Wednesday, January 30, 2013

An Efficient Frontier for Retirement Income by Dr. Wade Pfau
(Social Science Research Network) 

When I questioned Dr. Pfau about what he and his co-authors meant by the statement, "clients may wish to consider their retirement income strategies more broadly than relying solely on systematic withdrawals from a volatile portfolio" in the paper "The 4% Rule is Not Safe in a Low-Yield World" (see below), he responded by referring me to this new paper to be published in the February issue of The Journal of Financial Planning.
The paper uses Monte Carlo simulations and "current market" assumptions to determine an efficient frontier of investment allocations that best meet the two competing financial objectives for retirement defined by Dr. Pfau:  "satisfying spending goals and preserving financial assets."  He examines allocations involving six different types of investments.  Based on his methodology and assumptions, he concludes that the efficient frontier for a hypothetical 65-year old couple consists of combinations of stock and fixed single premium immediate annuities.
This is another excellent paper from Dr. Pfau that should be useful in helping retirees develop or refine their investment strategy.  However, the approach suggested doesn't appear to provide guidance on how adjustments are made in later years for deviations from the spending plan, actual investment experience, changes in health or changes in initial assumptions.  Perhaps he anticipates that the client and financial planner will meet periodically to re-run the model and make appropriate adjustments.  In any case, I look forward to further research by Dr. Pfau using this model, particularly inclusion of qualified longevity annuity contracts in the investment allocation mix.