in the year that the deferred annuity kicks in. This is a risk you must be aware of. The other problem with the deferred annuity is that it is a nominal annuity, so it's real value will continue declining after the 21st year of there is inflation.

And that's my take on this particular retirement income strategy.

Update: Readers interested in this approach should also see the Michael Edesess review of a similar PIMCO-Met Life retirement income product at Advisor Perspectives.

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A blog reader requested that I share a link to an article, "10 Reasons You Really Need a Will." That's something I need to learn more about myself.

From the mailbag

2012-01-23T23:43:00.001+09:00

A reader writes:

I just found your blog and as an individual investor am really appreciating your perspective. I've been looking for personal finance information grounded in data and peer reviewed academic literature. I am glad I found your site. A couple of questions...

Thank you. Your description of my blog makes me quite happy, as "personal finance information grounded in data and peer reviewed academic literature" is really a good description of what I am trying to do.

1) Has there been a version of the Trinity Study that looked at a more broadly diversified portfolio (domestic large, domestic small, international large, international small, EM, REITs, Commodities, and varying fixed income products)?

No, not that I am aware of. There have been studies adding small caps to the round up of usual suspects (large cap stocks, bonds, sometimes bills). And there have been studies which add international large cap stocks to the usual suspects too. But nothing coming anywhere near close to your long list of asset classes. For the Trinity Study style historical simulations approach, this would basically be impossible, as there isn't enough data to do it effectively. Monte Carlo would be the only option.

But this gets to an important point. It isn't really what happened in that past that matters so much as what will happen in the future. Especially for something like EM, past may really not be prologue.

The question you ask, though, is exactly what I was seeking to provide a framework to answer in my article "Capital Market Expectations, Asset Allocation, and Safe Withdrawal Rates" from the January 2012 Journal of Financial Planning. You've got at least 8 asset classes there. I explain an approach to figure out what you might expect given your assumptions about those asset classes.

For anyone reading, if you put together a table of numbers like what you see in my Table 4 from the article for as many asset classes as you wish, and you also specify an acceptable failure probability and a desired retirement length (10,15,20,25,30,35, or 40 years), then I can produce an equivalent of the Figure 3 for you and let you know the sustainable withdrawal rate and optimal asset allocation.

This really has to be customized to each individual as there is no universal agreement on what all those asset classes will do or on how they relate to each other.

2) Have you written about how someone can develop a plan to implement the floor/upside approach when in the accumulation stages (30+ years till retirement)? There seems to be several people who are advocating saving less for retirement and smooth out consumption across a lifetime and not delay gratification to the point you won't be able to enjoy the money you have saved. With that context it seems hard to nail down what the "number" you to need with the income stream you get from annuitizing, so dependent on current interest rates. Currently I've just used the initial 4% withdrawal based on projected spending and an assumed inflation rate. I know there are quite a few assumptions involved with this approach, but spending and inflation seem less sensitive than interests rates and the subsequent annuitized income.

It sounds from your question like you are already familiar with the work of Laurence Kotlikoff. If not, please check Spend 'til the End by him and Scott Burns. The book describes his ESPlanner software.

I do think I have something of my own to add to the answer as well. I have not gotten to the point where I can do anything nearly as sophisticated as ESPlanner, but please see my article, "Safe Savings Rates: A New Approach to Retirement Planning over the Life Cycle" from the May 2011 Journal of Financial Planning. Be aware, though, that this article branches off from the safe withdrawal rate literature rather than the floor/upside literature.

When you are far away from retirement, I agree that it can be fine to plan in terms of a 4% withdrawal rate, but I think an even better approach for young people far away from retirement is to focus on the savings rates instead of withdrawal rates. I agree that it is very hard to focus on "The Number".

However, it does seem that you have an entirely different reason for why it is hard to know your number, because you want to annuitize and don't know what the interest rate will be at retirement. That is a slightly different issue, since my article doesn't include annuities. One way to deal with the specific interest rate problem for annuities is that as you get closer to retirement you can start phasing in multiple annuity purchases over time. This doesn't completely fix the problem, but it does hopefully lessen it a bit.

As your question is rightly pointing out, when you are still in the accumulation phase, you still have trouble to know it is going to be needed at some distant future date to establish your floor. There may be some other sophisticated financial engineering techniques that may help, but generally I think this is a difficult problem with no easy solution.

Game Over

2012-01-20T11:25:00.000+09:00

I am clearly copying Carl Richards' gimmick at The Behavior Gap. I hope he thinks that imitation is the sincerest form of flattery. Here is the story...

Before retirement, the focus is usually on investment returns within what is reasonable with regard to one's willingness and ability to take risk. Meeting specific goals should be better integrated, so that the investment strategy doesn't take more risk than necessary. But at the end, the focus is on returns.

After retirement, maximizing returns need to longer matter so much. Retirees want to ensure that they have a steady stream of income for as long as they may live. Whereas before retirement one has more chance to recover from a market drop, such that a high returns / high volatility strategy may be more feasible, recovering from a market drop can be much more difficult after retirement. High portfolio volatility can be just as much of a concern as low portfolio returns. More volatility increases the chance that your portfolio hits zero. Then, it's game over! Once your wealth runs dry, there is no reset button (I hope video game analogies are not lost upon prospective retirees).

A low returns / low volatility strategy may not really be so bad for retirees. Certainly, the recommendations for 50-75% stocks coming from the early safe withdrawal rate studies need not be heeded [that is partly an artifact of the overweighting of the prolonged bear market for bonds between the 1950s and 1980]. This is one of the themes explored in my article from the January 2012 Journal of Financial Planning, "Capital Market Expectations, Asset Allocation, and Safe Withdrawal Rates."

Special Report: Retirement Income Planning (December 2011 JFP)

2012-01-19T17:15:00.000+09:00

In December 2011, the Journal of Financial Planning included the section, Special Report: Retirement Income Planning. I'd just like to make a few notes/observations about it.

From Jonathan Guyton's article, it is interesting to learn that 74.8% of surveyed planners either always or frequently use systematic withdrawal plans. The alternatives are time diversification or buckets (37.6% either always or frequently use) and the floor/upside approach (32.8% is the corresponding number for it).

Guyton's column is one of the first times I've seen someone sort of actually criticize the floor/upside approach, or at least suggest that systematic withdrawals may be superior to it. He suggests that for most retirees there is not really such an obvious distinction between necessary and discretionary expenses. The survey indicates as well that planners using systematic withdrawals were more likely to have clients not need to make any significant changes to their plans, relative to the other approaches. He writes, "the systematic withdrawal method for generating sustainable income has been much more effective in helping clients maintain their retirement lifestyles than either the time-based segmentation or essential-versus discretionary approaches."

He also suggests that dynamic withdrawal policies that respond to market conditions such as outlined in his earlier research articles are more popular (by a 2 to 1 margin) that the baseline assumption of early withdrawal rate studies that retirees use either fixed real or nominal withdrawals.

Finally, there is an interesting table showing that the mean initial sustainable withdrawal rate recommended by financial planners is 4.17%. Since many of these planners are using dynamic or variable withdrawal strategies, the safe withdrawal rate should be a bit higher than maintaining a fixed inflation-adjusted withdrawal no matter what. That was the point of Guyton's earlier research articles.

Next, Carly Schulaka's column includes an interesting point about what sorts of retirement income products would be helpful for retirement planning. Popular answers include an automated buckets approach, more transparent and affordable annuities, and more innovations for long-term care insurance and annuities. Those all look like good research topics.

Next, Cheryl Krueger's column makes the basic but important point that people need to plan for living longer than their life expectancy. You have a 50% chance of living longer than your life expectancy, and as you get older, your remaining life expectancy also increases. She talks about the "planning age" to use in making projections for retirement planning. For instance, I used an age of 100 in my "Getting on Track for a Sustainable Retirement: A Reality Check on Savings and Work" article. She does make a good point that I already know, which is that at some point I need to switch from using the Social Security Administration mortality data to data that accounts for future life expectancy increases and for the fact that people actually making plans for their retirement will tend to live longer than the average person.

Next, Matthew Greenwald provides an introductory article about the challenges of retirement planning related to longer lifespans and fewer sources of guaranteed income. He covers the various risks facing retirees.

Not part of the Report, but Betty Meridith also has an interesting column about retirement planning for the less well-to-do. She shows the sources of income for Americans aged 65 and older in 2008 as reported by the Social Security Administration. Only 12.7% of the income for this group comes from financial assets. These are averages across everybody. That reminds me, in Table 1 of an article I have in the National Tax Journal from 2006 based on the same data source (see page 26 of the pdf file / page 24 of the article), I looked at these income sources broken down by 10 different ratios of income to the poverty level. Income from assets really isn't a particularly important income source for most retirees across the income distribution. Safe withdrawal rates are not all that relevant for a lot of people, it seems. For many Americans, the best strategies may be to consider delaying Social Security and increasing annuitized income sources. She expresses three concerns from a report by the Government Accountability Office (GAO): older Americans may be at risk as they are too dependent on employment income, they are starting Social Security earlier than optimal, and they are decreasing their stock holdings too much.

On the last point about stock holdings, my article in the January JFP does suggest that lower stock allocations may not be so bad afterall for retirees, as long as they got there in a systematic way and didn't sell off in a panic after the 2008 market drop.

Finally, FPA members can access a report by Zach Parker and Paul Lofties called, "Capturing the Income-Distribution Opportunity: A Historical Analysis of Distribution Philosophies and a Solution for Today." Actually, this is an important paper. I know it better in its published form from the Spring 2011 Retirement Management Journal as winner of their first thought leadership award. I'm not sure if there is any version of this paper out there that is not locked behind a paywall. But I think the article is sufficiently important that I would like to discuss more in a separate blog entry.

That's all for now.

Guarantees vs. Control

2012-01-18T10:19:00.001+09:00

Glenn Ruffenach wrote an article for the new issue of SmartMoney Magazine called, "Is the 4 Percent Rule Viable?"

I think the answer is that it depends on your perspective. And I do think the article provides some pretty sensible advice. It didn't get too much into the nitty gritty of why my 1.8% number is not really incompatible with the Williams and Finke 7% number. For more details on that, it is basically what I was talking about here on Monday, and Doug Nordman also has a great explanation, "Is the 4% Withdrawal Rate Really Safe?"

One other brief matter. Perhaps taking inspiration from Carl Richards' The Behavior Gap (though he is much better at it), on the train ride to work today, I drew this:

It seems like retirement income strategies boil down to where you want to fall on the spectrum between having control of your assets and have guaranteed (inflation-adjusted) protections for life. More research should focus on the potential spending power and the cost-effectiveness of the different strategies on the frontier for these competing tradeoffs.

On the Pros and Cons of GLWBs

2012-01-17T12:07:00.001+09:00

Guaranteed Lifetime Withdrawal Benefit (GLWB) riders, also known as Guaranteed Minimum Withdrawal Benefit (GMWB) riders, provide a seemingly attractive offer for retirees: they protect on the downside with a guaranteed income for life, they include upside potential with step-up features for growing markets, and they are contracts which can be ended with remaining assets returned.

