Wise wise wise...

Fixing A Broken Retirement Withdrawal Plan
William Bengen

"This case illustrated an inflationary episode of unprecedented severity (at least for the U.S.) coupled with poor investment returns. Had no remedial measures been taken, the portfolio would have been exhausted in just 17 years. This underscores the need for early and decisive adjustments when a high-inflation regime appears. In my opinion, high inflation, not stock markets, is the gravest threat to the viability of retirement plans. This nightmare scenario of high inflation and low returns would have required an initial withdrawal rate of 3.6% to sustain the portfolio over 30 years. Had it been real, it would have redefined “SAFEMAX” (currently 4.5%) for the high-inflation regime." [my emphasis]

comments:

- I have often disdained people that suggest greater than 4% withdrawal rates for 65 and younger

- Some retirement writers are often spectacularly cavalier about 4% or even higher spend rates

- I have shown that simulated retirements that start in 1969 can suck (high inflation and crappy returns)

- I have come up with my own conservative spending rate formulas for early retirees

- I have simulated high inflation regimes that will destroy retirements

- I have pointed out, I think, that sequence of returns risk can be dwarfed by inflation effects...

So I am gratified now to see that Bill Bengen, of all people, throws out something less than 4% here.  Note that he is still talking here about a fixed period of <= 30 years.   So, what would a safe rate be if one is 50 with 50 years to go?!?  So, I guess I am feeling pretty good about my RH40 formula [age / (40 - age/3)] as an age based proxy for spending. In the case of a 65 year old it yields a 3.5% spend rate which is pretty close to Bills new estimate.  Kitces's comments on this are on the money:

...nonetheless, given that the longer the retiree waits to make adjustments, the more extreme they have to be, active monitoring to make mid-course adjustments is arguably the more appealing path.

Active monitoring, which was always the answer, shows up again!

See you in a week or so...

Happy Holidays
That's a Carleton College T-shirt, btw
Go Knights

Weekend Links - 12/21/2017

QUOTE OF THE DAY

...when you’re dealing with uncertainty and complexity, simple ideas are not dumbed-down ideas. They are often complex solutions gift wrapped for you in a way that makes their application practical and sustainable. .  Morgan Housel 

RETIREMENT FINANCE AND PLANNING

The Best Strategy for Retiring Without Adequate Savings. Joe Tomlinson

Most research on retirement strategies assumes that people have saved adequately. But data on household savings shows that many households fall short, and will need to call on relatives or other sources for support. This raises questions about the best withdrawal or annuity strategies when savings are insufficient. It turns out that which strategy works best is different than for adequately funded retirements. 

The Modern Tontine: An Innovative Instrument for Longevity Risk Management in an Aging Society; Weinert & Gründl. Goethe U

We show that partial tontinization of retirement wealth can serve as a reliable supplement to existing pension products. 

LDI Misapplied - Income Portfolios and Liability-Driven Investing, David Blanchett

Liability-driven investing (LDI)—in particular liability-relative optimization—represents a fundamental improvement over more common asset-only portfolio optimization techniques, such as mean-variance optimization. Almost all portfolios exist to pay for some future form of consumption, so liability-relative optimization is almost always more appropriate than asset-only approaches. By considering liability characteristics when solving for the asset allocation, LDI techniques take advantage of the natural hedging quality of certain investments. 

Tomlinson on hard retirements

From The Best Strategy for Retiring Without Adequate Savings. Joe Tomlinson, AdvisorPerspectives

• "Most research on retirement strategies assumes that people have saved adequately. But data on household savings shows that many households fall short, and will need to call on relatives or other sources for support. This raises questions about the best withdrawal or annuity strategies when savings are insufficient. It turns out that which strategy works best is different than for adequately funded retirements. 

• ...unlike most retirement research where we look for ideal solutions, here we will try to find the “least-bad” alternative. I’ll assume that retirement shortfalls will need to be funded by relatives. This will broaden our focus beyond the retiree, since we need to evaluate financial consequences for the contributing relatives." 

• "The lowest-risk 5th percentile balance is at 25% stocks and the additional risk from increasing the stock allocation is somewhat more severe. However, the risk at 75% stocks is not dramatically greater than at 25%, so a heavy stock allocation still makes sense, although going all the way to 100% may be too chancy." 

