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Post-Retirement Financial Strategies: Forecasts and Valuation

Post-Retirement Financial Strategies: Forecasts and Valuation. William F. Sharpe EFMA 2011 Keynote Address. A Post-Retirement Financial Strategy. An initial investment An investment rule Deterministic or stochastic A spending rule Deterministic or stochastic

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Post-Retirement Financial Strategies: Forecasts and Valuation

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  1. Post-Retirement Financial Strategies:Forecasts and Valuation William F. Sharpe EFMA 2011 Keynote Address

  2. A Post-Retirement Financial Strategy • An initial investment • An investment rule • Deterministic or stochastic • A spending rule • Deterministic or stochastic • (Possibly) an annuitization rule

  3. The Capital Market Model

  4. Capital Market Model:Investments • Market portfolio • All relatively liquid global bonds and stocks • Portfolio includes x% of outstanding securities of every issuer • Transactions only made to accommodate new issues, redemptions, etc. • All returns measured in real terms • Riskless Asset • Inflation-protected securities • e.g. Treasury Inflation-Protected Securities (TIPS) for U.S. investors • Assume that zero-coupon bonds exist with maturities for every future year

  5. Cumulative Market Returns

  6. Distribution Assumptions • Market real returns • independent and identically distributed • Single and multiple-year distributions are all lognormal • Equivalently, logarithm of return is normally distributed • Riskless real returns • Constant real rate through time

  7. Return-generating ProcessParameter Values

  8. Pricing

  9. Path-independent Pricing

  10. The Pricing Kernel

  11. Pricing Kernel Parameter Values

  12. State Prices Monte Carlo simulation:n = 1,000,000 scenarios

  13. Investor Utility Functions

  14. Expected Utility Time-Separable General

  15. The Fidelity Income Replacement Funds

  16. Fidelity Fund Characteristics • “Fidelity Income Replacement Funds combined with the Smart Payment ProgramSM help make it easier to convert a portion of your retirement savings into regular monthly payments • … The Funds are designed to be used in combination with other retirement income products” Source: www.fidelity.com

  17. Payout Rates

  18. Glide Paths

  19. Fido

  20. Fido: Proportions Invested in the Market Portfolio

  21. Fido: Distribution of Payments in Year 30

  22. Fido: Payment Distributions

  23. Fido: Payment Ratio Distributions

  24. Lockbox Strategies

  25. Lockbox Strategy Characteritics • For each payment date, establish a lockbox with: • An initial value • An initial asset allocation • Rules for any trades prior to the maturity date • At maturity, use proceeds for payment

  26. Lockbox Equivalents for Deterministic Payout Ratio Strategies

  27. Valuation

  28. log(Payment) vs. log(Cumulative Market Return)

  29. log(Price) vs. log(Payment)

  30. Present Values of Payments

  31. Vanguard Managed Payout Funds

  32. Vanguard Managed Payout Funds • Managed Payout Funds … have a "built in" systematic withdrawal plan (SWP) … • A second …feature of Managed Payout Funds is their three-year rolling average payout strategy, which can lead to a more consistent payout level than typical SWPs. • Managed Payout Funds, are designed, at your choice, either to be the sole fund in your portfolio or to complement other investments as part of your overall investment strategy, depending on your personal needs and preferences.

  33. Vanguard Managed Payout Funds Source: www.vanguard.com, April 18, 2011

  34. Vido: Payment Distributions

  35. Fido and Vido:Payment Distributions

  36. Fido and Vido:Payment Ratio Distributions

  37. Vido: Present Values of Payments

  38. The Four Percent Rule

  39. Vanguard Retirement Withdrawal Tool

  40. Asset Allocations • Conservative • no more than 35% stocks • Moderate • 35 to 65% stocks • Aggressive • At least 65% stocks

  41. Withdrawal Rate Criterion • 83 different ‘time-paths’ beginning in 1926, 1927, …, 2008 • “…beyond the year 2008, we just loop back to the returns of 1926 and cycle forward from there.” • “The monthly withdrawal amount …is the highest level of spending in which 85% of these historical paths would have left you with a positive balance at the end of your chosen investment horizon.”

  42. Cuatro

  43. Cuatro: Payment Distributions

  44. Cuatro: Payment Ratio Distributions

  45. Cuatro: Present Values of Payments:Years 1-30

  46. Cuatro: Present Values of Payments and Ending Wealth

  47. BuyHo

  48. BuyHo: Initial Values of TIPSand the Market Portfolio

  49. BuyHo: Payment Distributions

  50. BuyHo: Payment Ratio Distributions

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