Withdrawal Rates
Asset Allocation
Asset Returns and Expenses
Decision Rules
Retirement Profiles
Other Models
Q:
Is the software you've
developed available for purchase for us to use in our planning practices?
A: Yes, you can order Retirement Quant
here
Withdrawal Rates
Q:
Your withdrawal rate is significantly higher than Mr. Bengen's. Can you
elaborate?
A: This
is because Mr. Bengen did not use decision rules when doing his research.
Decision rules are designed to rescue poor performing portfolios. This
allows one to start with a higher initial withdrawal rate and plan to cut
back if the financials require it.
Q:
You mention using the
"Withdrawal Rule" in year's following a market downturn. Can you briefly
explain that rule and an application/example?
A: The original Withdrawal
Rule proposed by Guyton said that in years where your portfolio had a
negative return, you would freeze your income level at the prior year’s
amount. You would never recover freeze but continue from that point
going forward. When we modeled that rule, it became clear that that
rule was overly harsh. If your portfolio had a negative return but
your withdrawal rate was, say only 1%, it would seem silly to deprive
yourself of a cost of living adjustment. The rule was modified to take
effect only if your portfolio had a negative return and your initial
withdrawal rate was higher than your initial rate.
Q:
We have dealt with 30 and 40 years, and seen that lowering from 40 to 30
years does not make any significant difference in raising the IWR. My
question is, would there be even less of a difference if we tried to stretch
this to 50 years?
A: One can try it easily
enough using Retirement Quant. Simply change the expected lifetime in
the assumptions.
Q:
What is the impact on the withdrawal rates if an advisor charges 1% of the
assets?
A: It is the same as if the
median return of all assets was reduced by 1%. You can model any basis
point change in returns using Retirement Quant’s Return Sensitivity function
and see the effect on the success rate, withdrawals, etc.
Q:
Did you do the withdrawals in a lump sum once a year? When did you
rebalance?
A: Withdrawals were made once
at the beginning of a simulated year. Rebalancing was done then also.
Q:
When dealing with clients who have most of the assets in qualified plans,
how do you handle the increasing RMD withdrawals late in retirement when
they begin to exceed the IWR? Can this have an impact?
A: Tax implications and
strategies were not modeled. It is assumed that taxes are paid out of
withdrawals and so the model deals with establishing a retirement income
level. Taxes certainly do have an impact that is complex and probably
unique to each situation.
Asset Allocation
Q: At what point in
this process does one select specific funds to achieve the stated
allocations and how is it done?
A: The simplest and arguably the best approach to try to reproduce the
results of the model is to buy index funds or ETFs that match the asset
class. For example, there are many mutual funds that track the various
large and small cap, growth and value equity indices as well as REIT and
international indices.
Q:
Are the test portfolios rebalanced periodically throughout the period?
A:
In the earlier paper, portfolio balancing is determined by the Portfolio
Management Decision Rule. In my subsequent paper, I modeled portfolios
with rebalancing every year. Retirement Quant allows you to choose
either one of those strategies, a rule called the “Fastest Horse” strategy,
or a rule which rebalances the stock/bond allocation each year as a function
of your age (more bonds and less stocks as you get older).
Q:
In looking at the asset
allocation variable in determining retirement withdrawals, what are your
thoughts on incorporating some exposure to alternative asset classes such as
commodities, private equity, equipment leasing, etc.? Do you think
incorporating these alternatives could increase the IWR or improve the POS?
A: Adding uncorrelated asset
classes should improve the success rate and allow the initial withdrawal
rate to increase. One simple way to test this is to change the market
assumptions in Retirement Quant to use uncorrelated asset returns. If
you know the historical mean and standard deviation of an asset class, you
can override the value for an existing class and then model the returns.
Q: How do
you handle large cash inflows during the plan? For instance an Inheritance
or Property Sale during the plan?
A: These are not handled in
the paper and should be simulated to see their effects. Retirement
Quant has the ability to simulate future future cash inflows.
Q: The withdrawal rate should decrease
over time if your investments are the top ones so you limit/minimize the
concerns of the Fall rule. So, what funds will get us there?
Could this be that point in the model where one's planner assesses the funds
and lists those that are say in the top 10 to then select from?
