Asset Allocation Glidepath During Retirement

Transcription

1 Asset Allocation Glidepath During Retirement Wade D. Pfau, Ph.D., CFA The American College McLean Asset Management instream Solutions Retirement Researcher blog (wpfau.blogspot.com)

2 Asset Allocation Methods for Retirement Safe Withdrawal Rates and Fixed Asset Allocations Traditional and Rising Equity Glidepaths Valuation-Based Asset Allocation Valuation-Based Glidepaths Funded Ratio and Asset-Liability Management

3 Safe Withdrawal Rates & Fixed Aggressive Allocations

4 The 4% Rule Aggressive Fixed Allocations & Sequence Risk William Bengen Journal of Financial Planning, October 1994

5 Basis for the 4% Rule Figure 2.1 Maximum Sustainable Withdrawal Rates For 50/50 Asset Allocation, 30-Year Retirement Duration, Inflation Adjustments, No Fees Using SBBI Data, , S&P 500 and Intermediate-Term Government Bonds 9 8 Maximum Sustainable Withdrawal Rate SAFEMAX Retirement Year

6 Basis for the 4% Rule: Asset Allocation Maximum Sustainable Withdrawal Rate Figure 2.2 Maximum Sustainable Withdrawal Rates For Various Asset Allocations, 30-Year Retirement Duration, Inflation Adjustments, No Fees Using SBBI Data, , S&P 500 and Intermediate-Term Government Bonds % Stocks 25% Stocks 50% Stocks 75% Stocks 100% Stocks Retirement Year

7 Basis for the 4% Rule 4.5 Figure 2.3 Connection Between SAFEMAX and Stock Allocation 30-Year Retirement Duration, Inflation Adjustments, No Fees Using SBBI Data, , S&P 500 and Intermediate-Term Government Bonds SAFEMAX Stock Allocation

8 Basis for the 4% Rule Median Bequest (Remaining Real Wealth / Retirement Date Wealth) Figure 2.4 Connection Between Median Bequest and Stock Allocation 30-Year Retirement Duration, Inflation Adjustments, No Fees Using SBBI Data, , S&P 500 and Intermediate-Term Government Bonds Stock Allocation

9 Basis for the 4% Rule Withdrawal Rate Distribution Figure 2.5 Distribution of Withdrawal Rates by Stock Allocation 30-Year Retirement Duration, Inflation Adjustments, No Fees Using SBBI Data, , S&P 500 and Intermediate-Term Government Bonds Maximum Median Minimum (SAFEMAX) Stock Allocation

10 Monte Carlo Simulations

11 Sequence Risk Most vulnerable to returns when wealth is largest Pre-retirement dollar cost averaging reverses in distribution phase

12 Problems with 4% Rule Incongruity of funding a smooth spending stream from a volatile portfolio this is a unique cause of sequence of returns risk Solutions: Let spending fluctuate or lower the volatility

13 Traditional & Rising Equity Glidepaths

14 Rising Equity Glidepaths (with Michael Kitces) Journal of Financial Planning, January 2014

15 Traditional Target Date Funds To Retirement 100% 80% Bonds Stock Allocation 60% 40% 20% Stocks 0% Years Before Retirement Years After Retirement

16 Traditional Target Date Funds Through Retirement 100% 80% Bonds Stock Allocation 60% 40% 20% Stocks 0% Years Before Retirement Years After Retirement

17 Financial Planning: Maintain High Stock Allocation 100% 80% Bonds Stock Allocation 60% 40% 20% Stocks 0% Years Before Retirement Years After Retirement

18 Target Date Funds Rising Equity Glidepath 100% 80% Bonds Stock Allocation 60% 40% 20% Stocks 0% Years Before Retirement Years After Retirement

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21 100 Fixed 45% Stock Allocation 100 Fixed 60% Stock Allocation Traditional (Declining) Equity Glidepath Reverse Equity Glidepath Stock Allocation Accelerated Traditional Equity Glidepath 100 Accelerated Rising Equity Glidepath Years Since Retirement

22 Table 1 Historical SAFEMAX for Different Asset Allocation Strategies over 30-Year Retirement Periods Stocks/Bills Asset Allocations Stocks/Bonds Asset Allocations Fixed 45% Stocks Fixed 60% Stocks Rising Equity Glidepath Traditional (Declining) Glidepath Accelerated Rising Equity Glidepath Accelerated Traditional (Declining) Glidepath Note: The rising equity glidepath transitions from 30.5% stocks to 59.5% stocks over a 30-year period. The traditional equity glidepath transitions from 59.5% stocks to 30.5% stocks over a 30-year period. The accelerated versions of the glidepaths make the same allocation transitions over 15 years (see Figure 1 for an illustration).

