Determinants of Nest Egg Sustainability Jack C. DeJong, Jr., Ph.D., - - PowerPoint PPT Presentation

Determinants of Nest Egg Sustainability

Jack C. DeJong, Jr., Ph.D., MBA, CFA

Nova Southeastern University Co–Founder, Nest Egg Guru

John H. Robinson

Founder, Financial Planning Hawaii Co–Founder, Nest Egg Guru

Inspiration: Two Seminal Papers

• Brinson, Hood, & Beebower, FAJ 1986

– Found that asset allocation was the largest determinant of investment performance.

• Bengen, JFP 1994:

– Raised awareness of sequence of returns risk.

Both had a profound influence on retirement planning. Both have also been misapplied and applied heuristically.

Background:

• Over the past quarter century, academic

research has examined retirement income sustainability from many different perspectives.

• Despite the volume of research there

remains a significant gap between the research findings and the practitioner.

Motivation:

• Although there has been copious

research on retirement income sustainability, few papers have considered the relative influence of various factors that influence sustainability.

• This paper seeks to do this, and in doing

so to advance the planning profession beyond heuristics, such as the 4% Rule.

Factors Impacting Sustainability:

• Time Horizon.
• Interest Rates.
• Fees and Expenses.
• Asset Allocation.
• Inflation.
• Withdrawal Strategy.

Methodology:

• Sample: January 1970 – December

2013.

• Four Asset Classes: 45% S&P 500

Index, 30% Russell 2000 Index, 25% MSCI EAFE Index, and Intermediate Term Bonds.

• Bootstrapping generates 5,000

simulations using Nest Egg Guru’s Retirement Spending Calculator.

Impact of Time Horizon:

• $1,000,000 Initial Portfolio.
• Broad Allocation: 60% stocks, 40%

bonds.

• Intermediate Term Bond Return = 2%.
• Inflation Adjustment = 3% per year.
• Investment Fees & Expenses = 1%.
• Withdrawal Strategy = Constant

Allocation with Annual Rebalancing.

Remaining Balances at VaR:

Initial Withdrawal Rate 10 years 20 years 30 years 3% 10% = $928,778 10% = $883,506 10% = $629,459 5% = 874,917 5% = $727,405 5% = $375,528 1% = $785,606 1% = $477,258 1% = $0 4% 10% = 789,713 10% = $471,230 10% = $0 5% = 711,593 5% = $327,052 5% = $0 1% = 593,913 1% = $143,231 1% = $0

Impact of Interest Rates:

• $1,000,000 Initial Portfolio.
• Time Horizon = 30 years.
• Initial Withdrawal = $40,000 = 4%.
• Broad Allocation: 60% stocks, 40% bonds.
• Inflation Adjustment = 3% per year.
• Investment Fees & Expenses = 1%.
• Withdrawal Strategy = Constant Allocation

with Annual Rebalancing.

Assumed Rate of Return

• n Bonds:

Simulation Results 0% 2% 4% Success % 61% 80% 91% Median Portfolio Value $192,963 $706,801 $1,382,944 Bottom 10% Value $0 $0 $76052 Bottom 5% Value $0 $0 $0

Impact of Broad Asset Allocation:

• $1,000,000 Initial Portfolio.
• Time Horizon = 30 years.
• Initial Withdrawal = $40,000 = 4%.
• Inflation Adjustment = 3% per year.
• Intermediate Term Bond Return = 2%.
• Investment Fees & Expenses = 1%.
• Withdrawal Strategy = Constant

Allocation with Annual Rebalancing.

Broad Allocation:

Simulation Results 100% Stock 80% Stock 60% Stock 50% Stock Success % 95% 91% 80% 66% Median Portfolio Value $4,116,844 $2,003,705 $689,536 $280,039 Bottom 40% Value $3,145,978 $1,504,182 $450,806 $99,668 Bottom 20% Value $1,433,270 $589,912 $0 $0 Bottom 10% Value $556,123 $56,055 $0 $0

Impact of Inflation:

• $1,000,000 Initial Portfolio.
• Time Horizon = 30 years.
• Initial Withdrawal = $40,000 = 4%.
• Broad Allocation: 60% stocks, 40% bonds.
• Intermediate Term Bond Return = 2%.
• Investment Fees & Expenses = 1%.
• Withdrawal Strategy = Constant Allocation

with Annual Rebalancing.

Assumed Annual COLA:

Simulation Results 0% 1% 2% 3% Success % 100% 99% 93% 79% Median Portfolio Value $1,976,062 $1,649,277 $1,215,547 $693,573 Bottom 40% $1,704,976 $1,384,210 $960,756 $475,857 Bottom 20% $1,180,036 $833,542 $456,458 $0 Bottom 10% Value $841,262 $524,955 $141,868 $0 Bottom 5% Value $585,150 $292,404 $0 $0

Impact of Investment Expenses:

• $1,000,000 Initial Portfolio.
• Time Horizon = 30 years.
• Initial Withdrawal = $40,000 = 4%.
• Inflation Adjustment = 3% per year.
• Broad Allocation: 60% stocks, 40% bonds.
• Intermediate Term Bond Return = 2%.
• Withdrawal Strategy = Constant Allocation

with Annual Rebalancing.

Assumed Annual Investment Expenses as a %:

Simulation Results 0% 1% 2% Success % 94% 81% 54% Median Portfolio Value $1,633,944 $736,942 $57,521 Bottom 40% Value $1,284,430 $491,089 $0 Bottom 20% Value $624,639 $11,884 $0 Bottom 10% Value $212,261 $0 $0

Impact of Withdrawal Strategy:

• $1,000,000 Initial Portfolio.
• Time Horizon = 30 years.
• Initial Withdrawal = $40,000 = 4%.
• Inflation Adjustment = 3% per year.
• Broad Allocation: 60% stocks, 40%

bonds.

• Intermediate Term Bond Return = 2%.
• Investment Fees & Expenses = 1%.

Withdrawal Strategy:

Simulation Results Spend Stocks First Constant Allocation* Simple Guardrail** Spend Bonds First Success % 72% 80% 94% 97% Median Portfolio Value $912,593 $730,302 $1,390,418 $4,222,468 Bottom 40% Value $401,074 $473,983 $1,101,759 $3,369,795 Bottom 20% Value $0 $1,289 $524,032 $1,747,811 Bottom 10% Value $0 $0 $178,351 $854,500 Bottom 5% Value $0 $0 $0 $282,771

Conclusion:

• Low interest rates altered retirement

planning paradigm.

• Retirees choice of withdrawal strategy is

underappreciated.

• Other factors affecting sustainability:

– Living expenses. – Income taxes.

• Questions?