Both the February and March 2015 issues of the Journal of Financial Planning include articles which address and extend the work on rising equity glidepaths during retirement, which Michael Kitces and I published in the January 2014 issue.

Admittedly, the March one is also by us, and I’ll get to that it an moment, but the February article challenges the rising equity glidepath concept and is by David Blanchett.

David does a number of things differently in his article, but there is one portion (Table 2) where he discusses probabilities of success for different strategies which allows for an easier way to compare his results with our methodology. With a 4% withdrawal rate, he finds that declining equity glidepaths in retirement support higher probabilities of success than fixed equity glidepaths, which in turn supports higher probabilities of success than rising equity glidepaths. This finding contrasts with an earlier 2007 article he wrote comparing fixed equity allocations to declining equity allocations, and it also contrasts with our 2014 article.

Why this different finding? It turns out that this difference is being driven by his capital market expectations, which allow bond yields to be lower like they are at present, but which allow bond yields to gradually increase over time toward their historical averages. This is indeed a better way to do Monte Carlo simulations, and I now also use a similar approach in my own work, including at the Retirement Dashboard. When Michael and I wrote our initial article, we included three sets of capital market assumptions with a range of stock and bond returns, but we hadn’t yet built in a mechanism to allow average bond yields to change over time.

I re-ran the analysis that Michael and I did in our initial article, but I switched to the new capital market assumptions I use which allow for increasing bond yields over time while keeping a fixed average equity premium over bonds. I could match up the findings David discussed in his article. It does indeed seem that retiring at times with particularly low bond yields, which can be expected to increase over time, may not favor rising equity glidepaths during retirement. It essentially causes the retiree to lock in low bond returns and even capital losses on a bond fund as bond yields gradually increase (on average) over time.

This is not to say that rising equity glidepaths are never a good idea, though. David includes additional analysis testing glidepaths including a wide variety of scenarios and assumptions, and he continues to find a general trend in favor of declining glidepaths. While I have not fully replicated that part of his paper, I do think it is reasonable to conclude that this is all being driven by the capital market expectations. If interest rates were at a higher initial starting point, I’m guessing that rising glidepaths would look much better in his analysis. This would be an interesting point for him to address in the future.

Now on to the new article by Michael and I in the March JFP. Though we hadn’t read David’s article when we wrote ours, I do think that the articles are somewhat compatible. In our new article, we switch to rolling historical periods, rather than using Monte Carlo simulations. And while we didn’t think to test the results for environments with different initial interest rates, we did test the results for environments with different initial stock market valuation levels. We also do find that the choice of glidepath is not always fixed, as it does vary with the stock market valuation level at the time of retirement.

As we wrote, our results suggest that the valuation-based approach is generally superior to the rising equity glidepath approach and the fixed equity allocation portfolios, as the valuation-based scenarios produce comparable-to-slightly-better results across the board. For those who are willing to be even more flexible, there appear to be further benefits to potentially widening the valuation-based adjustments further (expanding or eliminating the bounding thresholds), though such an approach would have to be managed against a person’s risk tolerance and willingness to deviate so significantly from an underlying allocation benchmark. And in all but the most favorable valuation environments, retirees should consider more defensive bond allocations – i.e., bills as opposed to longer-term bonds – as even with valuation-based adjustments, stock/bond portfolios underperformed stock/bills portfolios from unfavorable and moderate starting valuations.

Another important point in that summary is that we did look at both short-term (6 month or 1 year) bonds as well as 10-year bonds in our analysis, and we found that the shorter-term bonds were of much greater help than longer-term bonds. When the focus is on protecting from downside risks, the additional volatility caused by the 10-year bonds hurt retirement outcomes by more than could be compensated by their higher average yields. This ties into David’s article as well, since his bond allocation was 75% to (I believe) 10-year bonds, and 25% to cash. Again, I wonder what his results would have been if those ratios were switched?

Ultimately, this brings up an interesting dilemma.

Today interest rates are at historical lows and stock market valuations are quite high.

Michael and I look at the market valuation component without specifically considering the interest rate component, and we determined that this is the time when rising equity glidepaths have tended to provide the best results for historical retirements. Meanwhile, the historical data really doesn’t provide much in the way of examples for times when both stock valuations were high while bond yields were simultaneously low.

Meanwhile, David looks at the lower interest rate component without specifically considering the high stock market valuation component (his capital market expectations are described in Appendix 1, and his stock returns are not related to past stock returns), and he concludes that declining equity glidepaths are best. But also, our subsequent research suggests that 10-year bonds may not be the appropriate choice in retirement anyway.

Do remember that ultimately, this whole discussion is about appropriate default glidepaths for those who have very little interest in investments… what should target date funds do post-retirement? Those with greater sophistication should be determining asset allocation based on their funded ratio, and should also be thinking more broadly about the role of income annuities and other strategies.

But, David has produced an interesting article which suggests more research is needed on this topic.

