Edwin Lung, Craig Roodt, L. Ryan, G. Warren, K. Wymer
We identify and discuss four key elements to address when designing the investment strategy for default retirement plans: whether to cater for member needs or their wants, objectives, the member for which the default is being designed, and risk appetite. Addressing these design elements requires making assumptions about the member, of which the literature provides limited guidance to plan sponsors. We outline the main assumptions and demonstrate the potential impact on retirement experience through illustrative models. We find that mismatches between the member and the way that they are characterized can adversely impact on welfare. TOPICS: Long-term/retirement investing, retirement, portfolio management/multi-asset allocation, portfolio theory Key Findings ▪ We identify and discuss the elements that retirement plan providers should address when designing investment strategies for default members, highlighting the issues and challenges involved. ▪ The four elements are: whether to cater for member needs or their wants, objectives, the member for which the default is being designed, and risk appetite. ▪ Illustrative modelling underlines the importance of assumptions about objectives and risk appetite.
{"title":"A Framework for Designing Investment Strategies for Default Retirement Plans","authors":"Edwin Lung, Craig Roodt, L. Ryan, G. Warren, K. Wymer","doi":"10.3905/jor.2020.1.081","DOIUrl":"https://doi.org/10.3905/jor.2020.1.081","url":null,"abstract":"We identify and discuss four key elements to address when designing the investment strategy for default retirement plans: whether to cater for member needs or their wants, objectives, the member for which the default is being designed, and risk appetite. Addressing these design elements requires making assumptions about the member, of which the literature provides limited guidance to plan sponsors. We outline the main assumptions and demonstrate the potential impact on retirement experience through illustrative models. We find that mismatches between the member and the way that they are characterized can adversely impact on welfare. TOPICS: Long-term/retirement investing, retirement, portfolio management/multi-asset allocation, portfolio theory Key Findings ▪ We identify and discuss the elements that retirement plan providers should address when designing investment strategies for default members, highlighting the issues and challenges involved. ▪ The four elements are: whether to cater for member needs or their wants, objectives, the member for which the default is being designed, and risk appetite. ▪ Illustrative modelling underlines the importance of assumptions about objectives and risk appetite.","PeriodicalId":36429,"journal":{"name":"Journal of Retirement","volume":"8 1","pages":"40 - 60"},"PeriodicalIF":0.0,"publicationDate":"2020-12-30","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"42478464","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
A. Clare, James Seaton, Peter N. Smith, Stephen H. Thomas
This article shows how the relatively new concept of Perfect Withdrawal Rate can be used in assessing the appropriate sustainable withdrawal amounts from a pot of wealth. This concept can be applied equally to private retirement funds, endowments, and charities—and, indeed, in any context requiring regular withdrawals from an initial source of funds. The subject of estimating sustainable withdrawal rates usually falls back on describing the likely minimum safe withdrawal possibilities for various portfolio constructions over different decumulation periods. This analysis employs either a long period of historical data or a recombination of data in the form of Monte Carlo simulations. To illustrate the power of the Perfect Withdrawal concept, the article considers the case of someone who initiated retirement on January 1, 2000, at age 65 and, with the benefit of actual investment returns, assesses investment and withdrawal rate options and lessons to be learned from this experience. The article also introduces the concept and a methodology for purchasing a delayed annuity so that at age 85 (on December 31, 2019), the hypothetical retiree is fully transitioned from investment income to annuity income for the rest of their life, no matter how long that may be. TOPICS: Retirement, pension funds, foundations & endowments, quantitative methods, simulations Key Findings ▪ The introduction of delayed annuities into retirement planning helps complete analysis of the decumulation experience. ▪ The larger the sum required for a delayed annuity, the more variable the final withdrawals in the decumulation journey become. ▪ The delayed annuity purchase amount is a moving target; withdrawal amounts have to adapt in the attempt to meet the objective.
