Author Topic: Nobel winner William Sharpe (Sharpe Ratio) Tackling Retirement Planning  (Read 2195 times)


  • 5 O'Clock Shadow
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Saw this a few weeks ago and didn't get around to posting it here. Basic thesis: 4% rule may be best we have but clearly model misses a lot of important info. I agree the problem is obvious, based on people's endless discussions about whether or not to really use 3.5%, 3%, how to time it, etc.

Challenging as those may appear, none compare to what Nobel laureate William Sharpe, 82, calls "decumulation," or the use of savings in retirement. It is, he says, “the nastiest, hardest problem in finance.” 

Many financial planners use a simple rule of thumb: withdraw 4 percent a year from your savings until you either die or run out of money. This one-size-fits-all solution is suboptimal for a reality where the potential outcomes are almost infinite, or as Sharpe describes it, a “multiperiod problem with actuarial issues, in a multidimensional scenario matrix.”

The first unknown confronting retirement planners is built out of standard actuarial tables. The multiplicity of possible mortality outcomes for any given year is simple -- who survives and who doesn't. But the possible combinations during roughly 30 years for two people is surprisingly large.

The second dimension comes from the 100,000-plus possible market outcomes for a global bond and stock portfolio each year. Apply all of those possible outcomes back to the mortality scenarios above and you begin to get a sense of the enormous range of potential outcomes.

Third, create a matrix for thousands of potential inflation results -- this determines the purchasing power of a retiree’s income. It’s not overstating it to call this a proxy for financial flexibility, security and even quality of life for a couple living off of their investments.

The next matrix is tied to inflation, and it is the 100,000-plus possible market returns that Treasury Inflation Protected Securities, or Tips, will pay -- a combination of the twice-annual interest payments, plus the adjusted principal at maturity.

A fifth matrix is all the incomes the couple will receive, including Social Security, insurance and any employment. Then take into account whatever they withdraw from their portfolio.

The final variable may be the most subjective and difficult to assess: the utility of income in each subsequent year.

Sharpe has published all of what he's got so far at
The website contains the content of the book as well as the MATLAB programs to run the simulations.

Anyone care to dig into this?


  • Magnum Stache
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The first unknown is easy. Go look up the 5% survival level - ie, what has a 95% chance of being long enough duration. Slightly more complex if you have a spouse, but figure what duration means you have a 5% chance ONE of you is still alive. Start with your age at retirement, not at birth.

If you're THAT old, you can probably make some money selling longevity seekrits and doing interviews ;)


  • Handlebar Stache
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There's some really good stuff in there, albeit more focused on a traditional retirement age. It's a very detailed analysis on the effects of lots of things - mortality rates for one or both of a couple, social security, reverse glide paths, use of annuities late in life, whether you care about leaving something in your will (and a nice list of things that are not taken into account so far.)


  • Magnum Stache
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IMO the 4% rule is robust under continuation of economic assumptions:

1) Good Governance: Residents of the US have historically been lucky to live in one of the least corrupt regimes in the world's history. If we transition to a one-party state like Egypt, Russia, Turkey, China, etc. we can say goodbye to the concept of shareholders receiving a fair share of corporate profits.

2) Controlled Inflation: If we spent a decade or two with inflation above 10% like many of the world's residents do, it is unlikely that any portfolio or withdraw rate could help us escape poverty.

So instead of playing multidimensional chess, watch these factors and be prepared to move your money offshore like other people in the world do.