23 12 Figure Maximum Sustainable Withdrawal Rates (MWR) For Stocks and Bills, 30-Year Retirement Periods Maximum Sustainable Withdrawal Rate Difference (Nonfixed - Fixed) Fixed 45/55 Asset Allocation Accelerated Rising (30 -> 60) Equity Glidepath Retirement Year (MWR for Non-Fixed Strategy) - (MWR for Fixed Strategy) Retirement Year

24 Table 2 Historical SAFEMAX for Different Asset Allocation Strategies over 30-Year Retirement Periods Segmented by PE10 Market Valuation Levels at the Retirement Date Using Stocks/Bills Undervalued Fairly Valued Overvalued Fixed 45% Stocks Fixed 60% Stocks Rising Equity Glidepath Traditional (Declining) Glidepath Accelerated Rising Equity Glidepath Accelerated Traditional (Declining) Glidepath Using Stocks/Bonds Fixed 45% Stocks Fixed 60% Stocks Rising Equity Glidepath Traditional (Declining) Glidepath Accelerated Rising Equity Glidepath Accelerated Traditional (Declining) Glidepath Note: The note in Table 1 explains the allocations for the various glidepaths. The asset allocations in Figure 1 indicate which years are treated as undervalued (high stock allocation), fairly valued (medium stock allocation), and overvalued (low stock allocation).

25 Valuation-Based Asset Allocation

26 Valuation-Based Asset Allocation & Sustainable Withdrawal Rates Journal of Financial Planning, April 2012 (article link)

27 Robert Shiller s PE10

28 Minimum Necessary Savings Rates for 12.5x Wealth (Percentage of Salary) Figure 4 For 60/40 Asset Allocation, 30-Year Work Period, 30-Year Retirement Period Comparing MSRs and E10/P at Retirement Year Comparing MWRs and E10/P at Retirement Year MSR = * E10/P R 2 = E10/Y overvalued undervalued Maximum Sustainable Withdrawal Rates (Percentage of Wealth) MWR = * E10/P R 2 = E10/P overvalued Comparing MSRs and MWRs by Retirement Year undervalued Maximum Sustainable Withdrawal Rates (Percentage of Wealth) MWR = * MSR R 2 = Minimum Necessary Savings Rates for 12.5x Wealth (Percentage of Salary)

29 45 Figure 2 PE10 Historical Data with Graham and Dodd Asset Allocation Decision Rule PE Low Stock Medium Stock High Stock Stocks Percentage Year Time Path for Asset Allocation Fixed 45/55 Asset Allocation Graham and Dodd Valuation-Based Asset Allocation Year

30 12 Figure Maximum Sustainable Withdrawal Rates (MWR) Using Stocks and Bills For Fixed and Valuation-Based Asset Allocation, 30-Year Retirement Periods Maximum Sustainable Withdrawal Rate Difference (VBAA - Fixed) Fixed 45/55 Asset Allocation Graham and Dodd Valuation-Based Asset Allocation Retirement Year (MWR for Valuation-Based Strategy) - (MWR for Fixed Strategy) Retirement Year SAFEMAX Fixed 50/50: 3.83% Valuation-Based: 4.2%

31 Valuation-Based Glidepaths

32 Defining Valuation-Based Glidepaths Bounded Valuation-Based Rising Glidepath Follows Glidepath with ±15% valuation adjustment But valuation-adjusts cannot lead to allocation about 30-60% range Bounded Valuation-Based Traditional Glidepath Follows Glidepath with ±15% valuation adjustment But valuation-adjusts cannot lead to allocation about 30-60% range Unbounded Valuation-Based Rising Glidepath Follows Glidepath with ±15% valuation adjustment Allows stock allocations to potentially range from 15% to 75% Unbounded Valuation-Based Traditional Glidepath Follows Glidepath with ±15% valuation adjustment Allows stock allocations to potentially range from 15% to 75%

33 Table 3 Historical SAFEMAX for Different Asset Allocation Strategies over 30-Year Retirement Periods Segmented by PE10 Market Valuation Levels at the Retirement Date Using Stocks/Bills Undervalued Fairly Valued Overvalued Fixed 45% Stocks Fixed 60% Stocks Rising Equity Glidepath Traditional (Declining) Glidepath Accelerated Rising Equity Glidepath Accelerated Traditional (Declining) Glidepath Valuation-Based Allocation: Bounded Valuation-Based Rising Glidepath Bounded Valuation-Based Traditional Glidepath Unbounded Valuation-Based Rising Glidepath Unbounded Valuation-Based Traditional Glidepath

