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Michael S. Finke, Ph.D., CFP Professor & Director Retirement Planning & Living Department of Personal Financial Planning T EXAS T ECH U NIVERSITY M ANAGING I NVESTMENT AND IDIOSYNCRATIC LONGEVITY RISKS FOR RETIREES

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Congratulations! Youre a pension manager!

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Pension Managers What do they worry most about? 1) Asset Return Risk 2) Longevity Risk

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Individual Pensions are Harder Asset Return Pension Manager Pool returns across generations Advisor One whack at the cat Longevity Risk Pension Manager systemic increases in longevity Advisor Idiosyncratic longevity risk

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Systematic Longevity Risk Source: Robine, 2012

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Wealthier Live Longer Source: SSA, 2008

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Idiosyncratic Longevity Risk Source: Frank, 2013

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Idiosyncratic Longevity Risk How do you deal with idiosyncratic risk? 1) Diversification (pool it) 2) Retain it Avoiding running out of money by spending less and accepting portfolio risk Live it up and accept greater risk of running out of money

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Turning Retirement Assets into Income

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The 4% Rule (William Bengen, 1994) Safe Withdrawal Rates (1920s - present)

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Philosophy of the 4% Rule Retirees have a lifestyle goal and not meeting that goal indicates failure Failure = inability to spend lifestyle goal for 30 years Portfolio risk increases likelihood of meeting spending goal Use prior returns to establish safe withdrawal rate

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Historical Random Returns 13.7% 23.5% 20.3% -1.5% -10.1% 31.0% 8.99% 34.1% -6.6% -38.5% 3.0% 4.5% 12.4% 7.1% 26.3% 27.3%

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Asset Pricing 101 p t = t [ * u (c t+1 )/u (c t ) * x t+1 ] Price at time t (now) = Expectation (now) Of (how much we discount the future) * Marginal utility tomorrow Marginal utility today *Expected payout tomorrow

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What This Means Demand for Consuming Now Decreases Asset Prices Demand for Consuming in Future Increases Asset Prices

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Whats Affecting Asset Prices? How Much Do Global Investors Value the Future?

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Capital Market is Global

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Global Real Interest Rates

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Importance of 1 st Decade Source: Milevsky and Abaimova, 2005

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Monte Carlo Failure Rates Historical Real Returns: Stocks 8.6%, Bonds 2.6% Stock Allocation: 30% 50% 70% Failure Rates 6%6%6% Slightly more realistic: Stocks 5.5%, Bonds 1.75% Failure Rates24%24%27% A little better than todays rates: Stocks 6%, Bonds 0% Failure Rates47%33%28% Early 2013 Rates:Stocks 4.6%, Bonds -1.4% Failure Rates77%57%46% Source: Blanchett, Finke and Pfau, 2013

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What if Rates Revert in 5 Years? Start out at current rates (Stocks 4.6%, Bonds -1.4%) Revert to Stocks 8.6%, Bonds 2.6% Stock Allocation: 30% 50% 70% Failure Rates 22%18%18% What if Rates Revert after 10 years ? Failure Rates 43%32%38%

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Other Problems with the 4% Rule Source: Blanchett and Finke, 1% fee

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No Risk Tolerance, No Optimization Source: Finke, Pfau and Williams, 2011

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Value of a Dynamic Approach Source: Blanchett, 2013

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Illustration of Dynamic Source: Pfau, 2013

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Assumes Historical Equity Premium

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S&P Dividend Yields

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What Does Current P/E Imply? Source: Asness, 2012

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Requires Managing Assets in Old Age

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Literacy and Confidence

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A Better Approach Prioritize spending categories (basic needs, discretionary expenses, legacy) Employ risk when a retiree is willing to accept possibility of a loss Deal efficiently with idiosyncratic risk Simplicity - make sure real people can handle it, use research to create defaults Be realistic about future asset returns

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Michael S. Finke, Ph.D., CFP Professor, Ph.D. Program Director Director Retirement Planning and Living Department of Personal Financial Planning T EXAS T ECH U NIVERSITYMichael.Finke@ttu.edu Q UESTIONS /C OMMENTS