A: Yes, the better your portfolio performs, the better your chance of
success. Trying to beat the market, however, is a tough business.
There are a lot of very bright people out there working very long hours
trying to do that. And there is a reason that those bright people call
it "placing a bet" when one picks something other than the market.
Those top 10 funds are yesterday's news. I highly recommend the book
"Fooled by Randomness."
Asset Returns
and Expenses
Q:
Given the fact that nearly
everyone agrees that investors get investor returns and not the theoretical
investment returns, even with an advisor's help, don't you realistically
have to reduce the withdrawal rate? If so, by how much?"
A: Use Retirement
Quant to model what you think are “investor returns”, evaluate the risk and
choose the appropriate strategy. Again, it is very easy to see the
effect of different returns, there is a dedicated function to just that, and
select the level of risk you are comfortable with.
Q:
What expenses did you assign to the various asset classes, and did you
assign any management expenses?
A: No expenses were assigned.
They are assumed to be included in the return of the asset class.
There are two ways that one can explicitly add expenses to the model.
One way is to modify the returns for the asset classes and subtract some
expense from the median returns. The other is use the Return
Sensitivity function described above.
Q:
If asset management fees were not factored into the analysis, is it fair to
say that the chosen withdrawal rate simply be reduced by that % each year?
A: No. The relationship
between withdrawal rates, market returns, and decision rules is not that
simple and one should model the scenario to see the impact. If the
management fee is a percent of assets, then you could model the effect by
reducing the mean returns by that percent. If the management fee is a
fixed dollar amount, then model that by increasing the retirement income
need by that amount.
Q:
Does the modeling methodology make any tax assumptions, or is it assumed
that the client has to pay taxes out of the withdrawals? Thank you.
A: Tax implications and
strategies were not modeled. It is assumed that taxes are paid out of
withdrawals and so the model deals with establishing a retirement income
level. Taxes certainly do have an impact that is probably unique to
each situation.
Q:
Do you believe that the PE rate inflation that has occurred over the last 80
years inflates equity returns and means we should count on lower rates in
the future?
A: It is probably unwise to
“count on” anything. The admonishment “past returns are not a
guarantee of future returns” is not just there for legal protection.
You might enjoy reading “Fooled by Randomness” and “The Black Swan” by
Nassim Taleb.
Decision Rules
Q: What if I use
other values for FALL, RAISE, EXCEEDS, and CUT?
A: You will get a different profile. The paper has a table which shows
how a change in each of these variables will affect a retirement profile.
In addition the graphs in the paper show you the effect on a basic
retirement portfolio. Making this perhaps more complicated is that
real-life situations, such as a pension or social security, also impact the
profile. You can use the Retirement Quant to simulate individual
profiles for yourself. Retirement Quant implements the Capital
Preservation and Prosperity Rules slightly differently from the paper.
Fall and
Exceeds are implemented as absolute withdrawal percentages rather than
as percent differences from the initial withdrawal rate. For example,
if the initial withdrawal rate was 5% and the value of Fall is 20%,
then a raise would be given if the current withdrawal rate hits 4% (twenty
percent less than the original five percent). In Retirement Quant, you
will specify the absolute number, i.e. 4%, rather than the 20%. This
change was made to make the rule simpler and perhaps easier to use.
Retirement Profiles
Q: Are there other
retirement strategies that would give a Progressive or Aggressive Withdrawal
Profile?
A: Absolutely. Use the Retirement Quant program to see what others
have suggested and play with it and see what you can create on your own.
Q:
It seems that your WD rates assume the portfolio value maintains full value
(inflated) throughout lifetime, leaving a large asset to heirs.
Wouldn't many clients want to use it up entirely over the 40 year period?
A: Every person is
different. The projected legacy (final estate) is one of the outputs
from Retirement Quant. It is easy to see the effect of different
withdrawal rates on the legacy using the Retirement Income function.
Not only that but you can also see the effect of different asset
allocations, retirement strategies, market returns, and retirement ages on
the legacy.
Other Models
Q:
Did you ever do these
exact same scenarios only changing the distribution period to 30 years
rather than 40 in order to compare more closely to the Bengen and Trinity
studies?
A: Simulations were run under
conditions similar to Bengen’s and the Trinity study and produced results
similar to what they obtained.