34 12 Figure Maximum Sustainable Withdrawal Rates (MWR) For Stocks and Bills, 30-Year Retirement Periods Maximum Sustainable Withdrawal Rate Difference (Nonfixed - Fixed) Fixed 45/55 Asset Allocation Unbounded Valuation-Based Traditional (60 -> 30) Equity Glidepath Retirement Year (MWR for Non-Fixed Strategy) - (MWR for Fixed Strategy) Retirement Year

35 Funded Ratio and Asset-Liability Management

36 (1) Funded Ratio Management Corporate pension funds & individual retirement Do Household Assets Exceed Liabilities? Assets: Resources Available to Fund Liabilities: current financial assets, home, future income, Social Security, etc. Liabilities: Planned expenditures over lifetime Present value: lifetime income and expenses discounted and summed to a single number Overfunded, Funded, and Underfunded

37 Michael Zwecher, Retirement Portfolios: Theory, Construction, and Management

38 Household Balance Sheet Assets Liabilities (Present Values) Human Capital Financial Capital Social Capital Legacy Discretionary Contingency Fixed

39 Calculating the Value of $10,000 Income Stream for a 65-Year Old Male Discount Rate: 2% Age Income Discount Factor Discounted Value of Income Survival Probabilities* Survival- Weighted Discounted Value 65 $10, $10, $10, $10, $9, $9, $10, $9, $9, $10, $9, $8, $10, $9, $8, $10, $9, $8, $10, $8, $7, $10, $8, $7, $10, $8, $7, $10, $8, $6, $10, $8, $6, $10, $8, $6, $10, $7, $5, $10, $7, $5, $10, $7, $4, $10, $7, $4, $10, $5, $ $10, $4, $ $10, $4, $ $10, $4, $ $10, $4, $7 Present Value of the Annuity = Sum of Survival-Weighted Discounted Values: $147,816 *Survival Probabilities are calculated from the Social Security Administration's 2009 Period Life Table.

40 Lifetime Financial Plan (in Inflation-Adjusted Terms) for the Brady Family (Social Security at 66) Income Spending Year Age Labor Income Pension Social Security Essential Discretionary $0 $6,000 $54,000 $60,000 $40, $0 $5,854 $54,000 $60,000 $40, $0 $5,711 $54,000 $60,000 $40, $0 $5,572 $54,000 $60,000 $40, $0 $5,436 $54,000 $60,000 $40, $0 $5,303 $54,000 $60,000 $40, $0 $5,174 $54,000 $60,000 $40, $0 $5,048 $54,000 $60,000 $40, $0 $4,924 $54,000 $60,000 $40, $0 $4,804 $54,000 $60,000 $40, $0 $4,687 $54,000 $60,000 $40, $0 $4,573 $54,000 $60,000 $40, $0 $4,461 $54,000 $60,000 $40, $0 $4,353 $54,000 $60,000 $40, $0 $4,246 $54,000 $60,000 $40, $0 $4,143 $54,000 $55,000 $35, $0 $4,042 $54,000 $55,000 $35, $0 $3,943 $54,000 $55,000 $35, $0 $3,847 $54,000 $55,000 $35, $0 $3,753 $54,000 $55,000 $35, $0 $3,662 $54,000 $55,000 $35, $0 $3,572 $54,000 $55,000 $35, $0 $3,485 $54,000 $55,000 $35, $0 $3,400 $54,000 $55,000 $35, $0 $3,317 $54,000 $55,000 $35, $0 $3,236 $54,000 $55,000 $35, $0 $3,157 $54,000 $55,000 $35, $0 $3,080 $54,000 $55,000 $35, $0 $3,005 $54,000 $55,000 $35, $0 $2,932 $54,000 $55,000 $35,000

41 Analysis for the Brady Family 66) Funded Ratio Based on Planning Age of 95 Discount Rate (in Inflation-Adjusted Terms) 1.5% Total Assets $2,198,787 Current Financial Assets $800,000 Labor Income $0 Pension $105,601 Social Security $1,293,186 Total Liabilities $2,288,539 Essential Spending $1,383,749 Discretionary Spending $904,791 Funded Ratio (Assets / Liabilities) 0.96 * Discount rate is 30-Year TIPS yield on Jan. 6, 2014

