Tuesday, October 21, 2014

Webinar: Understanding and Explaining Monte Carlo Results To Your Clients

Hello from Minneapolis.  I presented for 2 hours and 40 minutes today at the FPA Minnesota symposium.  I'm heading home now. I was really impressed by the turnout.  600 signed up for the conference, and it seemed like they were almost all there for the early morning session.  I'm used to crowds of 100-200 for these sorts of events, so kudos to the FPA Minnesota chapter!

I will be presenting another webinar open to anyone next Thursday, October 30. It starts at 4pm EDT.

This webinar will be for inStream solutions, and it will be a more informal type of webinar about how to interpret and use Monte Carlo simulations when working with clients.  I will have some slides, but they will be based on a Q&A type of approach, with some questions advisors may have about Monte Carlo, followed by my answers.  

For advisors reading this, Bob Veres also wrote a very nice article today for Advisor Perspectives, which discusses how larger planning firms are really getting excited about some of the features of inStream, and are using them in a slightly different way than we originally envisioned.  I still hope that the "best practices" feature described in the column will ultimately result in some great data to provide a better understanding about how real-world individuals make financial planning decisions over time.

Here are the webinar details for "Understanding and Explaining Monte Carlo Results To Your Clients":

You are invited to inStream's latest webinar.
Please join us for a discussion with Dr. Wade Pfau

- Learn how to better interpret probability levels of Monte Carlo simulations.  

- How to present the results easily

- How to explain the effect of different plan variables

- Convey what probability of success really means
Register now
The inStream team

Wednesday, October 15, 2014

Speaking Updates & Ph.D. Fellowship Opportunity at The American College

I started the day in New York City. This morning I joined Joe Tomlinson and Dirk Cotton for a MarketWatch panel discussion with Bob Powell.  Marketwatch will be producing some stories and videos about that event over the next couple months. As well, Joe, Dirk, and I enjoyed our own little Algonquin Round Table at the Algonquin Hotel last night. We had a good discussion about bond ladders for retirement, and came away with some research ideas for comparing bond funds and bond ladders in retirement. 

Academy of Financial Services

The Annual Meeting for the Academy of Financial Services will be held in Nashville tomorrow and Friday, October 16 & 17. For anyone in Nashville, it looks to be a good event with lots of folks from the retirement income research world. Michael Kitces, David Blanchett, and Joe Tomlinson will all be there, for instance.  I'm also filling in as a last minute replacement for Larry Kotlikoff to deliver the luncheon keynote address, and I'll be speaking on "Toward Best Practices in Retirement Income Planning." 

Speaking of research...

Ph.D. Fellowship at The American College

The Ph.D. Program in Financial and Retirement Planning is currently progressing along well, with three cohorts of students working their way through the program. This is a distance-based program with live webinar classes and a few one-week residencies. So students are located all over the United States. Thanks to a generous donation from two former executives at New York Life, there is a doctoral fellowship available for a student in the program. The idea for the fellowship is to spend about 20 hours per week conducting research in exchange for program tuition being covered, as well as a $30,000 per year stipend.  

We have been struggling to fill this position, on account that all of the current Ph.D. students also work as full-time financial planners and cannot devote an extra 20 hours per week beyond their already rigorous Ph.D. studies. This fellowship could be attractive to a young person just finishing their bachelors or masters degree in financial planning, and who is ultimately seeking an academic job. Though such an individual might prefer a full-time residency Ph.D. program. Nonetheless, if you fit this description, please do not hesitate to consider The American College along with other more traditional Ph.D. programs at Texas Tech, Georgia, Missouri, or Kansas State.

A third possibility, and the primary reason I bring this up on my blog, is that the fellowship could be filled by a recent retiree who has time and energy and a passion for research, and who might consider a twilight career at least as a part-time academic. I know some of my blog readers fit into this category, so let me know if you are interested to learn more.  Ideally, the doctoral fellow would be someone within commuting distance from Bryn Mawr, PA.  But I think we can be flexible about that, as now with tools like Skype or Google Hangout, it is easy interact online almost as easily as in person. The information below also suggests that the fellowship is for someone who can demonstrate financial need. But don't let that stop you from considering this opportunity, as I don't think a lack of financial need would prevent a highly qualified applicant from receiving the award. Please see the announcement below and let me know if you have any interest or questions. 

