tag:blogger.com,1999:blog-5621914599310831423.post621101461847105908..comments2024-03-28T09:15:32.976-07:00Comments on The Retirement Café: Dominated StrategiesDirk Cottonhttp://www.blogger.com/profile/05616143752082768155noreply@blogger.comBlogger6125tag:blogger.com,1999:blog-5621914599310831423.post-78768415047890458362015-02-17T06:48:41.667-08:002015-02-17T06:48:41.667-08:00Larry, I agree – perhaps more than you think.
&qu...Larry, I agree – perhaps more than you think.<br /><br />"<i>and at times you,</i> suggest using life expectancy tables to mark time periods"<br /><br />I don't think <i>at times</i> that retirees should consider life expectancy when spending from a volatile portfolio, I always think they should. Sorry if I haven't made that clear enough. The post I am working on for this week on game theory should make that abundantly clear.<br /><br />Second, I don't suggest that conservative estimates of safe spending are a good answer, but only that they are a safer guideline if you are going to play SWR than a more aggressive spend rate would be. If you look at the amount of savings you would need in order to spend 3.5% versus what you would need to spend 4.5%, you can see that conservative estimates are extremely costly. My point is not that SWR is fine with conservative estimates, but that SWR is a very risky strategy and that is shown by our inability to accurately know a safe spending rate. Hence, the range.<br /><br />I'm not a fan of SWR unless the retiree has a lot of money compared to her spending needs. (If you have a 1% spend rate, just about anything works.) I prefer a sound floor that takes the pressure off spending from the upside portfolio.<br /><br />Regarding asset allocation, I'm with William Bernstein: <br /><br />[Step] 1. Determine your basic allocation between stocks and bonds. First, answer the question, "What is the biggest annual portfolio loss I am willing to tolerate in order to get the highest returns?"<br /><br />That will be easier for some readers to understand than shifting the standard deviation curve away from Black Swans, but it means the same thing.<br /><br />Thanks for the additional explanation, Larry. I try to make my posts readable for a broad audience, but I think the discussion section is great for those "for extra credit" kind of guys!Dirk Cottonhttps://www.blogger.com/profile/05616143752082768155noreply@blogger.comtag:blogger.com,1999:blog-5621914599310831423.post-7300670610427782292015-02-16T18:37:41.015-08:002015-02-16T18:37:41.015-08:00Hi again Dirk, your combined posts for the 6th and...Hi again Dirk, your combined posts for the 6th and 13th of Feb got me thinking about a couple of other points:<br /><br />1) The problem I see with trying to be conservative with estimates, one about risk return parameters (point 2 below) and the second about longevity … and my main point here … is what happens with overly conservative longevity estimates, say age 95 for example as a suggested end age for all … is that the many are under spending just in case they’re the few who may outlive age 95 (a low percentage, depending a present age, but more so when most SWR perspectives look at 30 years implying the marker is only age 65).<br /><br />This is why myself and others like Ken Stein, and at times you, suggest using life expectancy tables to mark time periods – and then update that time period each year (what I call Dynamic Updating) along with updated risk & returns data. Such an approach shifts spending into the more likely years one may live as well as when they’re also more likely to be the go-go years (why save spending now for when you’re in the no-go years or not here at all?). Now I know the marble is rolling around – but herein comes the point where customization based on individual desires comes into play. The 4% rule has nothing to do with most people’s portfolio characteristics nor their current age.<br /><br />A comparison between bottom and top spending may be found here: http://blog.betterfinancialeducation.com/multi-media/how-income-may-compare-between-dynamic-and-safe-approaches/<br /><br />2) asset allocation should be targeted towards a much forgotten purpose – to shift the standard deviation curve away from the bad, left-tail, events as described succinctly by Larry Swedroe in his book “Reducing the Risk of Black Swans.” Basically the purpose of proper allocation is to first target one’s risk parameter and then to both tighten the standard deviation as well as shift the curve to the right side. More on that here: http://blog.betterfinancialeducation.com/behavior-corner/black-swan-portfolio-construction-is-it-possible/ <br /><br />In summary, 1) people should understand that conservative time frame estimates may result in their under spending relative to time periods closer to expectation from any actuarial table. 2) people should look at their portfolio's specific risk return characteristics instead of applying a rule of thumb not representative of their specific holdings. That’s enough to ponder – in short – for the moment: Rules of thumb are often not representative of specific people.<br /><br />Great blog posts both Dirk.<br />Larry Frankhttp://blog.betterfinancialeducation.com/category/larry-frank/noreply@blogger.comtag:blogger.com,1999:blog-5621914599310831423.post-89085454431556460432015-02-14T10:03:12.538-08:002015-02-14T10:03:12.538-08:00Note to my readers: The referenced paper can be fo...Note to my readers: The referenced paper can be found <a href="http://www.onefpa.org/journal/Pages/APR14-Lifetime-Expected-Income-Breakeven-Comparison-between-SPIAs-and-Managed-Portfolios.aspx" rel="nofollow">here.