42 Lifetime Financial Plan (in Inflation-Adjusted Terms) for the Brady Family (Social Security at 70) Income Spending Year Age Labor Income Pension Social Security Essential Discretionary $0 $6,000 $0 $60,000 $40, $0 $5,854 $0 $60,000 $40, $0 $5,711 $0 $60,000 $40, $0 $5,572 $0 $60,000 $40, $0 $5,436 $71,280 $60,000 $40, $0 $5,303 $71,280 $60,000 $40, $0 $5,174 $71,280 $60,000 $40, $0 $5,048 $71,280 $60,000 $40, $0 $4,924 $71,280 $60,000 $40, $0 $4,804 $71,280 $60,000 $40, $0 $4,687 $71,280 $60,000 $40, $0 $4,573 $71,280 $60,000 $40, $0 $4,461 $71,280 $60,000 $40, $0 $4,353 $71,280 $60,000 $40, $0 $4,246 $71,280 $60,000 $40, $0 $4,143 $71,280 $55,000 $35, $0 $4,042 $71,280 $55,000 $35, $0 $3,943 $71,280 $55,000 $35, $0 $3,847 $71,280 $55,000 $35, $0 $3,753 $71,280 $55,000 $35, $0 $3,662 $71,280 $55,000 $35, $0 $3,572 $71,280 $55,000 $35, $0 $3,485 $71,280 $55,000 $35, $0 $3,400 $71,280 $55,000 $35, $0 $3,317 $71,280 $55,000 $35, $0 $3,236 $71,280 $55,000 $35, $0 $3,157 $71,280 $55,000 $35, $0 $3,080 $71,280 $55,000 $35, $0 $3,005 $71,280 $55,000 $35, $0 $2,932 $71,280 $55,000 $35,000

43 Analysis for the Brady Family 70) Funded Ratio Based on Planning Age of 95 Discount Rate (in Inflation-Adjusted Terms) 1.5% Total Assets $2,338,000 Current Financial Assets $800,000 Labor Income $0 Pension $105,601 Social Security $1,432,399 Total Liabilities $2,288,539 Essential Spending $1,383,749 Discretionary Spending $904,791 Funded Ratio (Assets / Liabilities) 1.02 * Discount rate is 30-Year TIPS yield on Jan. 6, 2014

44 Response to Underfunded Status 1. Increase Assets (earn more, work longer, delay Social Security) 2. Decrease Liabilities (reduce spending) 3. Earn Higher Investment Returns (higher discount rate but risky) 4. Monetize Mortality (income annuity)

45 Modern Retirement Theory by Jason K. Branning, CFP and M. Ray Grubbs, Ph.D. Legacy Fund Assets Funding Priority Fund for Discretionary Expenses Contingency Fund Fund for Essential Needs

46 Investment Approach Asset-liability matching. Assets are matched to goals so that risk levels are comparable. Lifetime spending potential is the focus, not maximizing wealth Volatile assets are not appropriate for basic needs or contingency fund

47 Funded Ratio and Asset Allocation Pittman, Sam, and Rod Greenshields Adaptive Investing: A Responsive Approach to Managing Retirement Assets. Retirement Management Journal 2, 3 (Fall):

48 Safer withdrawal plan Source:

49 Asset Allocation and Funded Ratio in Practice Journal of Financial Planning, February 2013 (article link)

50 Spending ($) Dedicated Portfolio Distributions Time Segmentation Lifestyle Goal Dedicated Income Diversified Portfolio Age

51 Spending ($) Dedicated Portfolio Distributions Essentials vs. Discretionary Lifestyle Goal Diversified Portfolio Basic Needs Dedicated Income Age

52 Systematic Withdrawals Product Allocation Variable Annuities with Guaranteed Living Benefit Riders (GLWBs) Immediate Annuities (SPIAs & DIAs)

53 Real Value of Financial Assets at Death (Median Outcome) as a Percentage of Retirement Date Assets Figure Retirement Income Frontier for a 65-Year Old Couple With a 6% Lifestyle Goal, a 6% Minimum Needs Threshold, and a 2% Social Security Benefit As a Percentage of Retirement Date Assets (100,0) (0,100) (90,10) (90,10) (10,90) (80,20) (70,30) (20,80) (80,20) (60,40) (50,50) (40,60) (30,70) (70,30) (20,80) (10,90) Percentage of Lifetime Spending Needs Which Are Satisfied (10th Percentile Outcome) (60,40) Frontier: (% Stocks, % Bonds) Frontier: (% Stocks, % Fixed SPIAs) Other Product Allocation Combinations (50,50) (40,60) (30,70) (0,100)

54 Thank you! Any Questions? Wade D. Pfau The American College McLean Asset Management instream (Twitter) wpfau.blogspot.com (Retirement Researcher Blog)