I recently explored the performance of GLWBs compared to systematic withdrawals from one’s savings using US historical data in the column, “GLWBs: Retiree Protection or Money Illusion?” at Advisor Perspectives. Subsequently, Bob Powell included an interview with me in a column he wrote for MarketWatch, “Variable-annuity guarantees disappoint over time.” After reading some harsh criticism in the comments there and at SmartMoney, I do still stand by all the points I made in the interview.

Variable annuities and GLWBs are controversial. Some observers are set dead against them, while others think much more highly about their potential. In my initial column, my conclusions tended a little bit toward the anti-GLWB side.

I am not pushing any agenda and am only trying to determine what potential role GLWBs may have helping retirees to meet their goals. We do need to be careful, because in these trying and volatile financial markets, we might be too eager to grasp onto something offering assurances that might really be too good to be true. Skepticism is warranted.

Some of the feedback about my column and the interview suggest that my somewhat negative conclusions were unfair, and that GLWBs really are more useful than I gave credit. Today I’d like to further explore four of the pro-GLWB arguments I’ve been reading.

1. I only considered the rather plain GLWB rider offered by Vanguard. Other GLWB riders offer all sorts of interesting features such as guarantees to double one’s wealth and so on. These alternatives are much better.

This issue is the main reason for writing today. My initial response to this is that while other products may offer more attractive guarantees than Vanguard, they must also certainly be accompanied by much higher fees as well. But this gets to heart of a rather confusing issue for GLWBs.

If two different GLWBs offer the same initial guaranteed withdrawal amounts, it seemingly doesn’t matter what their fees are. Or at least, the role of fees may not be clear for someone who is just starting to learn about GLWBs. But the fees do matter.

Joseph Tomlinson* has written his inaugural monthly column at Advisor Perspectives on this issue. His column is, “Income Annuities versus GLWBs: A Product Comparison.” He argues that the way to assess the impact of fees from a GLWB is to look at the remaining account contract value as time passes. One of the features of GLWBs is that they can be terminated with assets returned. But higher fees will mean less is available to be returned. Fees on the variable annuity and GLWB rider reduce the contract value of the remaining assets, which also reduces the likelihood of the step up features for the upside potential kicking in. Market returns have to be so strong that the account value can still increase despite of the fees eating away at the account value.

To repeat, two GLWBs may offer the same guaranteed initial withdrawals, but if one has higher fees, then the contract value of the remaining assets will be depleted more quickly, which also has the implication that there will be fewer opportunities for upside gains should markets perform well.

Joseph Tomlinson’s new column explores this. He compares systematic withdrawals, Vanguard’s GLWB offering, a cash-refund annuity, and a more typical GLWB product with much higher fees than Vanguard. He estimates the average remaining bequest value in order to make a comparison about the impact of fees for different strategies offering approximately the same payouts. It’s a way to show the cost of the fees in more understandable dollar terms.

What he finds, naturally, is that one can’t really expect to enjoy downside protection along with upside potential. Risk is commensurate with reward. After fees for the guarantee, GLWBs end up behaving more like fixed income than like stocks. The potential for upside growth is constrained by the degree of downside protection. You can’t have your cake and eat it to. There’s no free lunch. You get the point.

2. By guaranteeing income, GLWBs will help their owners to maintain a higher stock allocation and to avoid the mistake of panicking and selling stocks after a market decline.

This is a popular argument from pro-GLWB sources. Essentially, the argument is that people who would otherwise be terrible investors prone to buying high and selling low or who might be permanently scared away from stocks will be suddenly transformed into proper stay-the-course buy-and-hold investors with a healthy dose of stock holdings on account of the GLWB guarantee. Examples of this point can be seen in letters to the editor about my column at Advisor Perspectives here and here.

I’m not sure about this. Especially, GLWBs still have an account balance, and assets can be returned, so people might still be prone to worrying about the account value and making the same mistakes.

What’s more, I’m not sure how one would even go about determining whether this point is true. Even if GLWB users make fewer behavioral mistakes with their asset allocations, we cannot know if that is due to the guarantee, or due to the different psychological make-up of GLWB users. This is called the sample selection problem. We would need a randomized experiment in which some people are randomly required to buy GLWBs and some are not, in order to properly demonstrate whether this point is true. Relying on anecdotal evidence and memories about client behavior is not enough.

This is a question which really requires further data exploration. It may or may not be true, and I would like to know! If anyone reading this does have such data, I’d be quite interested to hear about it and to potentially work with you on some data exploration.

3. Perhaps because future returns may be more gloomy than what we’ve observed in the past, GLWB providers may have been too generous and are now starting to leave the business.

This is certainly an interesting and important point. I do want to explore GLWBs further with simulations that may be more realistic. As I’ve argued many times, US financial market returns in the 20^th century were quite high by international standards, and perhaps higher than we can reasonably expect to see in the future. With more realistic (i.e. lower) return assumptions, GLWBs may come out looking much more attractive from a buyer’s perspective (which is bad news from the seller’s perspective). Of course, if a GLWB is so great that it ends up driving the seller out of business, this is bad news in terms of still getting one’s guaranteed income. But this is an interesting point that I want to explore further in the future.

4. GLWBs can provide their users with comfort and peace of mind, knowing that they have a guaranteed income source no matter how bad things get.

I don’t dispute this (subject to the insurance provider remaining viable). In my interview, this is what I meant which I mentioned that retirees must decide on a personal level whether they value the guarantees more than the fees. This really is a personal decision and I can’t give an answer for anyone. Only you can decide.

One commenter about the interviewer said that this point is stupidly obvious. Yes, it is chapter 1 of principals of economics that you only buy something if you value it more than the price. But the problem with GLWBs is that it is so hard to determine the real world meaning of the price. The benefit of the GLWB is also rather abstract as well.

In that regard, I do think the analysis provided in Joseph Tomlinson’s new column can be very helpful in quantifying the real world impact of the GLWB fees, and so help retirees to decide whether the guarantees are “worth it” for them.

Again, I am not condemning GLWBs. I suppose I am just saying that I would like to see greater transparency about the meaning of the fees so that people can make better decisions about them.

If you are thinking about purchasing a GLWB, make sure to do your homework and understand all of the features and fees.

*I have been getting to know Joseph Tomlinson as we share common interests both in comparing retirement income strategies, as well as in applying utility analysis to retirement income, which looks to find a balance between the safety of lower withdrawal rates and the added life enjoyment of being able to spend more with a higher withdrawal rate. You can find more of his writings at his webpage, and he will also have a research article I recommend checking in the upcoming February issue of the Journal of Financial Planning called, “"A Utility-Based Approach to Evaluating Investment Strategies."

Safe Withdrawal Rates: Have I been barking up the wrong tree?

2012-01-16T11:36:00.001+09:00

As a percentage of retirement date assets, what is the highest amount you can withdraw, while adjusting this amount for inflation in subsequent years, without running out of funds for a sufficiently long period of time?

This is a question plaguing retirees and near-retirees as lifespans and retirements lengthen, and as traditional defined-benefit pensions are falling by the wayside. Since William Bengen’s seminal investigation of the US historical data in his 1994 Journal of Financial Planning article, answers have tended to center around 4%, with perhaps 4-5% being a comfortable range for many retirees and planners.

For retirement planning research, I paid my dues by looking at three different methods (international data comparisons, speed of wealth depletion in the years since retirement, and impact of market valuation and yield measures at the retirement date) which each question whether recent retirees can still consider 4% to be safe over a 30-year horizon despite its historical success for retirements beginning up to 1980.

The question of safe withdrawal rates certainly does matter. My title is overly provocative. A 2011 Financial Planning Association survey described by Jonathan Guyton indicates that 75% of surveyed financial planners either always or frequently use systematic withdrawals with their clients. For them, the safe withdrawal rate is relevant. But my point is that safe withdrawal rates may be less important than I earlier thought.

That’s because for a lot of people involved in the retirement income debate, even when using a well-diversified portfolio of stocks and bonds (which is the recommendation in the safe withdrawal rate literature), the only safe withdrawal rate is 0%. We are deluding ourselves to think otherwise.

An alternative approach to retirement income planning that is gaining traction is the “guaranteed floor / upside potential” approach. With this approach, you first build a floor of very low-risk guaranteed income sources to serve your basic spending needs in retirement. The guaranteed income floor is built with Social Security and any other defined-benefit pensions, and through the use of your financial assets to do things such as building a ladder of TIPS or purchasing single-premium immediate annuities (SPIAs). GLWBs could also play a role here. Not all of these income sources are inflation adjusted, and you do need to make sure your floor is sufficiently protected from inflation, but this is the basic idea.

According to the Retirement Income Industry Association (disclosure: I am on their Academic Advisory Board), a fundamental goal of retirement planning is to “first build a floor, then expose to upside.” This is also the approach Moshe Milevsky has in mind when he recommends that you “pensionize your nest egg” and it is the way that Zvi Bodie suggests you can “risk less and prosper” in retirement.

Once you have a sufficient floor in place, you can focus on upside potential. With any remaining assets, you can invest and spend as you wish. Since this extra spending (such as for nice restaurants, extra vacations, etc.) is discretionary, it won’t be the end of the world if you must stop spending at some point. You still have your guaranteed income floor in place to meet your basic needs no matter what happens. With this sort of approach, withdrawal rates hardly matter. (Another note from the Jonathan Guyton article linked above: he suggests that retirees may not be as blasé as I’ve just made it appear about their abilities to fund even their ‘discretionary’ expenses).

“Safe withdrawal rates” and “guaranteed floor / upside potential” are really two competing approaches to retirement income planning. How can we reconcile them?

I think they can be reconciled by broadening some aspects of safe withdrawal rate studies. First, these studies ask the question about how much can be withdrawn over time from a risky portfolio, and so they do not directly incorporate other income sources such as Social Security, annuities, or pensions. Second, these studies focus on the probability of failure (also called shortfall risk, it is the probability of running out of wealth while still alive), without giving consideration about what is lost in terms of life satisfaction by using a lower withdrawal rate and spending less. The fact that with low withdrawal rates, people will typically leave behind a large pot of wealth (unless their retirement matches the worst-case scenario) is not something included in the analysis.

I have been part of a research effort with Michael Finke and Duncan Williams of Texas Tech University to incorporate the sustainable spending “safe withdrawal rate” framework into the “guaranteed floor / upside potential” framework. We look at safe withdrawal rates after adding other income sources from outside the retirement portfolio (such as Social Security and pensions). We also leave behind the safe withdrawal rate objective of worrying only about a low failure rate (low shortfall risk), and instead try to balance the competing tradeoffs between wanting to spend and enjoy more while one is still alive and healthy, against not wanting to run out of portfolio wealth while still alive (the guaranteed floor will always be in place though). We find that someone with flexibility about how much they can spend and with more outside sources of income may be willing to accept rather high failure rates as a part of balancing these competing tradeoffs.* Life is indeed a balancing act. Our study, “Spending Flexibility and Safe Withdrawal Rates,” can be downloaded now as a working paper, and it has been accepted for publication in an upcoming issue of Journal of Financial Planning.

