Study on Allocation of Investment at and after Retirement

[willn]

I've never felt the need to invest in bonds, but asset allocation is a popular theory that most experts recommend, moving higher percentages to bonds as you age and retire.  This study has some interesting info on a better twist to the conventional wisdom by moving to stocks as retirement progresses...

http://www.nytimes.com/2013/09/14/your-money/turning-the-conventional-stock-buying-wisdom-for-retirees-on-its-head.html

Even in a worst case, they found that new retirees who start with 30 percent in stocks and slowly increase that allocation by 1 percentage point a year to 60 or 70 percent in stocks would be able to withdraw 4 percent of their portfolio for about 30 years. Someone who held 60 percent in stocks and 40 percent in bonds over 30 years would run out of money two years earlier, but would also have to endure a bumpier ride, the researchers said.

[matchewed]

Wade Pfau has done some research on this, in fact this article may be based off of his work (I'll read it later), the gist of the concept is that the performance of those first couple of years are a big indicator of whether your retirement will succeed or not. Switching to a less volatile asset such as bonds will reduce the chances of a huge plunge early on.

I agree that the math works, the risks are of course that possibility the bond market tanks as well. Plus for Mustachians we're able to weather the storms by being flexible. AA isn't our only knob to turn to ensure long term FIRE success.

But a cool concept proven by math nonetheless.

[Exflyboy]

Eh what?... If you read the article it talks about running out of money after 23 years etc etc...

Whats this about "running out of money"??... I thought we could withdraw 4% forever and never dip into the capital??

I am suspecting that we as Mustashians need to invest EVERYTHING in Stock ETF's, thereby earning more than 4% on average.. Assuming we can live with the volatility we will then never run out of money.

In other words if the market tanks by 50%, we have to live on 50% of last years allowance.

Am I correct here?

Frank

[DoubleDown]

Fascinating, thanks for sharing. It's nice to see this study backing up my (mostly) intended approach, although it's even more radical than what I was planning in turning the traditional AA on its head at the start of retirement. This gives me a lot to think about since I'm FIRE'ing in 8.45 days (not that I'm counting or anything).

As far as paper assets, I was going to do a roughly 50/50 stocks/bonds split, but I might consider doing an even more conservative split as the study suggests, increasing the stock allocation every year. Gives me exactly what I'm looking for: not too much volatility in the earlier years, a willingness to risk more in the later years when I have fewer years left to cover, and the simulations back it up as an optimal strategy.

[willn]

Eh what?... If you read the article it talks about running out of money after 23 years etc etc...

Whats this about "running out of money"??... I thought we could withdraw 4% forever and never dip into the capital??

I am suspecting that we as Mustashians need to invest EVERYTHING in Stock ETF's, thereby earning more than 4% on average.. Assuming we can live with the volatility we will then never run out of money.

In other words if the market tanks by 50%, we have to live on 50% of last years allowance.

Am I correct here?

Frank

The 4% "safe" withdrawal rate number usually cited is from the Trinity study (and it's update for data thru 2009) and it only looks at most, 30 year retirement duration. Not forever! And it gives a 95% chance of being successful.  If you have a longer retirement duration the chance of failure presumably goes up.

And remember, that is historical data. We can't assume the past results are indicative of future performance.

[DoubleDown]

Eh what?... If you read the article it talks about running out of money after 23 years etc etc...

Whats this about "running out of money"??... I thought we could withdraw 4% forever and never dip into the capital??

I am suspecting that we as Mustashians need to invest EVERYTHING in Stock ETF's, thereby earning more than 4% on average.. Assuming we can live with the volatility we will then never run out of money.

In other words if the market tanks by 50%, we have to live on 50% of last years allowance.

Am I correct here?

Frank

Looks like willn already mostly addressed this as I hit the "post" button, but I'll add to the chorus:

The "running out of money" scenarios occur during a few of the 30-year time spans in history that fare poorly because of bad returns up front. The simulations test lots of different time spans, starting one year later for each simulation. For example, they'll test a portfolio's 30-year survivability starting in 1947, then 1948, etc. In about 5% of the scenarios, the portfolio ran out of money. And yes, it assumes no flexibility, that you would (probably somewhat foolishly) continue to withdraw exactly 4% regardless of market conditions, and that you would have no supplemental income, etc. You can certainly exercise some flexibility in spending or earning to improve your odds of not running out of money. You might be interested in doing some further reading on the "4% SWR" and asset allocation strategies in general.

I don't intend to drop my spending by 50% if the market tanks 50%, and I don't intend to be allocated 100% in stocks, but that's a school of thought you might choose to follow if it suits you. I think as summarized in the article, this strategy provides an excellent "heads you win, tails you don't lose" approach.

[lauren_knows]

Wade Pfau has done some research on this, in fact this article may be based off of his work (I'll read it later), the gist of the concept is that the performance of those first couple of years are a big indicator of whether your retirement will succeed or not. Switching to a less volatile asset such as bonds will reduce the chances of a huge plunge early on.

Yes. This is an interesting subject that I will be writing a blog post for on cfiresim.com soon about.

If you model a 40yr retirement that has a 90%+ success rate (for 75/25 stock/bond split), you can almost always increase your success rate by starting off at 50/50 and simulating a gradual change in AA to 75/25 or 80/20 over the first 10 years of retirement.

Counter to what a lot of people suggest (increasing bond holdings as you age), Wade Pfau actually wrote a paper that says the opposite: If you increase your equity holdings as you age, you have a better chance of success.  Though, I can't really imagine the real-world application being that easy. Telling your 80yr old Grandma to have a 95/5 AA is a bit unnerving.