• "If the 5th percentile numbers based on stock/bond mixes cause too much concern, a possible strategy is to accept defeat and purchase an inflation-adjusted SPIA. In this case the relatives would pay a monthly or annual allowance to make up the shortfall...The result would be a sure loss for the relatives, but more predictable than using stock/bond mixes...The SPIA strategy clearly wins out over a conservative strategy with a heavy bond allocation, but compared to utilizing a heavy stock allocation, there is more of a risk/reward tradeoff. "

Hindsight 8: The mis-allure of the constant spending plan

This is neither a technical or an analytic post nor is it a dissection of the 4% rule, a dissection that has been done a million times before by others better than me.  And don't get me wrong, given the chance for a lifetime of constant income/spending adjusted for inflation I'd be in.  I just don't have that in my future.  Anything I make of what I have at this age is all of my own design and decisions.  The idea of any constant set-and-forget constant approach is appealing but deceiving and I've had enough time looking at retirement finance to see the mis-allure a little better.  Not perfectly, just better.  The point of the post is to provide some slightly impressionistic thoughts on why I look elsewhere for my retirement solutions.

Weekend Links - 12/14/2017

QUOTE OF THE DAY

“Nothing focuses your mind like a drawdown,”  Kharitonov in WSJ 

RETIREMENT FINANCE AND PLANNING

The Return You Need, Dirk Cotton

as the liability's due date approaches, its far safer to begin shifting to lower duration, lower yielding, liability-matching assets… You can drown in a river that averages a foot deep and you can go broke in a market that averages 9% returns over the long-term. 

When Can I Afford to Retire and When Should I Commence my Social Security Benefits? Ken Steiner

Continuing to work is generally going to be the most effective way of increasing your retirement spending budget. 

Behavioral Impediments to Valuing Annuities: Evidence on the Effects of Complexity and Choice Bracketing; Brown, Kapteyn, Luttmer, Mitchell, Samek.

This paper examines two behavioral factors that diminish people’s ability to value a lifetime income stream or annuity, drawing on a survey of about 4,000 adults in a U.S. nationally representative sample. Our first main finding is that experimentally increasing the complexity of the annuity choice reduces respondents’ ability to value the annuity. We measure lack of ability to value an annuity by the difference between the sell and buy values people assign to the annuity. Our second main result is that people’s ability to value an annuity increases when we experimentally induce them to think jointly about the annuitization decision and about the decision of how quickly or slowly to spend down assets in retirement. Accordingly, we conclude that narrow choice bracketing is an impediment to annuitization, yet the impediment can be lessened with a relatively straightforward intervention. 

Is early retirement a realistic dream? Vanguard

I don’t have any sage advice for planning a wedding. (I’m afraid I wasn’t even much help planning my own.) But I do know that when it comes to planning for an early retirement, the earlier you start, the better off you’ll be.  

Hindsight 7: Embracing both the tech and the math

I've been working with spreadsheets on and off for 30 years, literally.  In 1987 I started to use Lotus 123 for the first time in my first year of grad school. I even had one of the first retail-friendly portables about the size of a decent sized woman's purse. It had those big giant floppy disks. (usually around this time I'll mention that I had to use a slide rule in what they now call middle school; I have to go to google images to prove to my kids there was such a thing). That spreadsheet skill plus a little finance knowledge carried me pretty far through however many careers I've had so far.

Hindsight 6: Household balance sheet

"Finally, the rank ordering of "feasibility" [1] before "sustainability" before "investment performance" is an ongoing discussion..." Collins and Gadenne 2017

This quote is in a must-read piece by Francois Gadenne and Patrick Collins titled “The Shapes Of Retirement Planning: Are You A Curve, A Triangle, Or A Rectangle” a well informed discussion (and literature review) of an integrative proto-methodology for tying together disparate domains of retirement finance like MPT, behavioral finance, and what we can call the balance sheet approach. Their paper was also recently covered at Kitces.com here.  Now Gadenne and Collins I trust, but when they point to people in the industry (that I probably don't trust) that are debating or "discussing" the question of the primacy or non-primacy and rank ordering of something like a balance sheet (call it feasibility here) amongst other planning frameworks like sustainability or portfolio performance, my first thought was "who are 'they' and have 'they' lost their minds?  I realize here that I am conflating the household balance sheet with the feasibility studies that that instrument enables but work with me here for a minute.

Senate Tax Proposal

I detest both conflict and politics.  I will note, however, that the senate tax proposal for first-in-first-out tax treatment of capital gains would suck for retirees.  This is one time I would feel compelled to write or call my senator.  Working and saving for a lifetime and taking care of oneself thereafter does not always seem to get the respect and consideration it deserves.  Taking from the old and human-capital-less to give to the profligate seems a bully's game as it surely is.