Moshe Milevsky and Huaxiong Huong earlier produced a related work, and what we think of as “spending flexibility,” they call “longevity risk aversion.” Joseph Tomlinson will also have a paper exploring these sorts of concepts in an upcoming issue of Journal of Financial Planning.

I do have an article on safe withdrawal rates in the current January issue of Journal of Financial Planning. I generalize the framework for safe withdrawal rates to include any assets or assumptions, and it think it can really serve as a final word from me about traditional safe withdrawal rate studies (except, I still want to look at variable withdrawal rates).

But the next generation of studies with a more comprehensive view toward withdrawal rates and retirement income is already on the way.

* This finding puts me in the rather odd position of having first recommended rather low withdrawal rates in earlier research, but now suggesting that much higher withdrawal rates (and chances for failure) may be acceptable in certain circumstances. If you are confused about this, Doug Nordman wrote a nice summary of these two competing viewpoints called, “Is the 4% withdrawal rate really safe?”

Update: just to clarify, when I talk about "safe withdrawal rates," I refer to the classical approach to safe withdrawal rates using a diversified portfolio of stocks and bonds. William Bengen and the Trinity study suggest stock allocations in the neighborhood of 50-75%. So it's a matter of how much can be safely withdrawn from a volatile portfolio. The "floor/upside" approach rejects this sort of view about the matter: volatile portfolios are inherently not safe.

Advisor Perspectives Column 3

2012-01-10T12:14:00.000+09:00

I'm back home in Japan now. On the flight, I read Zvi Bodie and Rachelle Taqqu's new book, Risk Less and Prosper. It's a good and important book that I'm looking forward to writing a full review about when I get a chance in the coming days. It's also pretty short (I miscalculated how long it would take to read and found myself without any more reading material with another 6 hours left in the air).

For now, my third column at Advisor Perspectives is available. It is, "Safe Withdrawal Rates: A Do-It-Yourself Approach." It summarizes my new January article in the Journal of Financial Planning, “Capital Market Expectations, Asset Allocation, and Safe Withdrawal Rates,” but it also includes lots of new material, such as a different example to explain the approach.

I think the Figure 2 in the column (not the full research article) is quite interesting, though I only used it to make a minor point. The figure shows the average (arithmetic) real stock returns and standard deviations for stocks in 19 countries and the GDP-weighted world portfolio between 1900 and 2010. It highlights how good Americans had it. Only Australians enjoyed both higher returns and less volatility. This figure is meant to highlight how difficult it is to develop expectations for future returns. And not only that, but the volatility of future returns is also incredibly important when thinking about safe withdrawal rates.

The column and article are about providing an approach to see how safe withdrawal rates are impacted by different assumptions, so that we it not captive to the historical data averages most commonly used it studies.

Links

2012-01-05T11:30:00.001+09:00

A few articles related to my research have been released in the past few days:

1. A new research article of my own is in the January 2012 Journal of Financial Planning. It is "Capital Market Expectations, Asset Allocation, and Safe Withdrawal Rates." This article doesn't necessarily contain any earth shattering new relevations. But I think that it potentially offers a worthwhile contribution by outlining a framework to get a safe withdrawal rate based on any sorts of asset classes and return assumptions. One no longer needs to be limited by the assumptions used in previous studies.

2. In the same January 2012 Journal of Financial Planning, Harold Evensky reviews retirement planning research from 2011 issues of the JFP. His article is "Retirement Income Research Proved Fruitful in 2011." As he is truly one of the most important thinkers in the financial planning world, I'm relieved and honored that he had a positive assessment of my research.

3. Dan Moisand, another leader in the financial planning field, has written an article for Financial Advisor about getting on track for retirement. His article is, "Why Advisors, Clients Must Battle To Keep Retirement Savings On Track."

New Year's Book Order

2012-01-02T20:39:00.000+09:00

Happy New Year everyone!

Since it seems quite relevant to the purposes of my blog, I thought I'd share the contents of my first book order this year:

"Risk Less and Prosper: Your Guide to Safer Investing"
Bodie, Zvi

"Thinking, Fast and Slow"
Daniel Kahneman

"The Quest for Alpha: The Holy Grail of Investing (Bloomberg)"
Larry E. Swedroe

"Can I Retire?: How Much Money You Need to Retire and How to Manage Your Retirement Savings, Explained in 100 Pages or Less"
Mike Piper

"Investment Mistakes Even Smart Investors Make and How to Avoid Them"
Larry Swedroe

"The Behavior Gap: Simple Ways to Stop Doing Dumb Things with Money"
Carl Richards

"The Only Guide You'll Ever Need for the Right Financial Plan: Managing Your Wealth, Risk, and Investments (Bloomberg)"
Larry E. Swedroe

"The Tyranny of Compounding Fees: Are Mutual Funds Bleeding Retirement Accounts Dry?"

2011-12-29T21:56:00.000+09:00

With the William Bengen interview, the new Michael Kitces et al. article, and the Special Report on Retirement Income Planning, the December 2011 Journal of Financial Planning is filled with many interesting articles. There is another nice article too that was lost in the initial shuffle for me. It is Stewart Neufeld's, "The Tyranny of Compounding Fees: Are Mutual Funds Bleeding Retirement Accounts Dry?"

Dr. Neufeld looks at how fees divide up the market returns shared by investors and the financial industry over time. First, he outlines the types of fees paid by mutual fund investors, which include not only the explicit management and expense ratio fees, but also a variety of other fees such as trading costs and commissions. He indicates that the average actively managed domestic stock mutual fund pays an annual 1.5% management expense fee, with another 1% added on top for other expenses.

He also summarizes the existing research which tends to show that actively managed mutual funds tend to underperform the benchmark indices by the amount of their fees.

His main focus is to look at how this causes returns to be divided between the financial industry and the investor, both with a historical average stock return, and in rolling periods from the historical data. For the historical average stock return, he finds that over a 50 year investing period, a 2.5% total fee allows the financial industry to capture 74% of market gains, leaving only 26% of the gain for investors.

This is all rather important for safe withdrawal rate studies as well. Studies using the historical index data do not capture the impact of fees on withdrawal rates. If the safe withdrawal rate is 4% when using the pure S&P 500 benchmark index, it could be substantially lower for someone using an actively managed stock fund which underperforms this index.

Here is a figure I made, which will be described in my upcoming (in a few days) article in the January 2012 Journal of Financial Planning, showing the relationship between fees (or investment underperformance) and safe withdrawal rates over 30 years with an accepted 10% failure rate. This is based on historical data, and a 2.5% annual fee (2.5% underperformance from the benchmark indices) causes the withdrawal rate to fall from 4.3% to 3.1%. [This is always a question: why doesn't the withdrawal rate fall by the full amount of the fee? The answer is because withdrawals are always the same inflation adjusted amount, but as the account balance shrinks, the fee amount gets smaller... it is a percentage of the lower account balance.]

This is potentially a big problem for someone paying high fees on their investments: the 4% rule is not applicable!!

Getting back to Dr. Neufeld's article, I think the last two paragraphs from his conclusion are so valuable that I will quote them here to conclude:

On the basis of the research presented here, I recommend that pension plan fiduciaries be required to select default investments that track broad market indices (equity, money, bond) and that have total fees (MERs) as low as possible, ideally not more than 10 bps. For this to be effectively implemented, an additional requirement is that investments with these characteristics be made available in all tax-deferred retirement plans. If this were a legal requirement, then competition in the marketplace would ensure that many low-cost funds would be formed for potential inclusion in retirement plans. In the meantime, pension plan fiduciaries should work to structure their plans so that more low-cost funds are included.

Investment advisers should also direct clients to low-cost (ideally < 10 bps) index funds unless this approach contravenes the client’s expressly stated investment objectives. To do otherwise is to act against the best interests of the client. Among the general public, financial education is weak and financial literacy is low, and therefore it is easy for advisers to recommend investments that primarily benefit themselves and not their clients. A contribution of this research is to demonstrate the extent to which various levels of fees and expenses are damaging to clients’ portfolios and therefore which investments should be avoided by ethical advisers.

Happy Holidays!

2011-12-24T22:12:00.000+09:00

Happy Holidays and many thanks for reading my blog!

January will be a busy month for non-research related activities at my job, so there may not be a whole lot of new content here until February.

But please don't drop your RSS feed or email subscription or anything like that!

I'm planning for a big year here in 2012. Along the lines with what I started with my recent column on GLWBs, I'm planning to create a systematic analysis comparing many different retirement income strategies:

inflation-adjusted annuities

fixed inflation-adjusted withdrawals

variable withdrawals based on many kinds of decision rules related to market returns

ceiling/floor variable withdrawal strategies

portfolio withdrawals + a deferred annuity

portfolio withdrawals mixed with annuities

portfolio withdrawals mixed with GLWBs

asset dedication / time diversification approaches

I'm not sure what to call it, but something along the lines suggested in Zvi Bodie's book about TIPS about mainly using TIPS and then buying call options on the stock index with any extra funds

approaches which only withdraw interest and dividends, leaving the principal intact (professional analyses usually dismiss this as being a mental accounting behavioral mistake, but it sure is popular with people posting comments on finance web sites)

And if everything goes according to plan, at some point during the year I will also be able to include a detailed analysis of taxes for all these strategies as well.

I think I may have been too harsh on GLWBs in my column, since one of my main points is that US historical data gives us a misleadingly rosy picture about what may happen in the future. A part of that rosy picture is that it is easy for systematic withdrawals to "beat" GLWBs. So part of my future analysis will account for the possibility (probability) of lower future returns for stocks and bonds.

So thank you again for reading and please stay tuned in 2012!

Withdrawal Rates, Savings Rates, and Valuation-Based Asset Allocation

2011-12-14T10:37:00.000+09:00

In discussing William Bengen's interview from the December 2011 JFP in a recent blog entry, I wrote:

In Question 9, William Bengen seems to suggest that the next step for withdrawal rate research could be something like using a valuation-based asset allocation, which I have done for the accumulation phase. Michael Kitces has explored this for retirement in one of his Kitces reports, though I don't think any public link is available. I've thought of looking at this, but based on what I could already see with accumulations, it will be a foregone conclusion that a valuation-based asset allocation will increase sustainable withdrawal rates. The only question, really, is by how much? Perhaps I will write up a column about this for Advisor Perspectives some day.

Well, curiousity got the best of me, and I ended up writing a full research article about this. Not just a short column. The article is called, "Withdrawal Rates, Savings Rates, and Valuation-Based Asset Allocation." Interested readers can download the article from RePEc.

GLWBs: Retiree Protection or Money Illusion?

