Tuesday, June 28, 2011

Getting on Track for Retirement

I have finished a new article called, “Getting on Track for a Sustainable Retirement: A Reality Check on Savings and Work”. This paper can be downloaded from RePEc. It is scheduled to be published in the October 2011 Journal of Financial Planning.

The new article serves as a follow-up study for “Safe Savings Rates: A New Approach to Retirement Planning over the Lifecycle,” as it uses the basic underlying idea from that article that it is important to link the pre-retirement and post-retirement periods together when thinking about planning for retirement. Mostly that has not been done, as research either focuses on finding a safe withdrawal rate for the retirement period, or on how to best meet a wealth accumulation target at the retirement date for the accumulation period.


In a way, I am more excited about this new article than about “safe savings rates,” because the earlier article was really meant to set young people on a sustainable path to retirement, but this is not something young people tend to worry much about. Those already late in their careers who are thinking seriously about retiring in the coming years may have been interested in the “safe savings rate” concept, but be left wondering how to apply it to their own personal situations.


This new paper provides the answer about how to do this.  In doing so, there are two key points made in the paper:


1) I elaborate more on the notion that trying to meet a wealth accumulation target is not necessary, by also demonstrating just how difficult it can be to know if you are on track for meeting a wealth accumulation target anyway.  Because there is so much market volatility over short periods of time and because what happens just before retirement has the biggest impact on your wealth due to the “portfolio size effect,” trying to determine how much wealth you will end up with based on how much you’ve accumulated by even 5 years before retirement is quite difficult. Figure 3 in the paper shows how little predictive power there is in trying to link earlier wealth accumulations to the accumulation at the retirement date. So let’s not bother with trying to do this. On this point, I’d really like to thank Michael Kitces for his blog entry and the New York Times article by Tara Siegel Bernard it inspired, for getting me to think more about this issue.  Though it’s not explicitly stated, I think Michael was focusing on the notion that you must meet a wealth accumulation target before entering retirement, and I do wonder if he will find my point to be persuasive. 


2) Instead, let’s consider your current age, how much wealth you’ve already accumulated (as a multiple of salary), your stock allocation, your salary pattern, the replacement rate you wish to obtain in retirement from your savings, and what you think might be your reasonable maximum lifespan for your planning purposes. Using this information, we can simulate what would have happened for hypothetical individuals with the same characteristics in all the rolling periods from the historical data. I define a “safe” retirement plan as one that would have worked in the worst-case scenario offered thus far by history. You can decide beyond this whether you feel optimistic to plan for something better than the worst-case scenario, or whether you might plan for something even worse.


In the paper, I provide a lot of details for an example of someone aged 55 who currently saved 4 multiples of her salary. She wants to plan for expenditures through age 100, wants to maintain a 60/40 asset allocation for the rest of her life, and wants to enjoy a 50% replacement rate of her (constant real) salary from her savings after retirement (Social Security and other income sources are added on top of this 50%). Various “safe” strategies (i.e. those working in the worst-case scenario from history) for her include:


-save 52% of her salary for the next 10 years (Retire at 65)


-save 15% of her salary for the next 16 years (Retire at 71)


-save 0% of her salary for the next 21 years (Retire at 76)


These numbers are the reality for her.  If they seem too demanding (only having 4 multiples of salary saved by age 55 does leave a harsh road ahead), then a more realistic retirement plan needs to be made. Table 2 of the paper provides many more details about the “safe” retirement ages for various asset allocations, wealth accumulations, savings rates, and replacement rates for this 55 year old.


Because of space constraints in the paper, I could only discuss the 55 year old in detail.  Once you have read the paper and understand how Table 2 works, you can also consider the situation for different current ages (35 years old, 45 years old, 50 years old, and 60 years old) in the following extra tables. [for the younger ages, to count your current wealth accumulation you must consider whether it is really earmarked for retirement or whether it might be used for something else like childrens’ educations]


I think the results from this research will provide good news for some and bad news for others.  The good news is that for those who have been saving, a successful retirement awaits (assuming you keep some stocks and do not plan to spend too much) with much lower wealth accumulations than the 20x or 25x wealth numbers you may have seen before. As you can see below, even 60 year olds can reasonably expect to retire by their mid- to late 60s if they’ve already accumulated at least 6 multiples of salary.  On the other hand, a 60 year old with only two multiples of salary saved may need to forget about retiring before age 70, even if the replacement rate is only 30% (not counting Social Security). This does assume you plan expenditures through age 100, which may be too high for those in poor health, but it is growing in likelihood that one spouse from a married couple will make it this long.


