Wade Pfau on Modern Retirement Theory at Forbes

A recent article by Wade Pfau in Forbes covering the work of Jason Branning and M. Ray Grubbs (Modern Retirement Theory) treads little new ground in retirement finance yet I found much of the article worth highlighting here.  These are important points that often get overshadowed when we discuss things like asset allocation, safe withdrawal rates, Social Security deferral, etc. 

As Mr. Pfau recapitulates Branning and Grubbs MRT so I recapitulate his article here in bullet points.  There are probably enough highlights here that you might be better served going to the original article: What Is A Safety-FirstRetirement Plan?  On the other hand I think that each point here is worth contemplating individually. As quoted from the text of the article:

• A truly safe withdrawal rate is unknown and unknowable

• Academics have studied these models [how people allocate their resources over a lifetime to maximize lifetime satisfaction] since the 1920s to figure out how rational people make optimal decisions. In the retirement context, the question to be answered is how to get the most lifetime satisfaction from limited financial resources. It is the basic fundamental question of economics: How do you optimize in the face of scarcity? … Nobel Prize winners such as Paul Samuelson, Robert Merton, Franco Modigliani, and William Sharpe have explored these models. [for what it's worth, William Sharpe once called retirement income planning "the hardest problem I've ever looked at"]

• In 1991, Nobel laureate and MPT founder Harry Markowitz wrote about how MPT was never meant to apply to the investment problems of a household. Rather, it was for large institutions with indefinite lifespans and no specific spending objectives for the portfolio. This should have been a eureka moment for the entire retirement income industry, but MPT is still misapplied today…MPT does not address this more complicated issue [i.e., retirement and finite lifespans]. " [emphasis added] 

• Another important aspect of the investment approach for the safety-first school is that investing decisions are made in the context of the entire household balance sheet... This moves beyond looking only at the financial portfolio to consider also the role of human and social capital.  [emphasis added]

• Stated again, the objective of investing in retirement is not to maximize risk-adjusted returns, but first to ensure that basics will be covered in any market environment and then to invest for additional upside. 

• Retirees only receive one opportunity to obtain sustainable cash flows from their savings (one “whack at the cat” as Michael Zwecher has memorably described it) and must develop a strategy that will meet basic needs no matter the length of life or the sequence of post-retirement market returns and inflation.  Retirees have little leeway for error, as returning to the labor force might not be a realistic option. [emphasis added]

• Failure should not be an option when meeting basic needs. Thus, income annuities serve as a fundamental building block for retirement income. 

• Individual retirees cannot self-insure to protect from longevity risk, and without annuitization they are obliged to plan for a long lifespan…A retiree seeking to self-annuitize must assume a time horizon extending well beyond life expectancy (such as thirty years with the 4% rule), to better hedge against the consequences of living beyond their planning age. A retiree must spend less when on the self-annuitize path. [emphasis added]