The Sy Sternberg and Fred Sievert Doctoral Fellowship
The Sternberg-Sievert Doctoral Fellowship was created to provide financial support to an individual who has both the desire and demonstrated potential to pursue a career in retirement planning research in an academic or industry setting. Funding for the Fellowship is provided by industry trailblazers Sy Sternberg and Fred Sievert who both dedicated years of service to New York Life as Chairman of the Board/CEO and President of the company, respectively.
The Sternberg-Sievert Fellowship includes tuition and fees for the PhD in Financial and Retirement Planning as well as an annual $30,000 stipend for living expenses. The Fellow must be able to work at least 20 hours per week on The American College campus while pursuing the doctorate online. Primary responsibilities of the Fellow include assisting faculty with research projects and providing support to The College’s Centers of Excellence which include the New York Life Center for Retirement Income. In addition, the Sternberg-Sievert Fellow may be required to represent the Fellowship program at donor events and when media opportunities arise.
Applicants must be newly admitted to the doctoral program and be able to demonstrate financial need.

A master’s degree in finance, economics, consumer science, actuarial science, or related discipline from a regionally accredited institution is required. Residence within commuting distance of The American College’s Bryn Mawr, Pennsylvania campus is highly preferred but not required.

A demonstrated ability to read and interpret scholarly material is required; the capacity to write for scholarly publications is highly desirable; a background in data collection, data analysis, and/or experience using statistical software packages such as SAS or R is highly preferred.

Applicants must have a professional appearance and be able to demonstrate fluency in both speaking and writing in the English language.
Tuition funding and stipend will be renewed annually for up to four years from starting the doctoral program and is contingent on annual satisfactory academic standing and job performance reviews as the Sy Sternberg and Fred Sievert Doctoral Fellow.
To Apply:
Indicate your interest in being considered for the Fellowship on the doctoral program application form and write a formal letter to the Doctoral Fellowship Committee that explains your interest in becoming the Sy Sternberg and Fred Sievert Doctoral Fellow. Your letter should include a discussion of the specific qualifications that you believe will maximize your effectiveness as the Sternberg-Sievert Doctoral Fellow. Add the letter to your application packet.

Thursday, October 9, 2014

Next-Gen vs. Traditional VAs

Over the past several years, I've published a few articles questioning the value of deferred variable annuities with income guarantee riders (VA/GLWBs), including one in the Summer 2013 issue of the Journal of Retirement. These VAs with guarantees are marketed as offering upside potential, downside protection, and liquidity all in one convenient package. But my concern is that the impact of compounding fees over time creates an overwhelming cost to the VA/GLWB user, such that one could be better off by just combining stocks and simple income annuities. That was a conclusion in my article about the efficient frontier for retirement income

Along these lines, Jefferson National asked me to write a sponsored white paper [you are supposed to be a financial advisor to gain access to the paper, and this VA is not otherwise available directly to consumers] about their new Monument Advisor investment-only variable annuity designed to be used by financial advisors.  Fees for the Monument Advisor variable annuity add up to $240 per year for an account of any size, and the reason to consider this VA is because the advisor and client have already determined that there is value to the financial plan by seeking the tax deferral offered by variable annuities. Besides these tax deferral aspects, the VA otherwise basically behaves like a traditional investment account, at least after age 59.5.

So the question becomes: should someone seeking tax deferral through a variable annuity use the low-cost Monument Advisor investment only approach, or should they go ahead and proceed with traditional VA with guarantee riders, which may also include commissions, insurance, and guarantee fees?

In the article I reinterpret this question in terms of: what will be the difference in outcomes for someone using a lower-cost investment-only VA vs. someone using a higher cost VA with guarantees, in terms of the retirement income that can be supported.

