Sunday, July 31, 2011

Nearly Optimal Asset Allocations in Retirement

I've just finished a short new paper called, "Nearly Optimal Asset Allocations in Retirement."  It can be downloaded from RePEc.  In many ways, it follows from the topics considered in my last few blog posts. 

I think the main message can be summed up by the article's conclusion:

Sustainable retirement withdrawal rates depend on capital market expectations, retirement durations, asset allocations, and acceptable failure probabilities. While this is all generally known, what this article does in particular is to show how lower stock allocations can support withdrawal rates nearly as well as higher stock allocations. This is true even with simulations based on the historical data, which may provide an overly optimistic view for forward-looking stock returns. These results are important to emphasize, because many retirees will be weary of high stock allocations, and the traditional advice from withdrawal rate studies for retirees to keep at least 50 percent stocks may not really help that much after all. Lower stock allocations can potentially perform nearly as well in supporting a given withdrawal rate while also perhaps allowing nervous retirees to sleep more peacefully at night.

Reading W. Van Harlow's recent article is really what specifically prompted me to write this new article. His conclusion of 5-25% stocks for retirees may be fairly reasonable after all, at least for rather conservative retirees who want low failure rates. At least, retirees don't really need to feel obliged to keep the 50-75% stock allocations that are commonly recommended in retirement withdrawal rate studies.

 I think this article relates well to the discussion in "Trinity Study and Asset Allocation" at the Boglehead's Wiki entry, "Trinity Study Update".  I wish the article could be a bit longer to cover more of the related literature and issues mentioned in the Wiki, but I am already really pushing the acceptable length limits for the the intended publication outlet as it is.This article is fairly short, and the key information is found in Tables 2 and 3.