Hindsight 5: early retirement vs not-early retirement

One of the consistent themes in my posts has been harping on the difference between two types of retirements: early and traditional.  I no longer think the differences are quite so stark as I used to at least in the private economy where I think at some point all private or independently employed retires are headed towards the moral equivalent of early retirement the way I am thinking about it: laid off early by a robot, no pension except the one you make yourself, no paid-for health care, side gigs, extreme longevity horizons, etc.  Public employees with pensions are a different story not told here.

My top 8 all-time posts in order of clicks

I don't think this is the "best of" it's just blogger.com keeping count:

• The 2017 RiversHedge 20 Best-of Awards Oct 13, 2017
• On the affinities between hurricanes and retirement Sep 13, 2017
• Bitcoin madness Nov 19, 2017
• On diminishing returns of financial modeling complexity Sep 25, 2017
• What I use in my own process - draft 1 Oct 22, 2017
• Trend Following Can Enhance Withdrawal Rates Aug 17, 2017
• Some Initial Thoughts on the "Divide by 20" Idea  Jul 6, 2016
• Seven Years of Investing in Peer-to-Peer Lending  Jun 3, 2016

Hindsight 4: The funky-ness of geometric returns in a multi-period setting

This is not a tutorial on arithmetic vs geometric returns.  For that there are some other great resources. Start with Wikipedia.  There are also a number of great covers of geometric returns. In particular I'm thinking of papers by Michaud, Mindlin, and Meucci.[1]  Even Markowitz's new book has a great cover in chapter 3 of vol 1. There are others.  My point here in this post is that it took me a while to get the hang of how geometric returns work over a multi-period time frame.[2]  I started the journey when I was creating a mean-variance thing. I say thing because it wasn't really an optimizer, just a tool to look back using historical data to contextualize some trading strategies.  At the time I didn't know if I should use arithmetic or geometric (compound) returns as input.  I asked around and got conflicting answers.  The debate, such that it was, was solved when I read Markowitz:  "[while] in the long run one gets the geometric mean return, not the arithmetic mean return...the inputs to a mean-variance optimizer must be the (estimated forthcoming) expected (that is, arithmetic mean) returns rather than the (estimated forthcoming) geometric mean returns. This is because it is true that the expected (or arithmetic mean)  value of a weighted sum of random variables is the weighted sum of of their expected values...but it is not true that the geometric mean of a weighted sum is the weighted sum of their geometric means." His parentheses and emphasis.

That settled that.  But I was interested in more and worked through Michaud, Mindlin , Meucci and some others like Bernstein on geometric frontiers .  I did some spreadsheets.  I wrote some simulation programs isolating geometric returns. I rewrote the programs to consider, like a good retiree, spending.  After that I just tried to pay attention to what I was doing and what others were writing.

Weekend Links - 12/7/2017

Reminder: Pearl Harbor Day

QUOTE OF THE DAY

Even the most pessimistic forecasts of household undersaving fall short of the most optimistic estimates of government retirement plan underfunding. Andrew Biggs 

RETIREMENT FINANCE AND PLANNING

It’s Not About the Money- On Lifestyle Diversification in Retirement, ofdollarsanddata

I understand the skepticism you may have listening to a 27 year old financial blogger tell you that retirement isn’t only about the money. However, the fact remains that once you have some base level of financial security, your day to day happiness in retirement will be more heavily impacted by your relationships, your hobbies, and your sense of purpose than your financial assets. I completely relate to this as my day to day happiness is effected far more by my dating life and blogging life than what is happening with the S&P 500. 

Hindsight 3: ruin risk as the pairing of two separate and independent things

I've spent a little bit of time over the last seven years thinking about ruin rate estimates, from the first scare I got as a novice retiree from an institutional service I used back in 2010 to playing with several different forms and styles of simulation to my recent completion (2017) of an R-script flexible ruin estimator that looks like it satisfies the Kolmogorov "lifetime probability of ruin" PDE (except I get to be a little more flexible in using non-normal return distributions).   In first-cut "hindsight" terms it's really simple: I never thought about the problem as involving two separate and independent probability distributions that represented two separate and independent real world processes:  1) portfolio longevity (with consumption) in years, and 2) conditional survival probability for a given start age.

Hindsight 2: the continuous unstable present vs the future

I used to imagine that retirement planning was all about the future.  This is a forgivable illusion of course (at least when starting out) because one is forced, when planning, to think about things like planning horizons, death dates, future long term care costs, simulations of future spending and returns, bequests to heirs at death, fear of running out of money some day, social security start dates and so forth.  It took me a while to dial back this impulse to if not try to predict at least project oneself too far into the future, a future that doesn't really exist and won't look like the future you expected if and when you get there.   This future-think is important of course and needs to be examined but once that has occurred I think the day-to-day practice of retirement becomes a different game.