An important note is that this paper did not incorporate annuities and a complete framework does indeed need to also consider the role for annuities in retirement income. I hope to say more about that in the coming months.


I wish you a happy retirement, and please feel free to contact me at wpfau@grips.ac.jp or in the comments section below about anything. 


















Further Discussions of this article can be found at:

Peter Benedek's "Retirement Action" Website


  1. Have you thought of creating a simple application that takes all the data and lets anyone enter the particular combination of variables of interest to them? The multiple panels of Table 2 and multiple versions of it for different ages make the whole thing a bit complicated to follow, not as an exposition but as an actual tool people can use for their own situation. In other words, that would really enhance its ease of use for planners and self-directed investors.

  2. Thank you for both of your comments.

    To answer this one, simply, yes, I am thinking about this. But at this point I am no where near having anything prepared in this regard. I do hope to do this some day. The trouble is that I don't actually use Excel, except to export the tables to it to format them. Though it can be done, I have not yet learned how to convert my computer programs (I use MATLAB) into an interactive program that I can post on the internet. But, again, I do hope to get to this point some day. Thanks again

  3. Wade, this is great, but could you also provide a graph where life expectancy is a variable? People are living longer to be sure, but age 100 is still an infrequent case.

    I agree with Canadian Investor about the value of turning this into an interactive program.

  4. Larry,

    Thanks for the suggestion. Actually, next Tuesday I will have a short adaptation article about this in something called the "Wealth Strategies Journal". It's the other WSJ. One of the things I include there is a table with a maximum planning age of 90, which can then be compared to the max age of 100.

    For people who are on track to retire by their 60s, it actually doesn't make much difference about the maximum age. Only the people who are not on track and won't get to retire until quite late anyway will see a big difference.

    I will be sure to post a link to the article once it is available.

  5. Great research! With the recent housing bubble burst, it would be great if you could add another data: property investment. Since you said it yourself, the market is as volatile as it can get and It seems to go the same with the realty market. It just depends on whether you're an investor, or a seller. A detailed analysis of ones income property would be greatly appreciated, good job on this one.

  6. Hi Wade,

    This might not be the most timely comment, but if you still want to have an Excel spreadsheet that helps people calculate the various outputs they want to get based on their particular circumstances, I would be more than happy to help. I'm great with Excel and would like to come up with a few scenarios for myself.

  7. Pierre,
    Thanks. I'll hold on to this. I've been busy with other things recently, but I hope by next year to be getting to the point where I can focus more on getting things converted from their current Matlab software form into something that can be interactive. Best wishes, Wade

  8. Would you be willing to share your matlab code?

    Thanks, another matlab user

  9. Matlab user again here. Maybe this is a newbie question, but when you're referring to salary, do you mean net or gross?

    Thank you for this very interesting article.

    1. Hi,

      It is gross salary. I don't think I want to share the Matlab code for this one, but you are welcome to try to replicate it. Robert Shiller has all of the data I used on his webpage.

  10. Hi Dr. Pfau:

    Thank you for sharing this work. This is very interesting and very valuable to people like me who only have a DC plan (and SS someday). I was wondering if you could point me to the tables for people who are age 45. I'm 46 and, as you concluded, it's hard to tell whether or not my husband and I are on track just by looking at current balances and trying to estimate what growth we might see in the years ahead. I also look forward to reading about your analysis of how annuities may fit into a retirement plan.

  11. Hi:

    Do the stock allocation tables assume that the stock allocation will be constant throughout the lifespan? I'm currently at a 100% stock allocation but I've read that I should consider changing it as I get closer to retirement age. I'm about 20 years away from retirement now. I'm just wondering if the tables are based on the assumption that I will always be 100% stocks. If so, I know that I probably need to bump up my savings rate beyond what the tables indicate.

    1. Hi,

      All of the stock allocations shown assume that stock allocation is held over one's lifetime. In terms of choosing a stock allocation to use with the table, it would probably be a good idea to consider the stock allocation you will have when you are around your retirement date. That is when the portfolio is the largest and the stock allocation has the biggest absolute impact.