2011-12-13T12:07:00.000+09:00

My second column for Advisor Perspectives, "GLWBs: Retiree Protection or Money Illusions?" is now available. Of course, having a guaranteed income for life is a very desirable goal for retirees. But I'm concerned whether the guarantees made by these retirement products will really be all that helpful, since they are not adjusted for inflation. I thought that the illustration Vanguard uses on page 5 of their brochure (accessible through the link below after you tell them your state) was rather misleading in that by using July 31, 1996, as the start date, they just might have cherry-picked the best possible moment in history to illustrate how GLWBs provide both growth potential and then market protection. Looking back at the historical record, events will rarely make GLWBs appear so attractive.

This is not to say that GLWBs are a completely bad idea. I do understand that they are a form of insurance, not an investment, and generally we do not want our insurance to pay off. But in simulating the performance of GLWBs with historical data, I observe that financial markets would have to get significantly worse than they've ever been, and/or we would have to live for a significantly long time before there is ever a chance for the GLWB guarantees to kick in. Though I haven't done a proper actuarial study of the value of the GLWB rider, what I have done is enough to convince me that a 0.95% annual rider on the total withdrawal base (which may be more than the remaining account value) is an awful lot to pay for this guarantee. There's got to be a better way to get guaranteed income for retirees, and that is something I hope to keep exploring in future columns.

As GLWBs are a new topic for me, I needed to do lots of background reading to get up to speed on how they work. Below are the references I consulted to learn about GLWBs:

Bernicke, Ty A. "Variable Annuities: From Controversial to Mainstream Using a Two-Bucket Strategy, Part 1." Journal of Financial Planning 20, 8 (August).

Bernicke, Ty A. "Variable Annuities: From Controversial to Mainstream Using a Two-Bucket Strategy, Part 2." Journal of Financial Planning 20, 9 (September).

Benedick, Peter. 2011. "Vanguard's GLWB: Credit to Vanguard for Delivering on the Promise." RetirementAction.com

Blanchett, David. 2011. "The Expected Value of a Guaranteed Minimum Withdrawal Benefit (GMWB) Annuity Rider." Journal of Financial Planning 24, 7 (July): 52-61.

Chen, Peng. "The Real Flaws - A Response to 'Understanding Variable Annuities with GMWBs'." Advisor Perspectives (March 1).

Heubscher, Robert. 2011. "Understanding Variable Annuities with GMWBs (and the flaw in Ibbotson's analysis)." Advisor Perspectives (March 1).

Tomlinson, Joseph A. 2011. "Income Choices." Financial Planning (May 1).

Tomlinson, Joseph A. 2009. "Thoughts on the Future of Retirement Income Products." Retirement Income Journal (December 16).

Vanguard's GLWB Marketing Literature

Veres, Bob. 2008. "Cheerleaders in Lab Coats." Financial Planning (May 1).

Xiong, James X., Thomas Idzorek, and Peng Chen. 2010. "Allocation to Deferred Variable Annuities with GMWB for Life." Journal of Financial Planning 23, 2 (February): 42-50.

Valuations-Adjusted Withdrawal Rates

2011-12-11T22:55:00.000+09:00

Following up from yesterday’s blog post, it is worthwhile to also look at valuations-adjusted withdrawal rates.

A relationship that has been documented on a number of occasions (my paper in the August 2011 JFP about this builds upon a number of earlier works, and the history of these developments is reviewed quite effectively in Todd Tresidder’s “Are Safe Withdrawal Rates ReallySafe?”) is that market valuations at the retirement date are fairly closely related to that retiree’s subsequent maximum sustainable withdrawal rates.

This can be seen in the following figure by comparing the thick blue curve (these are the actual maximum sustainable withdrawal rates over 30 years for a 100% stock allocation) with the dashed blue curve (this is EY10, which is just 100/PE10… overvaluation means high PE10 and so low EY10, and vice versa). The relationship is not perfect, but the two curves move together fairly closely.

The red curve is the “valuations-adjusted” withdrawal rate. It is the actual MWR times PE10 and divided by the median PE10 over the entire period (15.71). This normalizes the withdrawal rate. MWRs tend to be quite high for those entering retirement when PE10 is quite low, and so this calculation would adjust the MWR downward. As well, MWRs are low when valuations are high (high PE10 or low EY10), and this calculation would increase the MWR. The median MWR over the whole period is about 6.5%. If EY10 was always equal to the MWR, then the red curve would basically be flat at about 6.5%.

But while the relationship is pretty good, it isn’t perfect. The red curve gets lower at times that EY10 exceeds the MWR, and the red curve gets higher when EY10 falls below MWR.

I’m not exactly sure how much value there is in looking at the red curve, but it is great if it can spark some further interesting insights from anyone, and it is at least worth a blog post on the subject.

Notice that the red curve doesn’t get far above 6.5% very often. That is because it is somewhat rare for the MWRs to be above EY10. It does happen occasionally. In particular, we can see this happen in the late 1800s, late 1940s, and early 1950s.

This is one of the reasons I am fearful for retirees in 2000. EY10 is at its lowest point in history, just a little over 2. There will need to be a break from the usual trends seen in history for the 2000 retiree’s MWR to get above 4%. Will the 4% rule still work?

Of course, this is for 100% stocks, which is not the allocation that most retirees will use. But my article I linked to above shows this same general problem for a 60/40 asset allocation as well.

Valuations-Adjusted Wealth

2011-12-11T00:11:00.000+09:00

Related to my article on "safe savings rates," I discussed how valuations were linked both to how much wealth could be accumulated with a given savings rate (or what savings rate is needed to achieve a wealth target), and what withdrawal rate would be sustainable over 30 years. High valuations tend to mean that someone could reach a wealth goal with a low savings rate, but would then also experience a low withdrawal rate. Meanwhile, low valuations tend force retirees to use a higher savings rate to meet a target, but could then get away with using a higher withdrawal rate anyway.

Individuals from Virginia to Texas, and perhaps somewhere in between, have suggested making an adjustment to the wealth accumulation for valuations. Something like a normalized wealth accumulation. I finally just now checked this. Using a 10% savings rates, I checked how much wealth could be accumulated after 30 years of savings in real inflation-adjusted terms.

Then I multiplied this amount by the median value of PE10 over the historical period (1881-2010 for PE10 values) and then divided it by PE10 for that year. This would adjust wealth downward when PE10 is high, because the fraction is less than 1, but would adjust wealth upward when PE10 is low, because the fraction is greater than 1.

I think the idea was that this adjusted curve should be rather flat.

But it is not really all that flat after all.

In looking at this following figure, I can't come up with any story to explain it, and I'm open to suggestions.

The valuations-adjusted wealth accumulations were quite high in the 1960s. But surprisingly/interestingly, the accumulations are low around 2000 when valuations were at an all time high. I can't really come up with any clear explanation for the movements in the red curve. Perhaps there is no deeper meaning to this figure. What do you think?

Wealth Strategies Journal: When Can I Retire?

2011-12-10T23:48:00.001+09:00

I wrote a short article for Wealth Strategies Journal called, "When Can I Retire? Answers from the Historical Record."

The last paragraph of the introduction effectively summarizes the issues explored in this article:

The purpose of this article is to explore some loose ends from the "Getting on Track" article. That article provides a framework for mid-career individuals to develop a progress report about their retirement plans by showing which savings rate they may still need to use and how much longer they may still need to work. How would the results change for a younger, mid-career individual who wishes to plan for retirement sustainability without relying on Social Security income? What impacts do annual percentage of portfolio fees have on sustainable savings rates and retirement ages? And how different are the results for a retiree making plans to enjoy a sustainable retirement through age 90, rather than through age 100?

If you are interested in those issues, particularly the impact of a 1% fee and the impact of planning up to age 90 instead of age 100, then please have a look. Also, this article is written from the perspective of a 40 year old.

Regarding the specific issues addressed in the article, I'd really like to thank Ricky Hutchins, CFP, and Jean Lesperance for their suggestions.

More results for "Getting on Track for a Sustainable Retirement"

2011-12-07T14:19:00.001+09:00

In October, I published “Getting on Track for a Sustainable Retirement: A Reality Check on Savings and Work” in the Journal of Financial Planning. The article explains the full methodology.

I suggest that the way to know if one is on track for a sustainable retirement is to consider hypothetical individuals with the same current situation and retirement plans, but who reached their current age at different points in history. See how these hypothetical individuals fared over rolling periods from the historical data. Determine what else must be done (what savings rate is needed over how many more years of work) so that all the hypothetical individuals from history facing the same current circumstances could have retired successfully. This provides a recommended strategy calibrated to history’s worst-case scenario. In most cases, such extremes were not necessary, but there is always a possibility that one’s own retirement period will create a new worst-case scenario.

For today, I received a request from a financial planner for some additional tables which may be more informative for people planning their retirements. I include these tables below, for 35, 40, 45, 50, and 60 year olds. These tables are different from what I've posted before because they assume an 80% replacement rate and different stock allocations. A couple things to keep in mind about these tables:

-they are calibrated to the worst-case scenario in history and assume you will live to 100

-but they do not include the effects of account fees

-they assume that the stock allocation stays fixed your whole remaining life

-they assume you maintain a constant salary in real inflation-adjusted terms until you retire

-they assume your current wealth accumulation is the part devoted specifically for retirement and will not be used for children's education, etc.

-though I could later improve my program in this regard, there are not any spending differences from the portfolio for pre- and post- Social Security uptake.

So, they do have some limitations. But I hope they may help give you an idea about whether you are on track for your retirement.

Retirement Planning, December 2011

2011-12-02T14:54:00.000+09:00

I'm just now finishing a first draft for my second column at Advisor Perspectives, which about GLWBs, as Vanguard recently introduced a relatively low cost version of them that has many people excited. I'm happy with how the column is turning out, but working on it has kept me rather busy. GLWBs are rather complicated products, and I had to first understand exactly how they work. Fortunately, in my column I am suggesting that for the most part retirees are probably better off not using them. That column should be finished and available in a couple of weeks.

As I am falling behind, I haven't had a chance to read all of the articles yet, but the new December 2011 Journal of Financial Planning looks to have lots of interesting articles that I want to read.

First, one that I did read is the 10 Questions with William Bengen, the father of safe withdrawal rates. I've always found his emphasis on the SAFEMAX, which is the worst-case maximum withdrawal rate experienced thus far in history, to be a much more useful concept than the later approach taken by the Trinity study. The Trinity study calculates portfolio success rates for a number of different strategies, which suggests to me a degree of scientific certainty that just isn't there, when thinking about what may happen in the future. I think the Bengen approach makes more explicit that a lower SAFEMAX could happen in the future, while this isn't as obvious with the Trinity study's probabilities tables.

Though readers of my blog will know these points by now, Morningstar just made available an article of mine which was previously locked behind a paywall at the Retirement Management Journal, and which summarizes my research about safe withdrawal rates.

But back to the William Bengen interview, there is lots of interesting stuff. Personally, I'm quite happy with his answer to Question 4. He also stands by the use of 4.5% as a safe withdrawal rate, which I don't really agree with, but I feel he has done his due diligence and don't begrudge him for the view. For everyone's benefit, I hope he's right! In Question 7, Lance Ritchlin asks him about a point he made in a May Forbes article that retirees using 4.5% would still have all their initial principal remaining after 30 years in 96% of the historical periods. I do wish to emphasize that this is true in nominal terms, not in real terms. I explored that in an earlier blog entry.

