In his Rethinking 65 article, Slow and Steady Wins the Retirement Funding Race, Ed Prince outlines Dr. Wade Pfau’s “conservative formula for guiding clients to a secure retirement.” Dr. Pfau’s approach is essentially the same as the Actuarial Approach recommended in this website, with one fairly significant difference—it assumes all household investments earn the same conservative bond-like rate of return. And while you can change the default assumptions in the Actuarial Financial Planner to accomplish this same level of conservatism if you like, we believe higher assumed rates of return on risky investments/assets can be justified.
How our approaches are similar
They are much more similar than they are different.
- We both determine our funding metric by dividing the present value of household assets by the present value of household spending liabilities. He calls the resulting metric the Funded Ratio, we call ours the Funded Status.
- Consistent with the economic concept of Liability Driven Investing, we both separate household essential and discretionary spending and encourage households to fund essential expenses with non-risky assets and fund discretionary expenses with riskier assets.
- We both encourage households and financial advisors who use the approach to consider the amounts and timing of all expected expenses, either recurring or non-recurring.
- As discussed in our prior post, the metric is self-correcting over time and has guardrails.
How our approaches are different
We provide an Excel spreadsheet in our website for households and financial advisors to use to calculate the present values of assets and liabilities.
We provide default assumptions in the spreadsheet for:
- Lifetime planning periods for both spouses (and for the period the couple is expected to be “either alive” or “both alive.” This enables households to determine the present values of recurring expenses after the expected first death within the household.
- Inflation
- Investment return on non-risky investments
- Investment return on risky investments
We also provide opportunities within the spreadsheet to input different rates of future increases in items not assumed to grow with inflation.
All the assumptions can be overridden to better suit user preferences, with the biggest difference being able to input more aggressive assumptions for funding of household discretionary expenses based on the assumption that riskier assets may be expected to earn higher rates of return in the long-run.
Summary
While Mr. Prince indicates that Dr. Pfau acknowledges that his approach is not for everyone because it is so conservative, we believe that the Actuarial Approach, with its increased flexibility and robustness, is a reasonable approach that can be used for/by any type of investor/household.