Obviously, if the investment portfolio is depleted, someone will be happy to still have guaranteed income. But the value of that guaranteed income can be oversold. Fees in the VA/GLWB will have eaten away the account value more quickly, so that there will be no growth in benefits to keep pace with inflation, and there will be no liquidity either. As inflation erodes the value of the VA/GLWB's guaranteed income, the real value of this guaranteed income could become much less than the user realizes. When markets are down, a VA/GLWB ends up behaving like a SPIA, but with a lower payout rate. And the question is: what has the VA/GLWB user given up in the process of seeking the somewhat illusionary upside potential and liquidity for their assets? Again, the illusionary nature of these is that compounding fees eat away at the potential for either upside or liquidity when it may be most needed later in retirement. 

In the white paper, I first review the points made in favor of using VA/GLWBs, including tax deferral, the ability to lock in growth for a hypothetical benefit base during accumulation, the ability to guarantee income for life, and liquidity.

Then I construct a composite hypothetical VA/GLWB, based on the characteristics of those offered by 5 major companies. I look at maximum allowed equity allocations of both 60% and 100%, a guaranteed roll-up rate in the deferral period of 5.3% compounded, a 1.29% mortality and expense fee on the account value, a 1.35% rider fee on the benefit base (which can end up being a much higher percent of the remaining assets when the account value is less), a 4.8% guaranteed income withdrawal rate for a 65 year old, and annual fees of $39.

This compares to the investment-only VA with annual fees of $240 and a 1% annual advisory and investment fee applied to the account value.

With Monte Carlo simulations, I then investigate the amount of lifetime guaranteed income supported by the VA/GLWB, and then try to replicate the same withdrawals from the investment-only VA. 

Let me provide one example based from the article. Consider a 10 year accumulation period followed by a 30 year distribution period. There is a 58% chance that the VA/GLWB contract value will have hit zero (though the guaranteed income would still be provided). There is a 12.1% chance that the investment-only VA would be depleted while replicating the same payments. In the median outcome, the VA/GLWB would be depleted. In the median for the investment-only VA, the VA would have supported all of the income provided by the VA/GLWB and still have a real value of $159,709, relative to $100,000 at the start. Real wealth actually grew by 60%.

Ultimately there is no single answer about what is right, as it depends on a person's preferences, but this analysis helps to make clear about the tradeoffs involved. With the VA/GLWB, some guaranteed income will always be provided, though in real terms it may end up being quite low. The effect of the compounding fees is dramatic. It is much less likely that there will be any liquidity, because fees eat away at the contract value.  In this example, there was a 12.1% chance of running out of assets with the investment-only approach. But in the median outcome, the investment-only approach could have matched income from the VA/GLWB and still experience real asset growth of almost 60%. That's the true cost of the guarantee. And making these costs more clear is the point of the white paper.


Retirement Income Research in the new issue of the Journal of Personal Finance

The Fall 2014 issue of the Journal of Personal Finance is available. It's the first issue in which Joseph Tomlinson and I have served as co-editors. A more complete announcement about the journal and its articles is included below, but first I'd like to highlight the two articles in the issue that are of more direct relevance to retirement income research. 

Portfolio Size Matters

First, the lead article by Gordon Irlam is about dynamic asset allocation over the lifecycle. I think this is a fascinating article and is well worth reading. In a recent post, I mentioned that there are three general ways to approach dynamic asset allocation: mechanical glidepaths based on age, valuation-based allocation, or the funded ratio. Gordon's research works at the intersection of mechanical glidepaths and the funded ratio, as he finds that the optimal asset allocation does depend not only on age, but it also very much depends on the ratio of one's portfolio wealth to their desired spending amount in retirement (the Relative Portfolio Size [RPS] which is 1 / withdrawal rate). 

In other words, target date funds are inadequate because they base asset allocation only on age, when the funded status of the individual (the RPS) is just as important to determining optimal asset allocation. Of course, the point of target date funds is to move people in the right direction when they don't care about investing and have no idea what their RPS is, but more sophisticated investors should be able to do better than just using a mechanical glidepath.