In Question 9, William Bengen seems to suggest that the next step for withdrawal rate research could be something like using a valuation-based asset allocation, which I have done for the accumulation phase. Michael Kitces has explored this for retirement in one of his Kitces reports, though I don't think any public link is available. I've thought of looking at this, but based on what I could already see with accumulations, it will be a foregone conclusion that a valuation-based asset allocation will increase sustainable withdrawal rates. The only question, really, is by how much? Perhaps I will write up a column about this for Advisor Perspectives some day.

This might also be a good point to recommend the last few blog entries from Bob Seawright's "Above the Market" about data-driven analysis. I think of myself as being very much data driven, but we must remind ourselves of something that I remind students about a lot in my econometrics class. That is, I sort of think of the universe as one big Monte Carlo simulation, and all we get to observe is one run of the simulations. While valuation-based asset allocation clearly provides improved risk-adjusted returns in the historical data (this is my finding), this could be because of an "unlucky sample" that makes it look like things work, but it is only a coincidence. There are no certainties and nothing can really be proved one way or the other, which is why I probably won't write much more on that topic.

By the way, getting an official link for the revised version of my Fisher and Statman study is moving exceedly slowly, but you can see it now if you click to see the revised version of the article here.

Another article I look forward to read in the December 2011 JFP is "Improving Risk-Adjusted Returns Using Market-Valuation-Based Tactical Asset Allocation Strategies" by Kenneth R. Solow, CFP®, CLU, ChFC; Michael E. Kitces, CFP®, CLU, ChFC, RHU, REBC; and Sauro Locatelli. I haven't had a chance to carefully read it yet, but I think it is reaching some of the same sorts of conclusions that I have reached, but perhaps from a slightly different perspective.

And also, I really want to read the Special Report on Retirement Income Planning.

I have received a couple of requests for data or other information as emails or blog comments which I haven't got around to doing yet. I haven't forgotten about you and will get to it some time. Thanks for your patience, and have a good weekend!

How Much is Too Much? (Wall Street Journal)

2011-11-20T01:03:00.001+09:00

Kelly Greene's new article, "How Much Is Too Much?" does an effective job surveying the uncertainties surrounding sustainable retirement withdrawal rates in recent years. I'm honored to have my research be included in her review. And also I'd like to thank Michael Kitces for sharing my research with her. Kelly even links here. For readers looking for the spreadsheet she mentions, you can find further descriptions about what you need to know to use it as well as the actual spreadsheet here.

This can also be a good chance for me to give a quick overview about a couple of important issues related to the themes of Kelly Greene's article.

I've been pursuing three different research approaches about how Americans should get use to lower withdrawal rates in the future. One of these is what Kelly discusses.

A second one is my review of safe withdrawal rates for 17 countries from the December 2010 Journal of Financial Planning, in which I argue that Americans enjoyed a rather remarkable 20th century, and the 4% rule may partly be an accident of American history. It didn't work nearly as well in most other countries, and perhaps we shouldn't expect it to continue working so well in the future. I summarize this research in a column at Advisor Perspectives.

The third approach is looking at how quickly Americans retiring in 2000 have been burning through their savings compared to retirees at other points in history. This is actually related to the research Kelly discusses from T. Rowe Price. I will have an article about this coming out in the Winter 2011 Journal of Investing, and for now you can see a working paper version about this. As well, this article is somewhat more brief and summarizes these three above approaches as well. [Note, for these research article links, you need to follow the links to download the article as a PDF. They are available and free of charge]. Todd Tresidder (Financial Mentor) has also written an excellent overview of issues related to safe withdrawal rates.

But at the same time, while the above is all doom and gloom, researchers Michael Finke and Duncan Williams at Texas Tech University helped persuade me to the notion that it isn't necessarily the "end of the world" if one runs out of savings. It depends on how flexible one can be with their spending and on how much guaranteed income they will still have from other sources. I explained their initial research findings in a column at Financial Advisor, and now I have combined forces with them to write a research article about this theme.

Just this week, Doug Nordman (Military Retirement and Financial Independence blog) wrote what I thought was an excellent article combining these issues from my research about how the 4% rule may fail but also how that may not always be so terrible.

As well, if you've never heard of me, please let me introduce you to my research on "safe savings rate." I argue that traditional retirement planning, which focuses on safe withdrawal rates and wealth accumulation targets, is misguided. One should instead focus on their savings rate. The reason is related to how market valuations fluctuate so much over time, and to how difficult it actually is to know if you are on track to meeting a wealth accumulation target even just a few years away. So focus on what you can control rather than on what you can't control.

My research articles from the Journal of Financial Planning which discuss this are "Safe Savings Rates" and "Getting on Track for a Sustainable Retirement." Not everyone wants to read research articles, and some columnists who wrote great introductions about these ideas include Felix Salmon and Dan Moisand (for safe savings rates) and Matthew Amster-Burton (for getting on track). I also wrote another column called "Retirement Planning and Worst-Case Scenarios" for Advisor Perspectives which gives my further thoughts about how to think about the possibility that things may be worse for future retirees than anything we've experienced before in the U.S.

This week in Advisor Perspectives I wrote a column expressing my concerns about whether an all-TIPS portfolio may be a viable alternative for retirement savers. I will also publish a research article in the January 2012 JFP which synthesizes my views about how one can put all of these concerns together and create a "do it yourself" safe withdrawal rate. Since it is not published yet, that link is to the draft version.

Finally, I also highly recommend blogs by the Oblivious Investor and Bob Seawright for more background on retirement planning. The Oblivious Investor explains investing issues very well and has written a short book helping many people prepare for retirement, and Bob Seawright emphasizes the important role of annuities to help reduce some of the anxieties that may come with planning for the unknown.

Future Salary Assumptions for my Research

2011-11-18T13:18:00.000+09:00

I received this question:

I did have a question about income replacement rates. In some of your articles you refer to a person replacing 50% of their income (with SS added on top). Is that 50% of their final salary? How would you estimate that if a person still has 15+ years more till their expected retirement? Is it save until I can have enough to replace 50% of my current income, or do you just inflate earnings by like 3% a year?

This refers in particular to my "Safe Savings Rates" and "Getting on Track for a Sustainable Retirement" articles.

Both of those articles are meant to illustrate a framework. I still need to develop some interactive software that will allow users to incorporate their own assumptions.

I provide calculations in real terms, which means adjusted for inflation. And I assume that someone has a constant real salary over their whole career. Their salary rises with inflation, but there is no change in real terms. This means that talking about replacement rates in terms of final salary is the same as replacement rates in terms of current salary, in real inflation-adjusted terms. That simplifies the discussion dramatically as I don't need to jump around to talk differently about different points in one's career.

Obviously, this is not realistic. Real people do not have such constant real salaries. It is a limitation of the research. But since everyone will have a different personal case, I thought this was okay as a baseline to explain the approach.

Let me give a bit more insight about the 16.6% savings rate from my "safe savings rates" article.

If everything about the baseline case is the same, except that the worker enjoys 1% real wage growth every year for their 30-year long career, then the safe savings rate increases from 16.62% to 19.81%. Two factors are at work:

1. Relatively less salary and savings are made early in the career, so less time for compounding

2. Now the real wage at retirement is 33.45% higher than in the first year of work. Since the worker wants to replace 50% of this final wage, she needs to have saved more.

Next, interestingly, if you combine the 1% real wage growth with the scaled age-earnings profile for workers aged 35-64 taken from Social Security Administration data, the safe savings rate falls to 13.47%. People who are still working at age 64, tend on average to have lower real wages than younger workers. Real earnings tend to peak at about age 50 and then decline at later ages for the average American (this is real earnings, not nominal earnings that incorporate the effects of inflation). I am assuming that you want to replace your final salary. If you want to replace your peak salary, it is another story, but since your final salary is now less in real terms than earlier in your career, then you did not need to save as much.

Now, everyone, again, is different. And plenty of people will need to deal with mid-career unemployment and things of that nature, which will require higher savings rates in other years. So, of these numbers, the 13.47% might actually be closer to most realistic, but if you want some precautions for unemployment or emergency expenses in some years, then that could get us back closer to 16.6%.

Length of Retirement and Safe Withdrawal Rates

2011-11-18T07:43:00.001+09:00

Brad asked a question in the comments of my last blog entry:

Wade - thanks for this post. I know it's still a work in progress but it's the first chart I've seen that shows MSWR for a 15 year retirement. I'm a Financial Planner that focuses on retirement income planning for my clients. Most research (Bengen, Kitces, etc) shows 30 year SWR's. But I recently had a client in his late 70's come to me to discuss retirement income. Seems like a 4% SWR would be inappropriate for someone with what could be a less-than-30 year lifespan. Michael Kitces and I emailed about this and he mentioned that even he hadn't done (or seen) the research on 15 - 20 year SWR's. Which brings me to my point: as a client ages and their retirement timeline moves from 30 to 20 to 10 years, the SWR should (I think) be raised to counter the effect of a declining lifespan. I, for one, continue to focus on a 4.5% - 5% SWR (I use Bengen's research plus Cuts/Freezes/Raises advocated by Guyton & Klinger) even when a client is in his/her 70's/80's. But, that doesn't "seem" right. Anyhow, thanks for letting me spill my thoughts and thanks for your research on this subject.

It's an important question!

The Trinity study does show portfolio success rates for retirement durations between 15 and 30 years. But let me offer two other looks at it. The first figure here shows William Bengen's SAFEMAX (the worst-case sustainable withdrawal rate from history since 1926 for a 60/40 portfolio of large-cap stocks and intermediate term government bonds) for retirement durations up to 40 years. Indeed, shorter retirement durations allow for higher safe withdrawal rates. For instance, for a 10-year duration, the lowest ever sustainable withdrawal rate in inflation-adjusted terms was 8%.

The next figure is based on Monte Carlo computer simulations of the same historical data as used in the previous figure. It shows the "safe withdrawal rate" as defined by that which has a 10% chance of failure for different asset allocations and different retirement durations. Again, you can see that someone planning for either shorter or longer retirement durations should not necessarily be basing their decisions on the default 4% rule, as that comes from a 30-year retirement duration.

Japan 1990 --- A Black Swan for Retirees? No.

2011-11-16T16:52:00.000+09:00

Matthew Amster-Burton wrote a nice article about my "Getting on Track for a Sustainable Retirement" at Mint.com

His article includes comments from Professor Zvi Bodie, who thinks my approach to retirement planning with a well-diversified portfolio is too exposed to black swans. I have great respect for Professor Bodie's work, and I'm honored to know he has even looked at my article, _and_ I can't disagree with his overall view.

