6/16/2021: How to make retirement income more stable. post
6/12/2021: Asset allocation on the savings portfolio. post
Summary: The glidepath on the savings portfolio gets adjusted quite a bit over a lifetime. Setting a glidepath at age 25 and sticking to it would be suboptimal. The glidepath needs be flexible, adpating to new circumstances to keep risk constant. However, if you prefer the more familiar approach of a predetermined glidepath on the savings portfolio, designing one customized to your personal circumstances--risk preference, pension start dates, and pension amount as a percentage of retirement income--would still be better than going with a generic target date fund glidepath that does not take these factors into consideration.
6/10/2021: Managing gap years without a bridge to Social Security. post
6/8/2021: Time diversification of stock risk. post
6/6/2021: Why retirement income recovers fully after a poor sequence of returns (temporary crash). post
6/4/2021: How retirement income responds to a poor sequence of returns (temporary crash). post
Summary: There is concern that a market crash right around retirement can permanently damage a retirement because portfolios are at their peak value and very sensitive to returns (sequence of return risk). TPAW manages this risk by maintaining a fixed asset allocation on the total portfolio and employing amortization based withdrawals. This results in a strategy that is well diversified across time, making the outcome less sensitive to the timing of returns. I show that a crash and subsequent recovery would have no harmful effect on retirement even if it occurred just prior to retirement when the savings portfolio is at its peak. During retirement, no matter when the crash occurs, the loss would be limited to reduced income during the depressed years. The income will recovery fully if and when the market recovers. There would be no permanent damage to the portfolio that persists after the market has recovered.
6/1/2021: Results of historical simulations covering 1881-2021. post
This thread develops the total portfolio allocation and withdrawal (TPAW) strategy. This strategy combines a "total portfolio" perspective with amortization based withdrawal (ABW) to create a strategy with attractive risk/return characteristics.
The total portfolio approach means that the present value of future savings and retirement income is counted as bonds in the portfolio. A fixed asset allocation is maintained on this "total portfolio." Retirement withdrawals are calculated by amortizing the total portfolio over retirement years.
The advantage of this approach is that total risk is kept consistent from year to year. This has two benefits:
1. The more even spreading of risk across years reduces the total risk that the retiree would need to take to achieve a given expected return.
2. It prevents surprises like risk increasing unexpectedly as the real value of a pension declines and the retiree relies more heavily on the savings portfolio.
Some discussion has taken place in the ABW thread, and the strategy is described in the ABW wiki. I am hoping to focus future discussion of the TPAW strategy in this thread, and eventually create a wiki article for it: .
CREATING THE PLAN
The planning is done by scheduling income and spending in a table like this (inputs in yellow):
The table above shows the plan for a 65 year old retiree. The retiree has $1,000,000 in savings plus $20,000 in social security starting age 70. They have scheduled $30,000 of essential expenses for the first two years to cover remaining college expenses for their youngest child. They have scheduled an extra $5,000 per year for the first ten years in extra withdrawals from the risk portfolio to support an active early retirement featuring more travel. The rest of their wealth is used to fund regular withdrawals growing at 1% per year. AA is set to 30/70 on the risk portfolio. This implies a savings portfolio AA ranging from 51/49 at age 65 to 46/54 at age 100. Regular withdrawals from the risk portfolio start out at $41,576 at age 65 and is scheduled to grow to $58,896 by age 100. The scheduled growth in withdrawals is not from a desire to spend more in old age, but as security in case returns are poor (precautionary savings).
People can now use the "simulator" spreadsheet to come up with their plan. This spreadsheet calculates TPAW allocation and withdrawals given stock and bond returns. It can be used for backtesting the TPAW strategy using historical returns, or for forward looking analyses using simulated returns. Users can use the results of the backtests and simulations to adjust their asset allocation and withdrawal plan till they find their preferred strategy.
The spreadsheet is located in the TPAW wiki under Simulator.
Let's do a simulation using the "simulator" spreadsheet for an investor who began with $30,000 in savings at age 25 (year 1946), saved $10,000 per year during working years, retired at age 55 (year 1976), got social security of $20,000 per year starting age 70, and just reached reached age 100 this year (year 2021).
Historical real returns during the period averaged 8.6% for stocks (S&P 500) and 2% for risky bonds (10 year T bonds). Safe bonds assumed to be 1.9%.
Suppose our investor guessed long term returns correctly and entered 8.6% for stocks and 2% for risky bonds. AA of 30/10/60 for stocks/risky bonds/safe bonds.
TPAW withdrawals for this investor would be the middle line in red in the graph above:
- Starting withdrawal would have been $54,819 at age 55 (year 1976)
- Lowest withdrawal would have been $46,755 at age 61 (year 1982)
- Highest withdrawal would have been $70,349 at age 79 (year 2000)
- Withdrawal during the recent financial crisis would have been $50,981 at age 88 (year 2009)
- Final withdrawal would have been $60,187 at age 100 (year 2021)
- Starting withdrawal would have been $46,814 at age 55 (year 1976)
- Lowest withdrawal would have been $36,081 at age 88 during the recent financial crisis (year 2009)
- Highest withdrawal would have been $52,167 at age 79 (year 2000)
- Final withdrawal would have been $39,811 at age 100 (year 2021)
- Starting withdrawal would have been $64,522 at age 55 (year 1976)
- Lowest withdrawal would have been $56,926 at age 61 (year 1982)
- Highest withdrawal would have been $95,526 at age 79 (year 2000)
- Withdrawal during the recent financial crisis would have been $72,648 at age 88 (year 2009)
- Final withdrawal would have been $92,213 at age 100 (year 2021)