{"title":"Perfect Withdrawal in a Noisy World: Investing Lessons with and without Annuities while in Drawdown between 2000 and 2019","authors":"A. Clare, James Seaton, Peter N. Smith, Stephen H. Thomas","doi":"10.2139/ssrn.3748618","DOIUrl":"https://doi.org/10.2139/ssrn.3748618","url":null,"abstract":"This article shows how the relatively new concept of Perfect Withdrawal Rate can be used in assessing the appropriate sustainable withdrawal amounts from a pot of wealth. This concept can be applied equally to private retirement funds, endowments, and charities—and, indeed, in any context requiring regular withdrawals from an initial source of funds. The subject of estimating sustainable withdrawal rates usually falls back on describing the likely minimum safe withdrawal possibilities for various portfolio constructions over different decumulation periods. This analysis employs either a long period of historical data or a recombination of data in the form of Monte Carlo simulations. To illustrate the power of the Perfect Withdrawal concept, the article considers the case of someone who initiated retirement on January 1, 2000, at age 65 and, with the benefit of actual investment returns, assesses investment and withdrawal rate options and lessons to be learned from this experience. The article also introduces the concept and a methodology for purchasing a delayed annuity so that at age 85 (on December 31, 2019), the hypothetical retiree is fully transitioned from investment income to annuity income for the rest of their life, no matter how long that may be. TOPICS: Retirement, pension funds, foundations & endowments, quantitative methods, simulations Key Findings ▪ The introduction of delayed annuities into retirement planning helps complete analysis of the decumulation experience. ▪ The larger the sum required for a delayed annuity, the more variable the final withdrawals in the decumulation journey become. ▪ The delayed annuity purchase amount is a moving target; withdrawal amounts have to adapt in the attempt to meet the objective.","PeriodicalId":36429,"journal":{"name":"Journal of Retirement","volume":"9 1","pages":"9 - 39"},"PeriodicalIF":0.0,"publicationDate":"2020-12-14","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"45530259","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
This article investigates the causes of the “high-fee puzzle,” which is that some people pay high-fees for financial advice and financial products when lower-fee advice and products are available. We hypothesize that lack of awareness of the size of the effect of fees on account balances is one cause. We survey college students with business-related majors, asking them questions on the effects of fees on account balances, as well as standard financial literacy questions. We find that only one-third of students are able to answer the fee questions correctly; three-quarters correctly answered the common financial literacy questions. We tested whether people understand the importance of fees when fees are presented in a simple, transparent manner. Our results suggest that policies to require simple, transparent fee disclosures may be more effective if more people understood the importance of fees. For pension participants, our results suggest the importance of investment menus excluding high-fee options and focusing on low-fee options. TOPIC: Retirement Key Findings ▪ We find widespread lack of knowledge concerning the size of the effect of fees on future account balances. ▪ This lack of knowledge may explain the “high-fee puzzle,” where people pay high-fees for financial products and advice when lower-fee alternatives are available. ▪ For pension participants, our results support the importance of investment menus excluding high-fee options and focusing on low-fee options.
{"title":"Financial Literacy, the “High-Fee Puzzle,” and Knowledge about the Importance of Fees","authors":"L. Muller, J. Turner","doi":"10.3905/jor.2020.1.078","DOIUrl":"https://doi.org/10.3905/jor.2020.1.078","url":null,"abstract":"This article investigates the causes of the “high-fee puzzle,” which is that some people pay high-fees for financial advice and financial products when lower-fee advice and products are available. We hypothesize that lack of awareness of the size of the effect of fees on account balances is one cause. We survey college students with business-related majors, asking them questions on the effects of fees on account balances, as well as standard financial literacy questions. We find that only one-third of students are able to answer the fee questions correctly; three-quarters correctly answered the common financial literacy questions. We tested whether people understand the importance of fees when fees are presented in a simple, transparent manner. Our results suggest that policies to require simple, transparent fee disclosures may be more effective if more people understood the importance of fees. For pension participants, our results suggest the importance of investment menus excluding high-fee options and focusing on low-fee options. TOPIC: Retirement Key Findings ▪ We find widespread lack of knowledge concerning the size of the effect of fees on future account balances. ▪ This lack of knowledge may explain the “high-fee puzzle,” where people pay high-fees for financial products and advice when lower-fee alternatives are available. ▪ For pension participants, our results support the importance of investment menus excluding high-fee options and focusing on low-fee options.","PeriodicalId":36429,"journal":{"name":"Journal of Retirement","volume":"8 1","pages":"29 - 38"},"PeriodicalIF":0.0,"publicationDate":"2020-12-12","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"46661592","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
The vulnerability of individuals planning for retirement has been growing as a result of the conversion from defined-benefit plans to defined-contribution plans, the steady increase in life longevity, and the uncertainty of asset returns under an ever-changing global environment. A serious problem is the lack of appropriate planning for retirement. How much should an individual in the United States save beyond the Social Security tax to maintain a reasonable lifestyle after retirement? The article designs a framework to facilitate the process of setting realistic goals for retirement planning, featuring the concept of agent-based simulations. Focusing on policy-rule-based investment strategies, the simulation framework includes multiple investable asset categories and explores dynamic allocation based on the investor’s age, current salary, and Social Security accumulation situation. Empirical results demonstrate a stylized application of the planning framework. TOPICS: Long-term/retirement investing, pension funds, portfolio management, retirement, Social Security Key Findings • Demonstrates the advantages of agent-based simulation models for addressing the survivability of pension plans. • Compares dynamic and adaptive strategies for integrating saving and investment decisions. • Provides a clear example of goal-based investing for individuals and for institutions such as the US Social Security System.