As I showed in my article, "An International Perspective on Safe Withdrawal Rates", things have indeed gotten very bad at times for other developed market countries. Japan's experience in the years following World War II set a devastating worst-case scenario for anyone to contemplate. Basically, hyperinflation, followed by stock and bond returns that couldn't keep pace, destroyed any chance for a successful retirement, though post-war Japan was probably not a place where people would have had an opportunity to enjoy a peaceful retirement anyway.

Just, I wish to add, the reason for writing my recent article about TIPS is that I don't think TIPS can be treated as invulnerable to these sorts of black swans. Will the US really keep repaying TIPS owners in the event of a hyperinflation? Will non-TIPS owners stand for that as their own life savings transform into just enough to buy a loaf of bread? I don't know.

Just one more brief point, Prof. Bodie mentions a 1990 retiree in Japan as experiencing such a black swan event. But retiring in 1990 Japan with a well-diversified portfolio would not have been so bad. 1990 is too recent to look at the typical 30-year retirement period, but here are the maximum sustainable withdrawal rates for new retirees over a 15-year period in each year of the historical record for a fixed 40/60 portfolio of stocks and bonds. These are higher than 30-year withdrawal rates, naturally. But they will be closely correlated, because due to sequence of returns risk, what happens early in retirement has a major impact on the final outcome. While the Japanese retiree in 1990 didn't have things great compared to other US and Japan retirees, it wasn't so bad. The big killer for retirements is not stock market losses alone. It's inflation and the impacts that can have on real market returns. Granted, that is what TIPS are designed to protect against. And that is why TIPS should be an important part of one's retirement portfolio. But I don't think it should be the only part, especially for those still saving for retirement.

I don't really have a good ending for post this yet. But there are a few things I'm working on related to this subject of retirement and inflation, so please stay tuned.

Are TIPS Really Safe and Worry-Free?

2011-11-15T11:14:00.000+09:00

I'm fortunate to now be a monthly columnist at Advisor Perspectives on topics related to de-accumulation strategies and safe withdrawal rates. Although I will make much more effort to focus on quality (as some of my blog entries tend to be rough drafts that end up getting re-written multiple times), the topics I discuss in my columns will be the same sorts of issues I've been discussing here.

My first column is available now, "Are TIPS Really Safe and Worry-Free?"

My purpose is not to do a hatchet job on TIPS. I think TIPS are very important and useful. But it troubles me that the same people who will focus on how potentially dangerous and risky it is to use a well-balanced portfolio of stocks and bonds for retirement, will at the same time use terms such as "risk free" or "safe" or "worry-free" when talking about TIPS. Let's not get our hopes up too much about TIPS. They can be an important component of anyone's portfolio, and they are certainly an important component of my own, but I wouldn't want to put everything into TIPS. Recognizing this is the point of the article. Please have a look.

What is a good withdrawal rate?

2011-11-11T22:47:00.002+09:00

I received this question through email:

Wade

I read your abstract on withdrawal rates and was very interested.

However, I am trying to ascertain what I may withdraw from my portfolio if the 4% rate, as you seem to think is inaccurate.

I am 70 years old.
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Here is my answer, which unfortunately doesn't provide a specific number:

It is a great and important question. But it is hard to answer though, without knowing more information.

For example, are you married, and if so, how old is your wife? Because, the 4% rule refers to a 30 year period. It can be higher or lower if you are planning for a shorter or longer period.

What is your asset allocation? What fees are deducted? This question might be harder to answer, but have your investments been performing as well or worse than the benchmark indices for stocks and bonds used in the withdrawal rate research?

What other income sources do you have? Social Security? Any pensions? Any annuities? Because the more income you have from other sources, the less tragic it would be if you run out of wealth, and so that allows for a higher withdrawal rate as well.

Relatedly, how flexible are you to decrease your spending later if markets perform poorly? In that regard, how much value would you get from spending more now? Is it worth it to spend more now, if the consequence is that cutting back more later may be necessary?

Does the assumption of the 4% rule, which is that you always will keep spending the same inflation-adjusted amount in the future, apply to you? Or is it likely that you will spend less in the coming years for unrelated reasons?

How is your health insurance situation?

Do you have any desires to leave an inheritance?

I think one needs to think about all of these questions (and perhaps more, I might add to the list later if I think of something else) when deciding how much to withdraw. I am concerned that the 4% rule will not work for recent retirees over a 30-year period. But that doesn't necessarily mean that someone shouldn't spend more than 4%. The purpose is to maximize one's lifetime satisfaction, balancing between how much to spend now, and what that might mean for cutting back on spending later.

Update: Dan Moisand's December 15, 2010, column, "A Little More To It" at Financial Advisor Magazine does a good job of also explaining the issue I was grappling with in trying to answer this question: the real world isn't always so clear and pristine as what we assume in the research about safe withdrawal rates. Real life gets in the way.

Halloween Horrors: The Devastation of Compound Fees

2011-10-31T13:50:00.000+09:00

Everyone has heard of the magic of compound interest. It has a corollary: that is, the devastation of compound fees. The idea is: suppose you pay 1% of your account balance each year as a fee.

For a lot of people, this could still be a good idea. If you receive good advice that gets you into a better asset allocation and keeps you from making costly mistakes with your investments, then the fees could more than make up for themselves.

What I am referring to here is merely comparing the case where someone is able to earn the exact indexed investment returns to someone whose returns fall below the indexed returns by an amount represented through 1% of the portfolio balance. In this regard, the 1% could be interpreted as a fee or as just general underperformance.

But the impacts can be extreme. The following two tables are in the style of what I describe in my recent paper, “Getting on Track for a Sustainable Retirement: A Reality Check on Savings and Work” from the October 2011 Journal of Financial Planning. Please see the paper for more explanation about what I am up to here.

Table 1 and Table 2 look at various strategies for a 40-year old with different current wealth accumulations, in terms of what retirement age is "safe" in the worst-case scenario from history for different future savings rates, asset allocations, and retirement income replacement rates. The only difference is that no fee is included in Table 1, and a 1% fee is included in Table 2.

This 40-year old is making plans for potentially living through age 100, and so will have to pay the 1% fee for 60 years. Comparing directly the numbers in Tables 1 and 2, one can see how much higher the retirement ages increase as a result of the fees. For instance, consider someone with a 60% stock allocation, 85% replacement rate target, 3 multiples of salary, and a 20% savings rate. In Table 1, this 40-year old found that 65 is the “safe” retirement age. But Table 2 shows that with the portfolio underperformance, this age increases by 5 years to 70.

The other direction to observe in the tables is how much higher the savings rate must be for the same retirement age. Again with this same scenario, in Table 1 the 40-year old could have retired at age 70 with a 10% savings rate rather than the 20% savings rate required in Table 2.

This is the devastation of compound fees: the 1% account balance fee would require the 40-year old to save an extra 10% of salary over a 30 year period to age 70, or to otherwise work an additional 5 years, just to be able to pay the 1% fee over the 60 year period between ages 40 and 100.

The reason for these extreme differences from the seemingly small 1% fee, is that it is taken from your portfolio balance. Think of it this way: if your portfolio is currently 10 times your salary, then you would have to save 10% of your salary to pay the 1% fee from the portfolio. Those two amounts would be the same.

Happy Halloween!

Cliff Notes for "An International Perspective on Safe Withdrawal Rates" (December 2010 JFP)

2011-10-30T16:34:00.002+09:00

I wrote the following last December, but never ended up using it for anything. It summarizes my research article from the December 2010 Journal of Financial Planning. Big thanks to the Oblivious Investor and Monevator for including it in their weekend reading lists.

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Conventional wisdom states that when it comes to retirement withdrawal planning, the 4 percent withdrawal rate rule is safe. That rule, dating back to William Bengen’s 1994 article in Journal of Financial Planning, says that a new retire can safely withdraw 4 percent of their savings in the first year of retirement and adjust this amount for inflation in subsequent years. This will be safe in the sense that the strategy will not lead the retiree to use exhaust all of their remaining assets for at least 30 years. The 4 percent rule has been widely adopted by the popular press and financial planners as an appropriate general rule of thumb for retirees. Since Bengen’s paper, a number of researchers have developed strategies to allow retirees to safely exceed a 4 percent withdrawal rate. Though the safe withdrawal rate fluctuates a bit from study depending on the dataset and assumptions used for its calculation, in this paper I calculate a safe withdrawal rate for the U.S. of 4.02 percent. That was the highest amount that could be sustained in the worst case retirement year. It happened in 1969 with a 57/6/37 for stocks/bonds/bills, which was the best possible asset allocation.

Prospective retirees must consider whether they are comfortable basing retirement decisions using the impressive and perhaps anomalous numbers found in the past U.S. data. The problem is that most every study about sustainable withdrawal rates is based on the same Ibbotson Associates dataset on U.S. financial market returns since 1926. The time period covered by this data may have been a particularly fortuitous one for the United States that will produce misleadingly large and dangerous "safe" withdrawal rates if asset returns fail to be so stunning in the future. Indeed, the U.S. consistently enjoyed among the highest inflation-adjusted returns and lowest volatilities for stocks, bonds, bills, and inflation. For stocks, only 3 countries enjoyed higher returns, and the only 4 countries experienced less volatility in stock returns. This combination of high returns and low volatility is remarkable for the U.S. and helps to support higher withdrawal rates. The story is similar for bonds, bills, and inflation as well. For bonds, only 3 countries enjoyed higher real returns, and only two countries enjoyed less volatility for those returns. Only two countries experienced lower average inflation than the 2.98 percent value in the US. As a consequence, tests using US data should provide for relatively high sustainable withdrawal rates from retirement savings. From an international perspective, the United States enjoyed a particularly favorable climate for asset returns in the twentieth century, and to the extent that the US may experience mean reversion in the current century, "safe" withdrawal rates may be overstated in many studies.

The results have shown that from an international perspective, a 4 percent withdrawal rate has been anything but safe. The SAFEMAX exceeds 4 percent in only 3 of the other 16 countries: Canada, Sweden, and Denmark. As for other countries, the most unfortunate retiree of all was a Japanese person retiring in 1940, whose maximum sustainable withdrawal rate was a miserably low 0.47 percent. Six countries experienced withdrawal rates below 3 percent: Spain, Italy, Belgium, France, Germany, and Japan. In Italy, the 4 percent rule failed in 62.5 percent of cases, and in Japan, withdrawals were sustainable for only 3 years in the worst-case scenario. For stock allocations between 30 and 90 percent, the United States enjoyed higher sustainable withdrawal rates than any country except for Canada. For the US, the maximum occurs at 57 to 60 percent stocks, but unlike many of the countries that show a much more pointed hump, the maximum is only slightly less for stock allocations between about 30 and 80 percent. Except for Switzerland, retirees in the various countries were generally better off by holding at least50 percent of their savings in stocks. Safe withdrawal rates do not obtain their safety from conservative asset allocations.

