Dr Michael Finke`s presentation ()

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MANAGING INVESTMENT AND
IDIOSYNCRATIC LONGEVITY RISKS
FOR RETIREES
Michael S. Finke, Ph.D., CFP®
Professor &
Director Retirement Planning & Living
Department of Personal Financial Planning
T EXAS T ECH U NIVERSITY
Congratulations!
You’re a
pension
manager!
Pension Managers
What do they worry most about?
1) Asset Return Risk
2) Longevity Risk
Individual Pensions are Harder
 Asset Return


Pension Manager – Pool returns across
generations
Advisor – One whack at the cat
 Longevity Risk


Pension Manager – systemic increases in
longevity
Advisor – Idiosyncratic longevity risk
Systematic Longevity Risk
24
Females
22
22
20
20
Number of years
Number of years
24
18
16
18
16
14
14
12
12
10
10
1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010
Denmark
France
Japan
Source: Robine, 2012
Spain
Sweden
UK
USA
Males
1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010
Denmark
France
Japan
Spain
Sweden
UK
USA
Wealthier Live Longer
Source: SSA, 2008
Idiosyncratic Longevity Risk
Source: Frank, 2013
Idiosyncratic Longevity Risk
 How do you deal with idiosyncratic risk?
1) Diversification (pool it)
2) Retain it
 Avoiding running out of money by spending
less and accepting portfolio risk
 Live it up and accept greater risk of running
out of money
Turning Retirement Assets into Income
The 4% Rule (William Bengen, 1994)
 Safe Withdrawal Rates (1920s - present)
Figure 2.1
Maximum Sustainable Withdrawal Rates
For 50/50 Asset Allocation, 30-Year Retirement Duration, Inflation Adjustments, No Fees
Using SBBI Data, 1926-2010, S&P 500 and Intermediate-Term Government Bonds
9
Maximum Sustainable Withdrawal Rate
8
7
6
5
4
SAFEMAX
3
2
1
0
1925 1930 1935 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990
Retirement Year
Philosophy of the 4% Rule
 Retirees have a lifestyle goal and not
meeting that goal indicates failure
 Failure = inability to spend lifestyle
goal for 30 years
 Portfolio risk increases likelihood of
meeting spending goal
 Use prior returns to establish safe
withdrawal rate
Historical Random Returns
-10.1%
3.0%
8.99%
13.7%
23.5%
-38.5%
31.0%
20.3%
34.1%
-1.5%
4.5%
27.3%
-6.6%
26.3%
7.1%
12.4%
Asset Pricing 101
pt = Εt[β * u’(ct+1)/u’(ct) * xt+1]
Price at time t (now)
= Expectation (now)
Of β (how much we discount the future)
* Marginal utility tomorrow
Marginal utility today
*Expected payout tomorrow
What This Means
Demand for
Consuming Now
Decreases Asset
Prices
Demand for
Consuming in
Future Increases
Asset Prices
What’s Affecting Asset Prices?
How Much Do Global Investors
Value the Future?
Capital Market is Global
Global Real Interest Rates
Importance of 1st Decade
Source: Milevsky and Abaimova, 2005
Monte Carlo Failure Rates
 Historical Real Returns: Stocks 8.6%, Bonds 2.6%
Stock Allocation: 30%
50%
70%
Failure Rates
6%
6%
6%
 Slightly more realistic: Stocks 5.5%, Bonds 1.75%
Failure Rates
24%
24%
27%
 A little better than today’s rates: Stocks 6%, Bonds 0%
Failure Rates
47%
33%
28%
 Early 2013 Rates:
Stocks 4.6%, Bonds -1.4%
Failure Rates
77%
57%
46%
Source: Blanchett, Finke and Pfau, 2013
What if Rates Revert in 5 Years?
 Start out at current rates (Stocks 4.6%, Bonds -1.4%)
 Revert to Stocks 8.6%, Bonds 2.6%
Stock Allocation: 30%
Failure Rates
50%
18%
70%
18%
years?
43%
32%
38%
22%
 What if Rates Revert after 10
Failure Rates
Other Problems with the 4% Rule
Source: Blanchett and Finke, 1% fee
No Risk Tolerance, No Optimization
Source: Finke, Pfau and Williams, 2011
Value of a Dynamic Approach
80%
Withdrawal Efficiency Rate
70%
Dynamic Complex
Dynamic Formula
RMD Method
Static
60%
50%
0%
Source: Blanchett, 2013
20%
40%
Portfolio Equity Allocation
60%
80%
Illustration of Dynamic
Real Withdrawal Amount
Figure 6
Individual Simulated Paths for Spending and Wealth
For a Couple with $100,000 Wealth and a 60% Stock Allocation
Simulations Based on Historical Averages
$12,000
$11,000
$10,000
$9,000
$8,000
$7,000
$6,000
$5,000
$4,000
$3,000
$2,000
$1,000
$0
65
Constant Inflation-Adjusted Spending
Guyton Rules
Blanchett Rule
70
75
80
85
Age
90
95
100
105
70
75
80
85
Age
90
95
100
105
$200,000
Real Remaining Wealth
$175,000
$150,000
$125,000
$100,000
$75,000
$50,000
$25,000
$0
65
Source: Pfau, 2013
Assumes Historical Equity Premium
S&P Dividend Yields
What Does Current P/E Imply?
Source: Asness, 2012
Requires Managing Assets in Old Age
Literacy and Confidence
90
Financial Literacy
Confidence
80
70
60
50
40
30
20
10
0
60
65
70
75
80
85
A Better Approach
 Prioritize spending categories (basic
needs, discretionary expenses, legacy)
 Employ risk when a retiree is willing to
accept possibility of a loss
 Deal efficiently with idiosyncratic risk
 Simplicity - make sure real people can
handle it, use research to create defaults
 Be realistic about future asset returns
QUESTIONS/COMMENTS
Michael S. Finke, Ph.D., CFP®
Professor, Ph.D. Program Director
Director Retirement Planning and Living
Department of Personal Financial Planning
T EXAS T ECH U NIVERSITY
[email protected]

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