22 Comments

  1. Avatar David Blanchett on March 2, 2015 at 10:41 pm

    Great stuff Wade! So I’ve run some additional numbers where I can model jointly the impact of varying initial yields and CAPE ratios. The model I used is the same model we used in this recent AP article:

    https://www.advisorperspectives.com/newsletters15/Retiring_in_a_Low-Return_Environment.php

    As it turns out, the optimal glide path for a retiree is highly dependent on the assumptions for initial conditions (no surprise there!). When I test a joint model of low yields AND high CAPE ratios, the Decreasing glide path is the best, followed by Constant, then Increasing. However, the results really aren’t that economically significant when the initial yield seed is low (the probabilities of success are all within 3%).

    Something else that I think provides a benefit to Decreasing glidepaths is the fact that it better matches risk aversion of retirees (i.e., as people get older, they tend to become more risk averse). This “risk preference” is not generally captured in our models (mine included), which focus entirely on achieving a goal (i.e., quasi-risk capacity).

    Good stuff!

  2. Avatar Ken Espanola on March 3, 2015 at 11:05 am

    I have read your article several times over and it just seems you raise more questions than answers. Assuming a late 60’s retiree with a moderate to conservative bent, at this point in the stock and bond investing cycle: which of the investing glidepaths would be most appropriate?

    • Wade Pfau, Ph.D., CFA Wade Pfau, Ph.D., CFA on March 3, 2015 at 6:18 pm

      This entire discussion is about a default for people with no interest in investing. If you are taking an active interest in these matters, you’ve got to consider your personal circumstances. I can’t really provide any specific answer for you, personally, without knowing about your situation.

  3. Avatar John Craig on March 3, 2015 at 11:28 am

    “It turns out that this difference is being driven by his capital market expectations, which allow bond yields to be lower like they are at present, but which allow bond yields to gradually increase over time toward their historical averages. This is indeed a better way to do Monte Carlo simulations, and I now also use a similar approach in my own work, including at the Retirement Dashboard.”

    Is this just a best guess, or is there some other basis for this conclusion?

    • Wade Pfau, Ph.D., CFA Wade Pfau, Ph.D., CFA on March 3, 2015 at 6:16 pm

      John, it’s a model fitted to the historical data.

      • Avatar John Craig on March 4, 2015 at 9:58 am

        Thanks Wade

        It seems logical to assume that since there were higher rates in the past, we can expect the same in the future. But is there something beyond that to assure us that higher rates will more likely than not reappear? Has there been any research to estimate the probabilities and scope of interest rate increases?

        • Wade Pfau, Ph.D., CFA Wade Pfau, Ph.D., CFA on March 4, 2015 at 10:56 am

          John, we fit an autoregressive model to the historical data. So indeed we do have a probability distribution about the future evolution of interest rates, assuming patterns observed with interest rate changes in the past can be extrapolated into the future. It is NOT a matter of just asserting an assumption of higher interest rates in the future. It is fitted to the historical data.

          • Avatar John Craig on March 4, 2015 at 11:13 am

            Wade, sorry I did not make myself clear.
            “…assuming patterns observed with interest rate changes in the past can be extrapolated into the future”
            Why is it reasonable to expect the past to repeat in this case? No one expects that the 10%+ equity returns of the past will repeat in the future, so why the assumption about past interest rates repeating?.



          • Wade Pfau, Ph.D., CFA Wade Pfau, Ph.D., CFA on March 4, 2015 at 11:17 am

            John, after three years of this, I think we ultimately must just accept that we cannot be clear with each other and stop trying. I said “interest rate changes,” not interest rates. And of course, interest rates may be guided by completely different behaviors in the future. We generally look to historical data for guidance, because it’s all we have. I’m finished discussing this with you.



  4. Avatar Jerome Moisand on March 3, 2015 at 5:03 pm

    The first time I read about this rising equity glide path idea, I was shaking my head a bit as this just didn’t seem to add up. Then I realized that this is essentially a mild form of TAA (and a clumsy one if you forgive me this judgment call). If valuations are high when retiring, a bad sequence of returns will likely occur (market drop and bear market), hence more bonds to being with, and then back to more equities (including during the next bull). That’s TAA for you, isn’t it? And if valuations are low when retiring, well, the higher level of equities in the long run will help improving returns even if the short-term add’l bonds might hurt a bit, but anyway, the sequence of returns is probably more favorable. Now I stated this is clumsy, because if one uses such TAA play by shifting around the stock/bond AA, better do it during your entire distribution period and make it a direct function of valuation. Yes, I know, TAA is often equated to market-timing and anathema to many people, while ‘equity glide path’ may sound less controversial, but… shouldn’t we call a cat a cat?
    As to David’s analysis, again, this is close to TAA thinking. Looking at stocks valuation in isolation doesn’t seem as meaningful as looking at the difference between stock forecasts (derived from valuation) and interest rate/bond yields (hence bond forecast), i.e. an ERP forecast. If the ERP remains very positive, then why would investors jump to bonds even if equity valuation is high? A TAA algorithm based on ERP estimates does seem to work fairly well in backtesting (did it with my own modeling efforts), and yes indeed it shows that today’s situation is rather peculiar.
    Don’t misread me, I am NOT convinced that a mild form of TAA is the way to go for either an accumulation phase or a distribution phase, this is full of its own challenges (technical as well as behavioral), I am just suggesting that your research seems to be circling around this topic without naming it. But in any case, please keep up the great work, this is always thought-provoking.