A few additional comments are warranted about the assumptions built into this study. In several ways, the assumptions provide an overly optimistic view of withdrawal rates. In each year for each country, I assume that retirees have the perfect foresight to choose the specific fixed asset allocation among their country’s stocks, bonds, and bills that would provide the highest withdrawal rate. Relaxing this, for instance, with a 50/50 asset allocation for stocks and bonds would cause the 4 percent rule to fail at least once in every country. As well, I assume that retirees do not have to pay any portfolio management or advisor fees from their assets beyond what they otherwise withdraw for their expenses. On the other hand, researchers have demonstrated that including more financial assets, using dynamic rules to adjust withdrawals to market conditions, and changing rebalancing strategies can all serve to increase safe withdrawal rates, and these modifications have not been incorporated here. As well, some of the worst outcomes were connected with World Wars I and II, and investors who are confident that world war is a relic of the past may feel comfortable ignoring those cases, or may at least assume that retiring comfortably would be the last thing on their mind.

These findings may be rather frightening. After all, who but the wealthiest could possibly save enough to live comfortably from the global safe historical withdrawal rate of 0.47 percent? From the perspective of a U.S. retiree, the issue is whether the future U.S. will experience the same asset return patterns as the past U.S., or whether Americans should expect some kind of mean reversion that could lower asset returns to levels more in line with what many other countries have experienced. It may be tempting to hope that asset returns in the twenty-first century United States will continue to be as spectacular as in the last century, but it should not be counted on.

Media reports about "Getting on Track for a Sustainable Retirement" (October 2011 JFP)

2011-10-29T15:05:00.010+09:00

I've published an article, "Getting on Track for a Sustainable Retirement: A Reality Check on Savings and Work" in the October 2011 issue of the Journal of Financial Planning. I'd like to think that with some further development, the methodology outlined in this article can provide a useful contribution to the field of retirement planning. I finished writing the article at the end of June, and I discussed it here then. That discussion also includes tables for 35, 45, 50, and 60 year olds.

The article is slowly garnering some interest, and as various people are writing about it, they are often adding some good points and interpretations of their own. I will start collecting such reports together here, along with some interesting new points.

Barbara Whelehan, "Retirement planning to age 100" Bankrate.com blog.

I liked how she noted that I am providing advice which is at odds with the ING "Find your number" commercials. The reason is, I argue that people should be focusing on how much they are saving, investing this in a simple balanced portfolio, and then not worry so much about the progress of their actual wealth accumulations.

CanadianInvestor, "What is a Viable Mix for Retirement Savings Success?" How to Invest Online blog.

He provides an excellent summary while also highlighting some key assumptions which may not apply for everyone and which do have a strong bearing on the results.

Peter Benedik, "Am I on track for retirement?" RetirementAction.com

Peter makes several good additional points. First, he observes from the tables that there is a relatively clear tendency that each 1 percentage point increase in your savings rate can allow you to retire about 0.6 or 0.7 years earlier. He suggests, too, that higher savings rates could help by getting you more used to a lower spending level, which in turn could allow you to retire earlier with a lower replacement rate. He also notes that each year of delayed retirement gets you an addition 5% of so replacement rate of income. Also, he notes that a case can be made for more aggressive stock allocations based on the table, as the worst-case scenarios are not all that different, but more stocks would bring more upside potential. Also, I especially like his point, "This type of analysis is especially critical and is typically a key missing feedback element from DC plans and their regular accompanying reports to participants. An annual indicator of expected and/or worst case retirement year(s) for some desired level of retirement income, given one’s current assets, savings rates and asset allocation, is a necessary feedback loop to allow each individuals to better understand the answer to the question: “Am I on track for planned retirement?”

Are retirement goals fixed or flexible?

2011-10-28T15:14:00.001+09:00

One of my early forays into research about personal financial planning was, “Lifecycle Funds and Wealth Accumulation for Retirement: Evidence for a More Conservative Asset Allocation as Retirement Approaches” from the Spring 2010 issue of Financial Services Review. The issue I was responding to was research by Harold Schleef and Robert Eisinger which argued that retirement savers are better off by maintaining more aggressive stock allocations near retirement, rather than decreasing their stock allocation as is done with retirement target date funds. I thought that their approach for reaching this conclusion didn’t sound particularly compelling. They defined retirement success only in terms of whether or not an individual reached their retirement wealth target by their target retirement date. Whichever asset allocation experienced the highest probability of reaching the wealth target was “optimal” in their framework.

Stocks tend to offer both higher average returns and higher volatilities over long periods of time. Because of the higher average returns, stocks will tend to maximize the probability of reaching a wealth target. This explains the findings by Schleef and Eisinger. But what I think must also be considered was the fact that the distribution of wealth provided by higher stock allocations is also wider, and this includes the possibility of experiencing much lower wealth accumulations as well.

I thought it was important to consider the whole distribution of outcomes. Here is what I wrote in my article:

Our findings will tend to provide some support for the use of target date funds. We argue that it is important to focus on more than just meeting a particular goal for retirement. The simulation approaches used by studies such as Schleef and Eisinger (2007) and Basu and Drew (2009) provide an entire distribution of wealth outcomes, and researchers have an opportunity to take advantage of all this information. The basic issue is this: For someone whose goal is to maximize their mean or median wealth accumulations at their retirement date, then it is clear from historical trends that the best chance for success is to maintain a high equity allocation near retirement, in contrast with the general philosophical approach of target-date funds. A risk averse individual, however, may have a different goal, such as minimizing the risk of suffering from extreme hardships in retirement.

Since writing that article, I’ve added more reasons why retirement savings shouldn’t be so focused on meeting a wealth accumulation target [my “save savings rates” paper argues that savers should focus on their savings rates and not worry about accumulated wealth or required withdrawal rates, and my “getting on track for a sustainable retirement paper” argues that it is quite difficult in practice to know whether you are on track to meeting a wealth accumulation target anyway].

But for today, the issue I want to focus on is how there is nothing magical about such a wealth target. You don’t automatically succeed because you have one dollar more, or fail because you have one dollar less. Goals are fungible, and people will adapt to having either more or less. To determine an asset allocation strategy for retirement savers, it is important to evaluate the whole range of potential outcomes and choose the distribution of outcomes that will maximize your expected lifetime satisfaction. A wealth target is not an all-or-nothing affair.

Now, I’d also like to argue that this extends as well to retirement spending. I don’t think retirement success or failure depends on whether or not one meets some particular goal. I’m inspired to write this by a blog entry which Michael Kitces wrote last December. He wrote:

The problem is that, if you're focusing on what it takes to achieve a client's goals, just insuring 50% of a goal seems to be a remarkably inadequate solution, if someone is really concerned about making sure that the goals are achieved. After all, if a couple's goal is to spend $60,000/year for the rest of their lives, then if "the bad stuff" happens and they must rely on the $30,000 (50%) that was insured, then haven't they still catastrophically failed to achieve their goals? The good news is that they won't be destitute without income. But if the purpose of the plan was to achieve the goal - the goal has still been failed!

To answer the question Michael asks, I think the answer is “not necessarily.” Everyone is different, and for some people this could represent a catastrophic failure. But more generally, I want to argue against the general acceptance of this sort of all-or-nothing retirement spending goal as being the conventional wisdom for retirees.

As Bob Curtis explains in his article, “Monte Carlo Mania” from Harold Evensky and Deena Katz’s book, Retirement Income Redesigned: Master Plans for Distribution, retirees do not have just one spending goal. They instead have different goals, each with a different priority. There may be some absolute spending floor which is seen as essential, and then some other discretionary spending on top of that, followed by a desire to own a nicer car and to enjoy one trip abroad each year, and then there is the possibility to provide some gifts to charity and relatives, and if that is taken care of than some additional spending toward enjoying more nice restaurants is a final possibility.

So to define what an all-or-nothing goal is, where would we draw the line for this person? Does it include everything I listed? Because that may greatly intensify the probability that portfolio wealth will be exhausted before death. So which goals should we cut in order to provide sufficient chances of being able to adequately cover the most important goals? The answer depends on how important each goal is, or how much utility each goal provides. When the goals are listed in the order of their priority, each successive goal must be providing less life satisfaction per dollar than the previous goal. That is why its priority is lower. Financial planners can help their clients to think about how much satisfaction each goal provides, and then to focus on the tradeoffs between satisfying more goals in early retirement which increases the chances of having to cut back on other goals later in retirement.

Planning for retirement is complex, unfortunately. We don’t know how long we will live and we don’t know what will happen with financial markets in the coming years. So we have to do the best we can to balance some complex tradeoffs. I am strongly in favor of making this process as simple as possible, but I really fear that thinking in terms of one all-or-nothing retirement spending goal is too simplified and could lead retirees to make mistakes which don’t provide them with the most expected lifetime satisfaction from their hard work and savings.

Do-It-Yourself Safe Withdrawal Rates

2011-10-27T23:31:00.000+09:00

I received a question today from the host of the “Retire Early in India” blog, which I'm enjoying reading through this evening. He had found an article I co-authored with Channarith Meng, which made an attempt to investigate the issue of sustainable withdrawal rates for 25 emerging market countries. This article appeared over the summer in the Journal of Personal Finance. It is called, “Safe Withdrawal Rates from Retirement Savings for Residents of Emerging Market Countries.”

He asked me, what is a safe withdrawal rate for someone in India, and how would it change for someone planning for a 60-year retirement?

First of all, most of the research about withdrawal rates is specific to the United States, and the above paper was meant mostly just to show how answers to this question can be quite different for other countries. Emerging market countries have rather limited data, and so the idea was just to provide an overview. I would not recommend using the results shown in the article for India for someone planning to retire in India.

This is because for new retirees, what really matters is what will happen with asset returns in the future, and not what has happened in the past. This notion is not original to me, but I did write an article which summarizes my concerns for recent US retirees called, “Retirement Withdrawal Rates and Portfolio Success Rates: What Can the Historical Record Teach Us?” It appears in the Fall 2011 Retirement Management Journal. I’ve summarized a key argument before on my blog:

Retirees now frequently base their retirement decisions on the portfolio success rates found in research such as the Trinity study. Studies such as those are fine for what they accomplish: they show how successful different withdrawal rate strategies were in the historical data. But it must be clear that this is not the information that current and prospective retirees need for making their withdrawal rate decisions. John Bogle makes clear why in his 2009 book, Enough. Though he was speaking about stock returns, the same idea applies to sustainable withdrawal rates, since they are related to the returns of the underlying portfolio of stocks and bonds. He wrote, “My concern is that too many of us make the implicit assumption that stock market history repeats itself when we know, deep down, that the only valid prism through which to view the market’s future is the one that takes into account not history, but the sources of stock returns” (page 102, original emphasis).

That argument is for the US. But I think it applies even more strongly to rapidly growing emerging market countries. The future is unlikely to be anything like what was experienced in the past.

So, then, how can we decide on a “safe” withdrawal rate?

I have a new article forthcoming in the January 2012 Journal of Financial Planning called, “Capital Market Expectations,Asset Allocation, and Safe Withdrawal Rates.” It provides my best attempt to give an answer to this. And in thinking about it now, I realize that this article doesn’t discriminate toward any particular country. It is written for Americans and the historical data baseline is US data, but the approach laid out at the end of the article and the graphs I’ve created to accompany the article can be applied to someone living in any country of the world.