</a>Dirk Cottonhttps://www.blogger.com/profile/05616143752082768155noreply@blogger.comtag:blogger.com,1999:blog-5621914599310831423.post-22022620781865168002015-02-14T08:18:47.383-08:002015-02-14T08:18:47.383-08:00Indeed Dirk. That comparison was made in Wade and ...Indeed Dirk. That comparison was made in Wade and my paper (JFP Apr 2014) "Lifetime Expected Income Breakeven Comparison between SPIAs and Managed Portfolios," <br /><br />Properly managed, portfolios can outlive people too. The red herring has always come from using set end dates instead of using rolling expected longevity ages. If there are always future years to be funded, there needs to always be future portfolio balances to do so. Unless the retiree spends too much - but that is the whole point of measurement and monitoring isn't it - along with meaningful Decision Rules about what to do and when to do it.<br /><br />Our Apr 2014 paper suggests waiting until older ages before committing to risk transfer. Purchasing power of the dollars between now and elder age is factored in the paper. We also "punished" portfolio cash flows by taking the portfolio fee out of the cash flow (thus reducing it by that amount), versus taking the portfolio fee out of the portfolio balance first before making the cash flow calculation. A subtle yet important distinction for those who feel the paper is tilted towards anti-SPIA.<br /><br />Social Security is the first helping in the risk-pooling category.<br /><br />Your welcome ... and great conversation Dirk!<br /><br />PS. Links to read any of our published JFP research papers are at BetterFinancialEducation.com for those who don't have login credentials to read JFP papers otherwise.Larry Frankhttp://www.betterfinancialeducation.com/page-1noreply@blogger.comtag:blogger.com,1999:blog-5621914599310831423.post-71785778265176956742015-02-14T06:35:36.501-08:002015-02-14T06:35:36.501-08:00Thanks, Larry. You add some important additional p...Thanks, Larry. You add some important additional points for consideration.<br /><br />I believe it was your referenced research that shows that the important variables of probability of ruin are spending rate, expected rate of return, life expectancy and asset allocation, in that order. I agree, tweaking the allocation is a second-order consideration.<br /><br />In addition to risk retention versus transferring that risk it to an insurance company, we also have to consider the risk-pooling benefit of annuities that cannot be duplicated by an individual retiree. In one case you have to worry about the risk of a single company and, in the other, the risk of a single retiree. A helping of each might be in order.<br /><br />You make great points. Thanks, again, for contributing!Dirk Cottonhttps://www.blogger.com/profile/05616143752082768155noreply@blogger.comtag:blogger.com,1999:blog-5621914599310831423.post-2633796591142279082015-02-14T05:28:29.505-08:002015-02-14T05:28:29.505-08:00A nice summary comparison Dirk. Many view these as...A nice summary comparison Dirk. Many view these as opposing strategies. I believe they are part of the same spectrum of strategies. SWR-F may be calculated and compared to SWR-V using the dynamic updating method, i.e., annual review.<br /><br />SWR-F merely represents an amount of spending that rarely would need to be reduced (but it may if market/economic events are outliers, say 2 standard deviations or more) ... thus a close proxy for what may be called necessary spending.<br /><br />SWR-V is a prudent maximum spending amount FOR THAT YEAR given the facts at the beginning of the year with returns and expected longevity updated (as you know - but readers may not - expected longevity is an age one never reaches based on current present age).<br /><br />The difference between the two is called "discretionary spending." The safety first crowd often gets alarmed or defines failure as a need for reducing spending. Once the model incorporates a method to distinguish necessary from discretionary spending, one realizes that essentially the same goal is accomplished - with the added benefit of being able to spend a little more (discretionary) when times are good; and not when they are not. BUT, spending is still possible - spending is not gone as safety first crowd fears.<br /><br />Our research (JFP Nov 2011) shows that spending is the one variable under one's control that can make a difference on outcomes (having money when older for those necessary spending years remaining at that time - i.e., not broke). Messing with allocation is not (essentially no difference when compared to control data).<br /><br />With all this in mind - since the future is always unpredictable, a flexible strategy that can adjust for the unexpected will provide better results over one that can not, or does not, adjust. What is underappreciated and under represented in most writings on the subject, is that a flexible strategy should incorporate a lower end of spending up front so it is clear where necessary and discretionary spending are.<br /><br />The next element often understood is that we all live on the same blue marble so there is no economic system we can extract ourselves from during bad times, or insert ourselves into during good times, that isn't being experienced by all at those times too. This gets to understanding the differences between risk retention (e.g., managing the portfolio - indexed investing) versus risk transference (have an insurance company manage the portfolio - annuity of some sort). Both methods are exposed to the same systemic risks. The difference is that the single insurance company increases risk because as a single company, they could one of those companies to disappear. An indexed portfolio would not (unless all companies within the index simultaneously disappeared).<br /><br />A great post once again Dirk!Larry Frankhttp://blog.betterfinancialeducation.com/category/larry-frank/noreply@blogger.com