Calculations are made using dynamic programming, which works backward to determine the optimal asset allocation at a particular age after accounting for what will be optimal at subsequent ages. He analyzes cases with a fixed life expectancies and variable life expectancies, and also for cases with and without a motive to leave a bequest. A summary of what his figures show is:

Figure 1: Success rates are naturally higher when the RPS is higher (implying the ability to use a lower withdrawal rate to meet one's goal). The highest RPS is needed in the years around the retirement date and after. After withdrawals begin, there is less opportunity for the portfolio to grow.

Figure 2: Optimal stock allocations decrease as the RPS gets larger at any particular age. Those able to use quite low withdrawal rates to meet their goals and who have no bequest motive have already won the game (in the language of William Bernstein), and so they can make due with a low stock allocation. Conversely, those with a low RPS will maximize the chances to meet their spending goals with a more aggressive stock allocation. Taking more risk is the Hail Mary pass to try and make the plan work. 

Figure 3: This figure moves away from a fixed age of death to a variable age of death. It increases the role for balanced portfolios later in life, since uncertainty remains for how long one can be expected to remain alive.

Figure 4: This figure is really interesting, because it shows the optimal lifetime asset allocations for various individual Monte Carlo simulations. Note that there is a general tendency for a U-shaped lifetime asset allocation path. Stocks allocations are highest when young, lowest near the retirement date, and then increase again at higher ages. This is where my research with Michael Kitces about the rising equity glidepaths fits in.  It's not that the rising glidepath is always optimal, but we think it is the best approximation that can be made for someone if we are not otherwise able to incorporate information about their funded status or RPS. The figure shows that in some simulations, the stock allocation does continue to decrease at higher and higher ages. Those would be simulations where things went quite well and the RPS continues to grow throughout retirement, so it is not necessary to have any stocks.  Remember, at this stage in the research we are just looking at the optimal asset allocations to meet a fixed spending goal. There is no need for further upside potential because spending will not increase and we don't care about leaving a bequest. 

Figure 5: Now he adds a bequest motive. The retiree also cares about leaving a bequest. This is a very interesting figure because it introduces higher stock allocations at low and high ages for people with very high RPS levels. As such, if Figure 4 was re-done with the bequest motive, I'm pretty sure that Figure 5 implies that a U-shaped lifetime asset allocation will apply to even more simulations (i.e. have the lowest stock allocation at retirement, and have higher stock allocations when young or old). 

He finishes the article with some sensitivity analysis about how changing assumptions would change the optimal asset allocations, and he also shows how a more optimal asset allocation strategy that includes the RPS will reduce the amount of wealth needed at retirement relative to various rules of thumb or target date fund glidepaths.

Gordon is doing great work, and he has developed www.aacalc.com to allow users the opportunity to test their approach for different circumstances. 

The Actuarial Approach

In the next article, Ken Steiner proposes an actuarial approach to planning for taking withdrawals from savings to support retirement. Ken is a retired fellow at the Society of Actuaries, and he hosts the blog, How Much Can I Afford to Spend in Retirement?  The five step actuarial process he outlines includes:

1. Gather data

2. Make relevant assumptions about future market returns, future inflation, and remaining time horizon

3. Calculate the preliminary spendable amount, which is a mathematical calculation of the sustainable spending amount that would lead precisely to portfolio depletion (or the desired bequest amount) and the end of the planning horizon

4. Apply a smoothing technique for spending so that annual spending doesn't fluctuate too much based on what is calculated in step 3.  

5. Store the results for next year's analysis.

He finishes the article with a comparison for how his approach performs against an RMD strategy, the 4% rule, and a strategy of withdrawing 4% of the remaining blaance each year. 

This article is highly worthwhile as well.