{"title":"Setting Realistic Goals for Personal Retirement Planning via Micro–Macro Analyses","authors":"J. Mulvey, Hang-Wei Hao","doi":"10.3905/JOR.2020.1.076","DOIUrl":"https://doi.org/10.3905/JOR.2020.1.076","url":null,"abstract":"The vulnerability of individuals planning for retirement has been growing as a result of the conversion from defined-benefit plans to defined-contribution plans, the steady increase in life longevity, and the uncertainty of asset returns under an ever-changing global environment. A serious problem is the lack of appropriate planning for retirement. How much should an individual in the United States save beyond the Social Security tax to maintain a reasonable lifestyle after retirement? The article designs a framework to facilitate the process of setting realistic goals for retirement planning, featuring the concept of agent-based simulations. Focusing on policy-rule-based investment strategies, the simulation framework includes multiple investable asset categories and explores dynamic allocation based on the investor’s age, current salary, and Social Security accumulation situation. Empirical results demonstrate a stylized application of the planning framework. TOPICS: Long-term/retirement investing, pension funds, portfolio management, retirement, Social Security Key Findings • Demonstrates the advantages of agent-based simulation models for addressing the survivability of pension plans. • Compares dynamic and adaptive strategies for integrating saving and investment decisions. • Provides a clear example of goal-based investing for individuals and for institutions such as the US Social Security System.","PeriodicalId":36429,"journal":{"name":"Journal of Retirement","volume":"8 1","pages":"23 - 38"},"PeriodicalIF":0.0,"publicationDate":"2020-10-31","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"41762491","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
This article presents a thorough evaluation of target date funds (TDFs) for the period 2010–2020. TDFs have grown enormously in assets, reaching $1.4 trillion at the end of 2019, and account for approximately 24% of all assets in 401(k) accounts. We report on the results of a style analysis evaluation of TDFs that determines their effective asset allocation. It examines both the constant in the style analysis regressions and resulting Sharpe ratios, which reflect the over- or under-performance of the funds relative to a passive benchmark with the same asset allocation. Lower cost TDFs tend to match the benchmark returns, while higher cost TDFs deviate from them considerably. We examine how TDFs performed in the stock market crash between February 19 and March 23, 2020, during which five-week period broad market averages fell by about one-third. We find that the value of long-dated TDFs (those with a target date of 2045 and beyond) fell by between 30% and 35%, while the 2025 funds, designed for people roughly 60 years old, lost between 20% and 25% of their value. We find that past performance only weakly influences future expected performance. As with equity funds in general in this period, TDFs with actively managed ingredient funds, on average, trailed the performance of their cheaper passively managed counterparts. TOPICS: Pension funds, portfolio theory, risk management, performance measurement Key Findings ▪ Even near term target date funds (TDFs) have considerable equity exposure. For instance, 2025 TDFs lost between 20 and 25% of their value in the five weeks between February 19 and March 23, 2020. Many longer horizon TDFs did no better than pure equity funds in this period. ▪ 75% of actively managed TDFs failed to do as well as the best fitting set of reference ETFs. ▪ Past performance is only a weak predictor of future performance for TDFs. An extra 1% per year return in 2010–14 period only increases the expected return in 2015–19 by 9 basis points per year.
