Wade in the Economist

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cjking
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Wade in the Economist

Post by cjking »

Am I really the first person to report this? I did a search but couldn't find anything.
NOW that defined-benefit, or final-salary, pensions are going the way of the dodo, many private-sector workers are accumulating a pensions pot to see them through their declining years. How big should it be?

Usually advice has focused on the best “withdrawal rate”, the proportion of the pension pot that can be taken as annual income while minimising the risk that the retiree outlives his or her savings. That withdrawal rate has generally been put at 4%. So any worker who wants to have a retirement income of $20,000 needs to generate a pot of $500,000.

But a new paper* from Wade Pfau of the National Graduate Institute for Policy Studies in Tokyo suggests that this approach is too limited, since it ignores the savings phase of retirement planning.
http://www.economist.com/node/18988664
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NAVigator
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Post by NAVigator »

For a lot more discussion about SWR involving Wade Pfau himself, see

Trinity Study Authors update their results

Good stuff!

Jerry
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empb
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Post by empb »

Very cool. Although I doubt that's where the Economist found it, I often wonder if this forum gets more attention than we think it does.

Congrats Wade.
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Dick Purcell
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Post by Dick Purcell »

Major congrats to Wade!

Compared to the widely repeated old Trinity notion of SWR 4%, Wade’s work questioning that 4% and advancing the whole-life approach of safe SAVING rate certainly merits The Economist’s attention. But to me, the most fundamental merit of Wade’s work is that it is focused on the financial needs and goals of people, rather than the confused maze of single-year mathematical abstractions and deceptive labels in university “investment education.”

Imagine a future world in which our universities wake up to their responsibilities to the investing public. They wall off the oceans of one-year-investment theory taught in their business schools as only for ivory tower theorists and financial industry interests. Outside those financial-industry-friendly business schools, they establish a new kind of investment education for guidance of people – focused on pursuit of people’s future financial needs and goals, using asset-class index funds with best grounds for long-term planning as well as lower fees, taught with “the majesty of simplicity.”

Dick Purcell
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wade
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Post by wade »

Thanks guys. That kind of fulfilled a life dream of mine. It was quite lucky is the person who (I assume) wrote that article is their pensions person, and he is also quite interested in Shiller's cyclically-adjusted P/E ratio. So I really hit a sweet spot for him.

Dick, thanks also for your comment at the Economist website. I appreciate it.

Wade
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Post by ThePrune »

I've just started reading Prof. Pfau's paper (Safe Savings Rates: A New Approach to Retirement Planning over the Life Cycle) and haven't even started reading his references! But already it's clear that I had a very different understanding of the classic "4% safe withdrawal rate" than most other people.

Having read papers by Bengen and many others, I had focused less on the withdrawal percentage proposal and more on the risk they were trying to address. Stated differently, these authors were trying to come up with a simplistic (yes, probably too simplistic!)withdrawal solution to overcome Sequence of Returns Risk. Since the worst case is a deep equity drop early in retirement (the withdrawal phase), these authors were, to my way of thinking, trying to give guidelines to help hedge against this risk.

Personally, I never interpreted their work as suggesting that the hedging withdrawal percentage (the classic 4% of starting portfolio plus 3% annual inflation adjustments) was anything more than an "early in retirement only" safety guideline. But after reading postings on this and other forums, it became clear than many people took these withdrawal percentages as a "forever after / through all retirement" rule. I certainly didn't think this way!

I was quite suprised to read the following paragraph in Prof. Pfau's article:
This study can be interpreted as providing a resolution to the “safe withdrawal rate paradox,” which David Jacobs (2006) and Michael Kitces (2008) developed independently. Consider the following: at the start of 2008, Person A and Person B each have accumulated $1 million. Person A retires and with the 4 percent rule is permitted to withdraw an inflation-adjusted $40,000 for the entirety of her retirement. In 2008, both Person A and Person B experience a drop in their portfolio to $600,000. Person B retires in 2009, and the 4 percent rule suggests he can withdraw an inflation-adjusted $24,000. The paradox is that these seemingly similar individuals experience such different retirement outcomes.
From my perspective, Person B in this example can no longer use Bengen's 4% withdrawal percentage. The event being hedged for (the deep drop in equity values) has occurred, so this withdrawal rate is an inappropriate and unneeded hedge. Other approaches would need to be used to decide on person B's appropriate withdrawal rate. But if trained academics thought of this as a paradox - well, lets just say that this Ph.D. engineer is wondering a bit about "academic clear thinking."
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patriciamgr2
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Congratulations Dr. Pfau

Post by patriciamgr2 »

I thought your research was extremely important when you first posted a reference to it here on the Forum. I note from the Economist editor's on-line comments you will be publishing another article in August about withdrawal guidance for new retirees (given recent market metrics). I know many Bogleheads would be delighted if you would post a link to that article when it's available.

thank you for sharing your important work with people like me who have more than an academic interest in these topics!

regards, patricia
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Post by wade »

Patricia: thanks for the comment. That new paper should be available on August 1. If you are not actually ready to retire yet, I do have a third paper now which is for mid-career people about how much longer you might need to save and work before being prepared enough to have withstood the worst-case scenario from history so far. Not to jump ahead, but I actually think the 3rd paper will be more interesting for people than the 2nd paper coming in August. The 2nd paper is caught in a firestorm that I am worried withdrawal rates will be rather low for recent retirees.