And now for the journal announcement:

Journal of Personal Finance
Vol 13 Issue 2

The Journal of Personal Finance with co-editors Wade D. Pfau and Joe Tomlinson is available to you. The Journal is distinctive in that it is practitioner oriented and a refereed academic journal that promotes research to examine the impact of financial issues on households as well as research on the practice and profession of financial planning. The IARFC supports the academic community of the financial services industry. Take advantage of this resource written by your peers.

The Journal of Personal Finance is a member benefit of the International Association of Registered Financial Consultants (IARFC).

You can access the full online version by logging into your membership or by joining the IARFC. 
Hard copies are available to Members and Non-Members at the IARFC Store:

Journal of Personal Finance
editors' notes
Click Here to Access Your JPF

This issue begins with a paper by Gordon Irlam that applies the economists' life-cycle finance approach to determining optimal asset allocations for retirement. The author demonstrates the inappropriateness of the common rule of thumb that stock allocations should be determined by age.

He demonstrates that portfolio size also needs to be considered. Applying the life-cycle finance approach and the use of accompanying tools such as stochastic dynamic programming is gaining more attention as a research area, and it shows promise for developing practical applications.

The second paper by Janet Koposko and Douglas Hershey deals with the impact of early life influences on planning for retirement many years later. The authors conduct a survey of college students who report the extent of childhood personal finance lessons learned, and the study relates this early experience to expectations of future planning and anticipated satisfaction with retirement. They find that early experiences are likely to carry even much later in life.

The next paper by Chad Smith and Gustavo Barboza bears some similarity to the Koposko/Hershey paper, but focuses on the impact of early influences on how college students deal with current financial issues. They find that financial lessons imparted from parents to students can play a strong role in reducing the financial burdens students assume. They also find that overconfidence can play a role in leading students to take on too much debt.

In the next paper, Ken Steiner proposes an actuarial approach to planning for taking withdrawals from savings to support retirement. His particular method bears similarities to the approach actuaries take in dealing with pension plans, and involves taking a fresh look at assets and liabilities each year, and making changes to the spending plan as appropriate.

He also suggests a smoothing technique to avoid too much disruption to spending plans. Next, we present a short paper by David Swingler that may appeal to those interested in financial math. He is an engineering professor, and he demonstrates the process he has gone through to develop a rule-of-thumb to apply to a common problem in finance math regarding the present value of a series of future payments.

The paper by Terrance Martin, Michael Finke, and Philip Gibson deals with the important issue of how race and trust affect the decision to seek financial planning services and the accumulation of retirement wealth. The study reports differences between black and Hispanic households in terms of the impact of low trust on financial planning decisions.

Finally, Michael Guillemette, Russell James, and Jeff Larsen provide us with a paper in the relatively new subject area of applying neuroscience to financial planning research. They report on experiments to test whether loss aversion is altered when subjects are placed under higher cognitive load, with more demands placed on mental processing. We will likely be seeing more neuroscience research in areas such as risk tolerance assessment.

As new co-editors, we welcome the submission of research papers that uncover new insights in personal finance and show the potential to have an impact on the financial advice provided to individuals.

- Joseph A. Tomlinson, FSA, CFP™
- Wade D. Pfau, Ph.D., CFA

The Journal encourages submission of manuscripts in topics related to household financial decision making. More information regarding the Journal of Personal Finance
can be found by visiting the website www.journalofpersonalfinance.com


The IARFC, International Association of Registered Financial Consultants, is a non-profit professional association of financial consultants across the United States and more than 25 countries. Founded in 1984, the association serves, educates and trains financial practitioners to help their clients wisely "spend, save, invest, insure and plan for the future to achieve financial independence and peace of mind."
International Association of Registered Financial Consultants

Monday, October 6, 2014

Celebrating 20 Years of the 4% Rule

In was 20 years ago today...