{"title":"An Analysis of the Performance of Target Date Funds","authors":"J. Shoven, D. Walton","doi":"10.3386/w27971","DOIUrl":"https://doi.org/10.3386/w27971","url":null,"abstract":"This article presents a thorough evaluation of target date funds (TDFs) for the period 2010–2020. TDFs have grown enormously in assets, reaching $1.4 trillion at the end of 2019, and account for approximately 24% of all assets in 401(k) accounts. We report on the results of a style analysis evaluation of TDFs that determines their effective asset allocation. It examines both the constant in the style analysis regressions and resulting Sharpe ratios, which reflect the over- or under-performance of the funds relative to a passive benchmark with the same asset allocation. Lower cost TDFs tend to match the benchmark returns, while higher cost TDFs deviate from them considerably. We examine how TDFs performed in the stock market crash between February 19 and March 23, 2020, during which five-week period broad market averages fell by about one-third. We find that the value of long-dated TDFs (those with a target date of 2045 and beyond) fell by between 30% and 35%, while the 2025 funds, designed for people roughly 60 years old, lost between 20% and 25% of their value. We find that past performance only weakly influences future expected performance. As with equity funds in general in this period, TDFs with actively managed ingredient funds, on average, trailed the performance of their cheaper passively managed counterparts. TOPICS: Pension funds, portfolio theory, risk management, performance measurement Key Findings ▪ Even near term target date funds (TDFs) have considerable equity exposure. For instance, 2025 TDFs lost between 20 and 25% of their value in the five weeks between February 19 and March 23, 2020. Many longer horizon TDFs did no better than pure equity funds in this period. ▪ 75% of actively managed TDFs failed to do as well as the best fitting set of reference ETFs. ▪ Past performance is only a weak predictor of future performance for TDFs. An extra 1% per year return in 2010–14 period only increases the expected return in 2015–19 by 9 basis points per year.","PeriodicalId":36429,"journal":{"name":"Journal of Retirement","volume":"8 1","pages":"43 - 65"},"PeriodicalIF":0.0,"publicationDate":"2020-10-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"48415708","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Defined-contribution plan (DCP) fiduciaries are often faced with conflicting perspectives when executing their responsibilities and terminating underperforming active managers are involved. Consultants, investment managers, and capital market intermediaries generally argue that more time is needed to prove that an investment strategy is suboptimal. These parties often have inherent conflicts of interest to argue for active management over passive management. Most conflicts are economic in nature, but some are steeped in intellectual hubris. In this article, the authors enter the fray from the plan participant (PP) side. Ultimately, the very essence of a DCP is to offer a menu of investment options that enable PPs to optimize wealth aggregation in a diversified manner using a multiasset class solution. We show that PPs are better served when fiduciaries monitor active investment managers and replace them with passive alternatives in a timely manner if they underperform. Too often plan fiduciaries churn a DCP by replacing underperforming active funds with other active funds. TOPICS: Manager selection, mutual fund performance, passive strategies, retirement, wealth management Key Findings • Defined-contribution plan participants are better served when fiduciaries monitor active investment managers and replace them with passive alternatives in a timely manner if they underperform. • A three-year rolling return window to compare active fund returns with benchmark returns seems to provide the best decision criterion for the active-to-passive decision. • Plan participants are far better served by fiduciaries who have a well-structured, discrete decision framework for replacing underperforming active funds.