I have summaries for these papers on my blog:

For people ready to retire: http://wpfau.blogspot.com/2011/05/can-w ... al_16.html

For mid- to late-career people: http://wpfau.blogspot.com/2011/06/getti ... ement.html

ThePrune: It sounds like we are mostly in agreement rather than disagreement. You write, "Other approaches would need to be used to decide on person B's appropriate withdrawal rate." What I'm doing is trying to say what that other approach is. Others would disagree with us though by saying that the solution to the paradox is that the person A should reduce spending, not person B increase spending.

About the paradox, I'm saying it's not a paradox after all. And just to defend academics for a moment, though I think the paradox was a fine idea, it was developed by practicing financial planners, not academics.
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Post by ThePrune »

wade wrote:ThePrune: ..... And just to defend academics for a moment, though I think the paradox was a fine idea, it was developed by practicing financial planners, not academics.
Dang it :oops: , I knew I should have read your references before making any comments! With your extra information, everything seems much more logical now.
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Post by LadyGeek »

Wade is in the wiki, which includes an RSS feed for his blog.

Wiki article link: Wade Pfau
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Post by DRiP Guy »

wade wrote:About the paradox, I'm saying it's not a paradox after all. And just to defend academics for a moment, though I think the paradox was a fine idea, it was developed by practicing financial planners, not academics.
I think the issue is easily managed with a little careful wording -- using the phrase "apparent paradox" could allow those learned folks who wish to address it to do so, but without giving it full credence as an actual 'full blown' paradox per def. #2 below (although interestingly, def. #1 and #3 do already incorporate the notion that the paradox itself may be merely an illusory status relative to the observer, i.e. "seems" -- rather than a bona fide unresolvable metaphysical puzzler.)
par·a·dox
   [par-uh-doks]
–noun
1. a statement or proposition that seems self-contradictory or absurd but in reality expresses a possible truth.
2. a self-contradictory and false proposition.
3. any person, thing, or situation exhibiting an apparently contradictory nature.
English is a funny thing. I never would have guessed that innocuous little "paradox" apparently contained in it roughly the same duality that "cleave" does -- That you can cleave to something, in order to adhere, to remain close, or you could also decide to cleave from, and thereby split or divide.

A paradox apparently can mean a statement or position that is truly mutually inconsistent and unsupportable, and therefore ought to be rapidly discarded, or it can mean a fundamental truth, cloaked in an apparent absurdity, which means you need to carefully protect and nurture it lest it be lost forever.

How we ever manage to get a point across clearly using these tools is a wonderment.
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Post by wade »

DRiP Guy wrote: A paradox apparently can mean a statement or position that is truly mutually inconsistent and unsupportable, and therefore ought to be rapidly discarded, or it can mean a fundamental truth, cloaked in an apparent absurdity, which means you need to carefully protect and nurture it lest it be lost forever.
I'm not sure if the 4% rule fits either of these. :? Perhaps "Safe Withdrawal Rates Puzzle" would be more appropriate.
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Post by Dick Purcell »

Wade, Prune, DRiPGuy –

I don’t think it’s a paradox or puzzle – just an illustration of the logical reality that the SWR is a function of stock market valuation on the start-retirement day, when the rate is applied to set the $$ number.

Probably best expressed as a simple function of some p/e measure such as PE10. I think we can pretty well deal with it using a formulation this simple:

SWR = (PE10ave/PE10) x 4%

Thus if on the magic day PE10 is above PE10ave, SWR % is proportionally lower, and vice versa.

Heck, with this fine adjustment, the 4% base number may even be safe!

Dick Purcell

PS -- For full correction I think we need the adjustment to be a little stronger. We have to not only "adjust the PE10 to average" but also reflect the lower return rates as the actual present p/e recedes to average. Maybe multiply the denominator by some number slightly above 1?? . . After some tests to determine that number of course.
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Post by LadyGeek »

FYI - A critique on the wording of the article's last paragraph is in a different thread: The Wrong Number
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Post by zed »

wade wrote:Patricia: thanks for the comment. That new paper [...withdrawal guidance for new retirees] should be available on August 1. .
Very interesting stuff. Has the new paper been posted yet?
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Post by wade »

zed wrote:
wade wrote:Patricia: thanks for the comment. That new paper [...withdrawal guidance for new retirees] should be available on August 1. .
Very interesting stuff. Has the new paper been posted yet?
Hi Zed, thanks.

Yes, the new paper is out:

http://www.fpanet.org/journal/CurrentIs ... wRetirees/
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Post by Bongleur »

Wade- Have you examined the "Crestmont PE Ratio" methodology? Claims to have an improved predictive value:

http://advisorperspectives.com/dshort/u ... -Ratio.php
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Post by wade »

Bongleur, thanks for the link to that article.

I do have both of Ed Easterling's books, but I haven't had a chance to read them yet. I haven't been too excited about working on valuations things these days, but I do need to read the Crestmont research as a part of continuing in that area.
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Post by Bongleur »

Looks like the details of the Crestmont calc are proprietary, but it would be great if they would give you the yearly data to plug in to your equations and see what it looks like.
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