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
(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 Process Parameter Values

8. Pricing

9. Path-independent Pricing

10. The Pricing Kernel

11. Pricing Kernel Parameter Values

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

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.
Here is what Vanguard says about the funds.
I want to focus on the use of an average of past asset values as the basis for dollars withdrawn each year. As the quotation indicates, this is indicative of a desire for more consistent payouts than obtained with “typical withdrawal plans”.
In this Vanguard is not alone. The use of average past values is common in institutions and among financial advisors.

33. Vanguard Managed Payout Funds
% Stocks 3/31/2011
Payout:
% of 3-year Average Daily Assets
Distribution Focus
65.5 %
3 %
Growth and Distribution
75.3 %
5 %
Growth Focus
84.1 %
7 %
A few years ago Vanguard introduced a family of three funds with accompanying withdrawal plans. Each holds a relatively constant asset mix and provides paychecks based on a percentage of average asset values over a prior 36-month period. The payout ratios are relatively small, suggesting that the funds are suitable only for retirees who really like their children or charities.
These have been relatively popular, with assets of . Over $750 million earlier this year. { Total value, all three funds, end of Q1, 2011: $774 million (Morningstar) }.
Source: 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 Moderate Aggressive
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 TIPS and the Market Portfolio

49. BuyHo: Payment Distributions

50. BuyHo: Payment Ratio Distributions

51. Annuities

52. A Riskless Constant-Payment Strategy: Costs with and without Annuitization
Male, 65; Annuity overhead = 15%; Annuity payments start at age 74
Annuity Cost = 68% of Non-annuitized Cost