{"title":"How Long Is Long Enough?","authors":"G. Buetow, Bernd Hanke","doi":"10.3905/JOR.2020.1.072","DOIUrl":"https://doi.org/10.3905/JOR.2020.1.072","url":null,"abstract":"Defined-contribution plan (DCP) fiduciaries are often faced with conflicting perspectives when executing their responsibilities and terminating underperforming active managers are involved. Consultants, investment managers, and capital market intermediaries generally argue that more time is needed to prove that an investment strategy is suboptimal. These parties often have inherent conflicts of interest to argue for active management over passive management. Most conflicts are economic in nature, but some are steeped in intellectual hubris. In this article, the authors enter the fray from the plan participant (PP) side. Ultimately, the very essence of a DCP is to offer a menu of investment options that enable PPs to optimize wealth aggregation in a diversified manner using a multiasset class solution. We show that PPs are better served when fiduciaries monitor active investment managers and replace them with passive alternatives in a timely manner if they underperform. Too often plan fiduciaries churn a DCP by replacing underperforming active funds with other active funds. TOPICS: Manager selection, mutual fund performance, passive strategies, retirement, wealth management Key Findings • Defined-contribution plan participants are better served when fiduciaries monitor active investment managers and replace them with passive alternatives in a timely manner if they underperform. • A three-year rolling return window to compare active fund returns with benchmark returns seems to provide the best decision criterion for the active-to-passive decision. • Plan participants are far better served by fiduciaries who have a well-structured, discrete decision framework for replacing underperforming active funds.","PeriodicalId":36429,"journal":{"name":"Journal of Retirement","volume":"8 1","pages":"39 - 48"},"PeriodicalIF":0.0,"publicationDate":"2020-09-23","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"41946843","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
This article begins by explaining how income-based increases in Medicare premiums produce dramatic increases in marginal tax rates for retirees with relatively high levels of income. It then explains how the taxation of Social Security benefits causes most lower- and middle-income households to have marginal tax rates for a wide range of income after Social Security benefits begin that are either 150% or 185% of their tax bracket. By combining these two factors, the authors show that most retirees will have marginal tax rates in retirement that rise and fall frequently and sharply as their income increases. This article then explains how this rising and falling pattern of marginal tax rates should affect retired households’ withdrawal strategies from their financial portfolio, where withdrawal strategy is defined broadly to include Roth conversions. TOPICS: Wealth management, retirement, social security Key Findings • Due to income-based increases in Medicare premiums and the taxation of Social Security benefits, most retirees face marginal tax rates that rise and fall sharply as their income rises. • The marginal tax rates for retired households receiving Social Security benefits fall sharply when their income places them beyond the income level where 85% of Social Security benefits is taxable. • We encourage these single and married households to make Roth conversions to take advantage of the relatively low marginal tax rates that exist beyond this income level. However, the amount of funds that can be converted at these relatively low tax rates depends upon whether the household has begun Social Security benefits and whether it will be on Medicare 2 years hence.
{"title":"Investment Implications of the Rising and Falling Pattern of Marginal Tax Rates for Retirees","authors":"William R Reichenstein, W. Meyer","doi":"10.3905/jor.2020.1.065","DOIUrl":"https://doi.org/10.3905/jor.2020.1.065","url":null,"abstract":"This article begins by explaining how income-based increases in Medicare premiums produce dramatic increases in marginal tax rates for retirees with relatively high levels of income. It then explains how the taxation of Social Security benefits causes most lower- and middle-income households to have marginal tax rates for a wide range of income after Social Security benefits begin that are either 150% or 185% of their tax bracket. By combining these two factors, the authors show that most retirees will have marginal tax rates in retirement that rise and fall frequently and sharply as their income increases. This article then explains how this rising and falling pattern of marginal tax rates should affect retired households’ withdrawal strategies from their financial portfolio, where withdrawal strategy is defined broadly to include Roth conversions. TOPICS: Wealth management, retirement, social security Key Findings • Due to income-based increases in Medicare premiums and the taxation of Social Security benefits, most retirees face marginal tax rates that rise and fall sharply as their income rises. • The marginal tax rates for retired households receiving Social Security benefits fall sharply when their income places them beyond the income level where 85% of Social Security benefits is taxable. • We encourage these single and married households to make Roth conversions to take advantage of the relatively low marginal tax rates that exist beyond this income level. However, the amount of funds that can be converted at these relatively low tax rates depends upon whether the household has begun Social Security benefits and whether it will be on Medicare 2 years hence.","PeriodicalId":36429,"journal":{"name":"Journal of Retirement","volume":"8 1","pages":"53 - 64"},"PeriodicalIF":0.0,"publicationDate":"2020-06-19","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"49616593","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Retirement planning is an issue that must be tackled early and solved backward. It must be tackled early because little can be done if an individual is not on the right path and has only a few years left to work. It must be solved backward because it makes little sense to aim for a portfolio that may not be able to sustain the desired lifestyle in retirement. This article introduces an approach that integrates the working period and the retirement period; leads individuals to consider all relevant variables at the beginning of their journey; and enables them to start saving early to build a target portfolio designed specifically to sustain a desired retirement. The analytical framework introduced yields closed-form solutions for the target retirement portfolio and the contributions that need to be made during the working years to hit that target. The framework proposed is illustrated with an empirical base case, sensitivity analysis, and Monte Carlo simulations. TOPICS: Long-term/retirement investing, portfolio management, retirement, wealth management Key Findings • Retirement planning must be tackled early and solved backward. • It starts with an estimation of the withdrawals needed to sustain a desired lifestyle in retirement; continues with the determination of the target retirement portfolio needed to sustain those withdrawals; and ends with the contributions needed to build that portfolio. • This article introduces a theoretical framework and an empirical illustration designed to help individuals get on the right path.
