1/5/2023: New risk inputs in the online planner. post
11/5/2022: Ways to save a plan in the online planner. post
10/14/2022: Making the online planner easier to use. post
8/20/2022: TPAW vs SWR with the same expected return assumption. post
7/21/2022: Option to reduce risk at older ages in TPAW. post
7/16/2022: Safe Withdrawal Rate (SWR) strategy added to tpawplanner.com. post
7/7/2022: Simulation option using only historical sequences added to tpawplanner.com. post
7/2/2022: Reward/risk ratio added to tpawplanner.com. post
6/26/2022: Expected stock return estimates from CAPE regressions. post
6/11/2022: Savings portfolio vs total portfolio: risk as a function of market performance. post
6/1/2022: Savings portfolio vs total portfolio: risk as a function of age. post
5/28/2022: Savings portfolio strategy added to tpawplanner.com
Summary: The online TPAW planner now supports a "savings portfolio" strategy in addition to the default "total portfolio" strategy. The savings portfolio approach is simpler and more familiar. The present value of future savings and retirement income is not counted as a bond. You directly specify the asset allocation of the savings portfolio. Income during retirement such as Social Security and pensions simply reduce the withdrawals required from the savings portfolio during the years in which you receive the income. Conversely, an extra expense in any year increases the withdrawal required from the savings portfolio for that year. The savings portfolio is amortized to meet the net withdrawal requirements. post
12/7/2021: TPAW now has an online planner: tpawplanner.com.
More features and easier to use than the spreadsheet planners. post
10/8/2021: The withdrawal strategy derived in Merton (1969) is ABW. post
Summary: The seminal academic papers on optimal allocation and withdrawal are Samuelson (1969) and Merton (1969). They have similar models and were published as companion papers in the August 1969 issue of The Review of Economics and Statistics. I show that the optimal allocation and withdrawal strategy derived in Merton (1969) aligns with the allocation and withdrawal strategy in TPAW.
9/28/2021: Updated "Planner with Monte Carlo Simulation" and "Simulator" spreadsheets. The update fixes an error in how entries in the "extra withdrawals" column were handled. post
9/4/2021: Why calculate the present value of the pension? post
8/23/2021: Instructions on how to customize "TPAW Planner with Monte Carlo Simulation." For accumulators. For retirees.
8/20/2021: "TPAW Planner with Monte Carlo Simulation" added to the wiki. post
Summary: This is the full featured planner that I've had in mind for a while. It uses Monte Carlo simulations to show the impact of your planning choices. You adjust your plan until you're satisfied with the simulation results.
7/3/2021 The problem with safe withdrawal rates (SWR). post
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 recover 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.
Online Planner: tpawplanner.com
Spreadsheet Planner: "Planner with Monte Carlo Simulation" located in the TPAW wiki.
The planners use Monte Carlo simulations to show the impact of your planning choices. You adjust the plan until you're satisfied with the simulation results.
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).
MONTE CARLO SIMULATION
The planner uses Monte Carlo simulations to show the impact of your planning choices. You adjust the plan until you're satisfied with the simulation results.
From instructions in the spreadsheet:
Let's look at an example for a user who is 25 years old, has $50,000 in savings, expects to save $25,000 per year till age 54, plans to retire early at age 55, and expects $30,000 in Social Security starting age 70. Planning till age 100. Expected stock return = 3.5% Expected bond return = 0%. All $ and rates are real.The graph below shows the results of the Monte Carlo simulation. 500 sequences of returns are randomly generated and the resulting retirement spending is summarized using percentiles. Adjust the asset allocation (cells I28:29) and the growth rate of scheduled withdrawals 'g' (cell Q49) till you arrive at your preferred spending profile. Raising the stock allocation will increase average spending but widen the dispersion (more risk, more return). Raising g will reduce spending in early retirement and increase it in late retirement, making the graph more upward sloping (higher saving). A higher g reduces the likelihood of bad outcomes in late retirement. So more risk averse people will want to choose a higher g (precautionary saving).
If you have a gap before social security and pensions start, pay special attention to the gap years to make sure that your savings portfolio does not run of out funds before social security and pensions begin. If the graph shows that the risk of running out of funds is unacceptably high, you can reduce the risk by (i) choosing a safer asset allocation in cells I28:29, (ii) increasing 'g' in cell Q49, or (iii) adding a fixed essential expense for all retirement years (not just the gap years) in column M. If using method (iii), add the same amount of essential expenses (e.g. $10,000) to all retirement years to keep risk consistent.
By choosing an AA of 35/65 and scheduled withdrawal growth g = 1%, the user gets the retirement spending profile graphed below. Median (50th percentile) withdrawal starts at $49,006 at age 55 and climbs to $64,059 by age 100. Even the 10th percentile outcomes don't look too terrible. Note that the 10th percentile outcome did not run out of funds during the gap years before SS starts (age 55-69). So with 90%+ probability, the user will be okay during the gap years.
Figure 2: AA=35/65, g=1%
If, instead, the user chooses a more aggressive AA of 60/40 and scheduled withdrawal growth g=0%, they get the spending profile below. The median starts out high at $73,173 but declines to $36,122 by age 100. The 10th percentile outcome runs out of funds towards the end of the gap year (ages 67-69) and then relies solely on Social Security of $30,000 from age 70. By age 97, even the 40th percentile outcome is down to Social Security alone. This is probably an unattractive scenario for most people. They can reduce AA, increase withdrawal growth 'g', or add essential expenses until they find their preferred spending profile.
Figure 3: AA = 60/40, g=0%