I explain how you need to make the best forecasts you can for the asset classes you plan to use [their means, volatilities, and correlations]. Then you use some software to construct what’s known in finance as the “efficient frontier.” Then you can overlay this efficient frontier onto some graphs I’ve made which are included here, which show lines for maximum sustainable withdrawal rates for different portfolio returns and volatilities, and for different retirement durations and different accepted failure rates.

From this overlay, you can find the point on the efficient frontier which allows for the highest maximum sustainable withdrawal rate. Then you check what the asset allocation is for this point on the efficient frontier, and now you have just found your recommended withdrawal rate and recommended asset allocation for the retirement duration and acceptable failure rate you’ve chosen.

As most safe withdrawal rate studies are created using very specific assumptions about portfolio returns and volatilities, I think the approach I’ve described in the article removes those constraints and allows users to consider any possibilities. These possibilities could be about including a role for market valuations, including additional asset classes like REITs or international funds, or for someone in another country just doing the analysis for their own case in terms of their own currency.

And so, I cannot personally say what the sustainable withdrawal rate is for someone in India, because I do not know what kind of expected returns and volatilities are feasible for someone living and investing there. But I do think you can use the framework I’ve described in that article to come up with a suitable answer for yourself.

About the issue of a 60-year retirement, so far I’ve only looked at cases of retirements up to 40 years. Sustainable withdrawal rates do get lower as the retirement period lengthens, but they get lower at a decreasing rate. The specific answer would depend on the assumed portfolio returns and volatilities, but if I’d have to give a quick guess about this, my guess is that it would not be too far off base to assume that the sustainable withdrawal rate for 60 years is 1 percentage point less than for 30 years. For example, 4% would become 3%. Again, that is just a guess.

The Fungible Nature of Retirement Spending Goals

2011-10-26T15:18:00.000+09:00

Today’s blog post is inspired by 3 sources

1) Duncan Williams and Michael Finke’s article about how retirees may be willing to accept higher failure probabilities for the opportunity to spend more in early retirement. I described their article in a column at Financial Advisor.

2) Robert Curtis’s “Monte Carlo Mania” article which I reviewed here the other day.

3) A series of email exchanges I’ve had with Michael Kitces, whose ideas as expressed on his blog and his Kitces Reports have been a guiding inspiration for my research this year. His take on these matters helped to prompt this analysis.

Step 1, I think the main idea of the Williams and Finke article can be expressed in a paragraph I wrote at Financial Advisor:

Figure 2 shows the case for a risk-tolerant male retiring at age 65, who has guaranteed inflation-adjusted income sources of $20,000 (Social Security, for instance), and a $1 million nest-egg. Far from the 4 percent rule, the figure shows how this retiree can maximize his utility using a 7 percent withdrawal rate with a 70 percent stock allocation. Rather shockingly, based on the traditional shortfall risk approach, this strategy actually would lead to a 57 percent chance of running out of wealth within 30 years. This, indeed, is the most surprising and thought provoking insight coming from Mr. Williams and Dr. Finke’s research. Acceptable failure rates might be much higher than we ever imagined. Calls for low failure rates may not have properly accounted for the risk aversion or the other sources of income available for retirees who may be willing to risk higher failure for the opportunity to spend more earlier on in their retirements.

Step 2, in “Monte Carlo Mania,” Robert Curtis argues that prospective retirees do not have just one overall spending goal for retirement. They have different goals, and these goals can be prioritized by their order of importance. Here is an adaption I am making from his article about some annual spending goals in order of priority:

1. Minimum annual living expenses: $50,000 (shelter, food, basic needs, basic travel)

2. Re-occurring expenses on ownership of nice family car: $5,000

3. International Travel: $10,000 

4. Gifts: $5,000 

5. Extra living expenses: $10,000

(Total Annual spending: $80,000)

Step 3, what I want to argue here is that these goals don’t just have an order of priority, but they also have a weighting based on their importance.

Williams and Finke discuss income sources from outside the savings portfolio which serve as a guaranteed income floor. Suppose, for instance, that the prospective retiree can expect $20,000 from Social Security. Should the retiree exhaust all of their savings, the retiree will be forced to live on only Social Security.

In our email exchange, Michael Kitces argued that this would be a devastating outcome for most retirees, as it implies a drastic reduction to one’s standard of living.

But as economists always want to say, life is about balancing tradeoffs. Someone who really wants to keep their portfolio failure rate very low, will need to use a rather low withdrawal rate, which may mean they can only expect to meet their Goal #1, and must forgo the opportunity to achieve Goals #2 - #5.

In facing this tradeoff, others may make a conscious decision to increase their withdrawal rate and make more of their goals achievable early in retirement. Finding how to balance the tradeoff is the whole purpose of the Williams and Finke article. But the answer depends on one’s weightings given to all these various goals, which in their article is defined as the coefficient of risk aversion. I already provided a quotation describing an outcome for a more aggressive-style retiree with a risk aversion coefficient of 1. But in my review article, I also explain the case for a more conservative retiree with risk aversion of 4 who has the same underlying guaranteed income floor:

This new research does not always call for such high withdrawal rates. The scenario shown in Figure 3 is the same as in Figure 2, except that now we are investigating the case for a more conservative and risk-averse 65-year old male. For this retiree, a 4 percent withdrawal rate with a 40 percent stock allocation is utility maximizing. This particular result is close to what is generally recommended in traditional shortfall risk studies.

What I want to do here is re-cast the risk aversion coefficient instead as a “coefficient of goal flexibility.” Low numerical values mean that the retiree is flexible about their spending levels, while high numerical values mean that the retiree is averse to flexible spending, or in particular is averse to a drop in their spending levels.

To see this, I want to give a utility weighting to the goals from Robert Curtis’s framework. I’ve illustrated below the utility provided by different spending levels for both the “flexibility tolerant” retiree and the “flexibility averse” retiree. Both naturally get more utility as their spending increases, but the flexibility averse retiree suffers from a big drop in utility when spending falls below the $50,000 minimum expense floor. This retiree is really unhappy to subsist only on Social Security. And so this retiree would want to accept only a very low failure rate, as is assumed in traditional safe withdrawal rate studies.

Meanwhile, the flexibility tolerant retiree does not suffer so much if spending must fall to $20,000, and also enjoys relatively higher marginal utility from increasing spending beyond $50,000. This is the retiree who is more like the first case described above… they will be willing to increase their spending higher to even potentially $80,000, with the clear understanding that this leaves them with a rather strong possibility that they will be spending some of their retirement with much lower spending.

The utility maximization approach provides a systematic way to analyze the shapes of these curves along with the probabilities of exhausting wealth with various withdrawal rates, putting it all together, and giving an answer about what strategy will afford the retiree with the most overall expected lifetime satisfaction over their whole retirement period.

But to see this, it must be clear that there is not just an all-or-nothing retirement spending goal. Goals are fungible. Different people will have different takes on it. And everyone can find a strategy that will provide them with the most expected lifetime utility given the constraints they face about their guaranteed income sources and their level of retirement savings.

20-Year Sustainable Withdrawal Rates for US and Japan

2011-10-25T11:20:00.001+09:00

As a part of the interesting discussion taking place at Todd Tresidder's Financial Mentor website about his new article called, "Are Safe Withdrawal Rates Really Safe?", John Gay asks:

Author: John Gay
Comment:
@Wade, @Michael, @Rob: Does anyone have details on the specifics of Japan's last 30 years or so in this context? ie, a 50/50 portfolio (or similar) invested in Japan's stock and bond markets (in yen) at their peak (or earlier if not enough data points) allowed a ??% withdrawal rate (in the same context as this discussion). Curious to see the outcome and how much deflation offset poor stock performance, how bonds helped (or didn't), etc. @Wade I know your research includes multiple countries but wasn't sure if you have isolated Japan (forgive me if I missed it).

Here is my attempt to provide a quick general answer about this.

First, since Japan's bubble burst starting around 1990, we don't yet have enough data to see the 30-year sustainable withdrawal rate for someone retiring at the start of the downturn.

So for here, I will consider 20-year sustainable withdrawal rates instead. They tend to be higher than 30-year rates, naturally. To give some context for comparison, here is the time path of maximum sustainable withdrawal rates for US retirees over 20-year periods, along with the asset allocation supporting this:

And here is Japan's case. Interestingly, for fixed 20-year asset allocations, Japanese retirees would be best served by abandoning stocks if they retired in the late 1980s.

And finally, here is the time path of these 20-year withdrawal rates for both Americans and Japanese using a fixed 50-50 asset allocation of stocks and bonds.

For Japanese retiring at the start of the Lost Decades, withdrawal rates get low, but didn't fall as low as at various times in the past. Deflation must have helped a bit. The withdrawal rates were lower for the American retirees in the 1960s who faced intense inflation after their retirements. This does leave some hope for recent US retirees, as if inflation can remain low, it could help support higher withdrawal rates than I find with my predictions in the "Can We Predict the Sustainable Withdrawal Rate for New Retirees?" paper. I did list this "inflation issue" as a caveat in my paper. In Todd's article, he doesn't seem particularly optimistic about the prospects for inflation remaining low though.

Safety of the 4% Retirement Withdrawal Rate Rule

2011-10-23T12:51:00.000+09:00

Todd Tresidder has posted a new article called, "Are Safe Withdrawal Rates Really Safe?" at his Financial Mentor website.

I think the article is quite effective in explaining a lot of the concerns about recent American retirees treating 4% as a safe withdrawal rate.

Retirees and Utility Maximization

2011-10-20T00:49:00.000+09:00

The online section of Financial Advisor magazine has published my article, "Retirees and Utility Maximization." I mention that title because I've been using the title a lot in the past, though the editors changed the title of the published version to "New Research Challenges the 4% Rule."

Here is the link to the article.

In the article I try to explain the findings and the importance of Duncan Williams and Michael Finke's article, “Determining Optimal Withdrawal Rates: An Economic Approach” from the Fall 2011 issue of Retirement Management Journal.

Please have a look.

A few days ago, a wrote a post, "Are high failure rates acceptable for retirees?" which is really a follow-up to this Financial Advisor piece.

I think these findings provide an important new perspective about retirement planning.

October 2011 JFP: Getting on Track for a Sustainable Retirement

2011-10-18T14:08:00.000+09:00

I've published an article, "Getting on Track for a Sustainable Retirement: A Reality Check on Savings and Work" in the current October 2011 issue of the Journal of Financial Planning. I'd like to think that with some further development, the methodology outlined in this article can provide a useful contribution to the field of retirement planning. I finished writing the article at the end of June, and I discussed it here then, but these days have been working on other issues.

CanadianInvestor, who runs a blog named How to Invest Online, has written up an excellent summary of the article. I couldn't have said things better myself, so let me refer you to his/her (?) write-up if you are looking for a brief summary of the article, accompanied by extra interpretations with which I fully agree.