The October 1994 issue of the Journal of Financial Planning contained William Bengen's article, "Determining Withdrawal Rates Using Historical Data." This article has had a truly profound effect on retirement income planning. In fact, one might argue that the article gave birth to retirement income planning. With this article, it becomes clear that post-retirement and pre-retirement investing are different beasts, as sequence of returns risk plays a bigger role when distributions are taken from the portfolio. In celebration of this 20-year anniversary, the Journal of Financial Planning currently has Bengen's original article on its main webpage. As well, Jonathan Guyton has written a wonderful cover story about Bengen's work, placing it in the historical context of where financial planning was in the 1990s, and how much things have changed in the past 20 years. 

That history lesson is especially valuable for me. In the article you will see excerpts from a short interview I had with the journal. One of the questions which was cut was: where was I 20 years ago? Well, I was just getting underway with my senior year of high school. It would still be a long time before I heard about the article. 

It's also worth noting that precisely 10 years ago in October 2004, Jonathan Guyton's first groundbreaking article on decision rules to guide retirement spending in response to portfolio performance was published.

In recognition of this anniversary, last week I spoke with financial planner Joshua Sheets on his Radical Personal Finance podcast about the history of the 4% rule. You can hear the podcast here.

Thursday, October 2, 2014

Meet Dirk Cotton, Joseph Tomlinson, Robert Powell and me in Manhattan on October 15

Details are below for this free event sponsored by MarketWatch:

MarketWatch Retirement Adviser: From Savings to Income
You’re invited: If you are planning to be in New York Oct. 15, we’d like to invite you to a free breakfast and panel discussion on how to convert retirement savings into retirement income. This Retirement Adviser event will be moderated by MarketWatch Senior Columnist and Retirement Weekly Editor Robert Powell. His guest panelists will be Wade D. Pfau, Professor of Retirement Income at The American College; Joseph A. Tomlinson, an actuary and financial planner based in Greenville, Maine; and Dirk Cotton, a financial planner in Chapel Hill, N.C. and former Fortune 500 executive. The panel will discuss withdrawal and income planning strategies, annuities, tax planning and more, and answer your questions. The event is free and begins with breakfast at 8:30 a.m. Seating is limited. For more information or to RSVP, please email MarketWatchevent@wsj.com by Monday, Oct. 13.

Friday, September 26, 2014

Webinar on September 30: Reasonable Portfolio Return Assumptions In Today’s Market

On Tuesday, September 30, from 1pm to 2:30 Eastern time, I will be presenting a webinar with Watermark Adviser Solutions. Anyone is welcome to attend, but please understand that the presentation is technically meant for financial advisers.
The webinars have limited capacity, and previous webinars did fill up quickly. If you sign up but then determine that you cannot attend, could you please consider cancelling your registration to make room for someone else? Thanks.

This webinar is about estimating portfolio return assumptions, and there will be lots of new material included. 

To register for this event, please follow this link:

Reasonable Portfolio Return Assumptions In Today’s Market

We hope you will join us.

Here is a general description:

As many know, there is a significant demand for financial advisers to evolve from providing only wealth management. We hear and believe that advisers should also offer retirement income planning as it is particularly relevant given the needs of today’s investors. The difference between traditional wealth management and retirement income planning is that traditional wealth management is only focused on growing wealth without regard to how the wealth will be used. Retirement income planning is a more complex planning problem which recognizes the need to sustain an income stream from the investment portfolio over the long-term. This is the situation facing thousands of investors today who are quickly approaching or already in retirement.

In addition, these investors face today’s low interest rate environment, where investment returns can be expected to be less than their historical averages. What was a reasonably conservative return assumption for investors in the early 1980s, since interest rates were much higher at that time, is likely much too high for a prudently invested portfolio looking forward from today over the next several years. There appears to be numerous ways that exist for estimating future stock returns, and experts disagree about which is the most appropriate. Some of the methodologies can even become quite technical.

During this webinar, our Director of Retirement Research, Dr. Wade Pfau, will look to identify a few basic methods which will give a broad range about future stock and bond returns in order to provide a good indication about the possibilities for today’s investors. The goal of our webinar is to help our financial adviser audience not only continue to understand a framework for retirement income planning, but also identify more accurate methods to use in the planning process with their clients.