{"title":"Retirement Planning: From Z to A","authors":"Javier Estrada","doi":"10.2139/ssrn.3619941","DOIUrl":"https://doi.org/10.2139/ssrn.3619941","url":null,"abstract":"Retirement planning is an issue that must be tackled early and solved backward. It must be tackled early because little can be done if an individual is not on the right path and has only a few years left to work. It must be solved backward because it makes little sense to aim for a portfolio that may not be able to sustain the desired lifestyle in retirement. This article introduces an approach that integrates the working period and the retirement period; leads individuals to consider all relevant variables at the beginning of their journey; and enables them to start saving early to build a target portfolio designed specifically to sustain a desired retirement. The analytical framework introduced yields closed-form solutions for the target retirement portfolio and the contributions that need to be made during the working years to hit that target. The framework proposed is illustrated with an empirical base case, sensitivity analysis, and Monte Carlo simulations. TOPICS: Long-term/retirement investing, portfolio management, retirement, wealth management Key Findings • Retirement planning must be tackled early and solved backward. • It starts with an estimation of the withdrawals needed to sustain a desired lifestyle in retirement; continues with the determination of the target retirement portfolio needed to sustain those withdrawals; and ends with the contributions needed to build that portfolio. • This article introduces a theoretical framework and an empirical illustration designed to help individuals get on the right path.","PeriodicalId":36429,"journal":{"name":"Journal of Retirement","volume":"8 1","pages":"8 - 22"},"PeriodicalIF":0.0,"publicationDate":"2020-06-05","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"41692160","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Jason S. Scott, J. Shoven, S. Slavov, John G. Watson
Simple presentations of the life cycle model often suggest a constant level of real consumption in retirement. Similarly, financial planners commonly suggest that people save for retirement in such a way as to enable them to maintain a level retirement standard of living equal to their standard of living while working. However, constant consumption with age is only optimal under the precise and unlikely condition that the subjective rate of time preference is equal to the real interest rate. Most people exhibit a positive rate of pure time preference, and additionally discount the future by both mortality and morbidity risks. In comparison, the real interest rate is roughly 0%—and the term structure of interest rates suggests this condition is likely to persist. These considerations suggest that optimal consumption in the life cycle model declines with age. This finding has major implications for optimal retirement saving. For instance, we find that for many, perhaps most, people in the bottom half of the lifetime earnings distribution, it is optimal to spend out their retirement wealth well before death and to live on Social Security alone after that. Very low earners may find it optimal to not engage in retirement saving at all. TOPICS: Long-term/retirement investing, portfolio theory Key Findings ▪ Under plausible assumptions, optimal consumption in the life cycle model declines with age. ▪ For many people in the bottom half of the lifetime earnings distribution, it is optimal to spend out retirement wealth well before death and live on Social Security alone after that. ▪ These results stand in contrast to standard financial planning advice that people save for retirement in such a way as to enable them to maintain a level retirement standard of living equal to their standard of living while working.
{"title":"Can Low Retirement Savings Be Rationalized?","authors":"Jason S. Scott, J. Shoven, S. Slavov, John G. Watson","doi":"10.3386/w26784","DOIUrl":"https://doi.org/10.3386/w26784","url":null,"abstract":"Simple presentations of the life cycle model often suggest a constant level of real consumption in retirement. Similarly, financial planners commonly suggest that people save for retirement in such a way as to enable them to maintain a level retirement standard of living equal to their standard of living while working. However, constant consumption with age is only optimal under the precise and unlikely condition that the subjective rate of time preference is equal to the real interest rate. Most people exhibit a positive rate of pure time preference, and additionally discount the future by both mortality and morbidity risks. In comparison, the real interest rate is roughly 0%—and the term structure of interest rates suggests this condition is likely to persist. These considerations suggest that optimal consumption in the life cycle model declines with age. This finding has major implications for optimal retirement saving. For instance, we find that for many, perhaps most, people in the bottom half of the lifetime earnings distribution, it is optimal to spend out their retirement wealth well before death and to live on Social Security alone after that. Very low earners may find it optimal to not engage in retirement saving at all. TOPICS: Long-term/retirement investing, portfolio theory Key Findings ▪ Under plausible assumptions, optimal consumption in the life cycle model declines with age. ▪ For many people in the bottom half of the lifetime earnings distribution, it is optimal to spend out retirement wealth well before death and live on Social Security alone after that. ▪ These results stand in contrast to standard financial planning advice that people save for retirement in such a way as to enable them to maintain a level retirement standard of living equal to their standard of living while working.","PeriodicalId":36429,"journal":{"name":"Journal of Retirement","volume":"8 1","pages":"7 - 25"},"PeriodicalIF":0.0,"publicationDate":"2020-02-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"https://sci-hub-pdf.com/10.3386/w26784","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"42273755","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
As the US population becomes more diverse, it will be increasingly important for policymakers addressing Social Security’s solvency to understand how reliant various racial and ethnic groups will be on the program versus other sources of retirement wealth. Yet, to date, studies on retirement wealth have tended not to focus on race and ethnicity, have largely ignored the role of Social Security, or have excluded the most recent cohort approaching retirement—the Late Boomers. This project uses data from the Health and Retirement Study (HRS) to document the retirement resources of White, Black, and Hispanic households at various points in the wealth distribution for five HRS cohorts of 51- to 56-year-olds between 1992 and 2016. TOPICS: Retirement, wealth management, social security Key Findings ▪ In 2016, the typical Black household had 46 percent of the retirement wealth of the typical White household; the typical Hispanic household had 49 percent. This inequality would be much higher but for the presence of Social Security. ▪ The 1992 to 2010 HRS cohorts showed little change in retirement wealth inequality, although a decline in 51- to 56-year-old White households’ retirement wealth between 2010 and 2016 narrowed the racial and ethnic gaps in retirement wealth slightly. ▪ The progressivity of Social Security, combined with lower average incomes for minority households, means that replacement rates are more equal than wealth—in 2016, the replacement rate of Black households was 82 percent of White households and Hispanic households was 95 percent.
{"title":"Measuring Racial/Ethnic Retirement Wealth Inequality","authors":"Wenliang Hou, Geoffrey T. Sanzenbacher","doi":"10.2139/ssrn.3520189","DOIUrl":"https://doi.org/10.2139/ssrn.3520189","url":null,"abstract":"As the US population becomes more diverse, it will be increasingly important for policymakers addressing Social Security’s solvency to understand how reliant various racial and ethnic groups will be on the program versus other sources of retirement wealth. Yet, to date, studies on retirement wealth have tended not to focus on race and ethnicity, have largely ignored the role of Social Security, or have excluded the most recent cohort approaching retirement—the Late Boomers. This project uses data from the Health and Retirement Study (HRS) to document the retirement resources of White, Black, and Hispanic households at various points in the wealth distribution for five HRS cohorts of 51- to 56-year-olds between 1992 and 2016. TOPICS: Retirement, wealth management, social security Key Findings ▪ In 2016, the typical Black household had 46 percent of the retirement wealth of the typical White household; the typical Hispanic household had 49 percent. This inequality would be much higher but for the presence of Social Security. ▪ The 1992 to 2010 HRS cohorts showed little change in retirement wealth inequality, although a decline in 51- to 56-year-old White households’ retirement wealth between 2010 and 2016 narrowed the racial and ethnic gaps in retirement wealth slightly. ▪ The progressivity of Social Security, combined with lower average incomes for minority households, means that replacement rates are more equal than wealth—in 2016, the replacement rate of Black households was 82 percent of White households and Hispanic households was 95 percent.","PeriodicalId":36429,"journal":{"name":"Journal of Retirement","volume":"8 1","pages":"12 - 28"},"PeriodicalIF":0.0,"publicationDate":"2020-01-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"47328288","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
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