    • Wade Pfau, Ph.D., CFA Wade Pfau, Ph.D., CFA on March 3, 2015 at 6:21 pm

      Jeremy,
      Thank you, and I do think that the newer article from Michael and I makes this point more explicit. A rising equity glidepath proxies what you are called TAA would do when starting in an overvalued market. We call it valuation-based asset allocation. In our first article we were investigating risk management on the downside, and historically the lowest withdrawal rates happened when retirements started at overvalued levels. So that’s why the rising glidepath was looking good.

  5. Avatar Joseph on March 3, 2015 at 6:14 pm

    No gliding paths for me. I stay equally allocated between stocks, bonds, cash and gold; rebalance at 35% /15% triggers. A permanent allocation from cradle to grave.

  6. Avatar Sven on March 3, 2015 at 7:16 pm

    How might the stable value fund figure in this? Most 401k participants should have these available to them. The SVF available in my 401k yields slightly more than Vanguard Total Bond Market. If rates normalize in the coming years, (big if) the stable principal of the SVF multiplied by a yield rising in concert with market rates stands a good chance of beating a bond mutual fund.

    This may be enough incentive to keep my funds in the 401k post retirement. The opaque risks in the SVF are another matter.

    Retirement research in general ignores the SVF, in spite of the fact that these are popular choices for plan participants. When I was getting started (in 1982) the SVF paying 13% looked awful good. Perhaps it is just a matter of historical return data being unavailable?

  7. Avatar Dirk Cotton on March 4, 2015 at 10:25 am

    This is great research from both sides and even more interesting when you collaborate to understand the different outcomes. I fear, though, that many readers are missing the most important statement in this post –

    Do remember that ultimately, this whole discussion is about appropriate default glidepaths for those who have very little interest in investments… what should target date funds do post-retirement? Those with greater sophistication should be determining asset allocation based on their funded ratio, and should also be thinking more broadly about the role of income annuities and other strategies.

    This research is aimed at understanding the best glide path for a retiree if we knew nothing more than his/her planned retirement date, the best allocation for a target date mutual fund with a wide target market, or someone who simply wants to do the minimum of planning work. My guess is that both David and Wade would say that doing the extra work to develop an individual customized retirement plan that incorporates more data about the individual than the planned retirement date would always be preferable to choosing a glide path.

  8. Avatar Mike Piper on March 5, 2015 at 11:33 am

    Thanks for providing this update, Wade. It’s helpful to see specifically which inputs drive different results.

    On a completely unrelated point: Is anybody else having trouble discerning links within paragraphs since the site redesign? I like the new look a lot, but with the link color so closely matching the regular text color, I have to actively look to find links rather than noticing them immediately.

    • Wade Pfau, Ph.D., CFA Wade Pfau, Ph.D., CFA on March 5, 2015 at 7:52 pm

      Thanks Mike! I’ve been thinking the same thing about the links. I’ll see if something can be done. I appreciate the feedback and hope all is well.

  9. Avatar Bill Marshall on March 5, 2015 at 3:07 pm

    I find that I’m following a rising equity glide path, but not as a result of explicit planning. I’m into a safety-first approach; whether you call it John Bogle’s “age in bonds”, or RIIA’s “floor and upside”, or William Bernstsin’s “liability matched portfolio”, or Zvi Body’s “Worry-free retirement plan”, the result is the same — I’m currently holding a large portion of my portfolio in bonds (specifically TIPS and SPIAs), and a smaller portion in equities. As I redeem the bonds and spend them, the resulting equity portion of my portfolio will increase. Its an increasing glide path, as you’ve mentioned in previous blog posts.

    But the point I wanted to add is that this result is independent of whether current interest rates are high or low, or whether current valuations are high or low, or whether I’m a sophisticated investor or not. I see it as a consequence of safety-first.

    • Wade Pfau, Ph.D., CFA Wade Pfau, Ph.D., CFA on March 5, 2015 at 7:53 pm

      Thanks Bill. I agree that the rising equity glidepath can be a natural result of a safety-first strategy.

      • Avatar Aaron Minney on March 8, 2015 at 9:37 pm

        Some interesting thoughts here Wade.
        Following Bill’s comment, I recall that one point from your paper with Kitces was that a partial annuitisation (safety-first) strategy had some benefits that could be replicated with a rising equity glide-path. How does this reconcile with the comparison of the latest piece by David?

        • Wade Pfau, Ph.D., CFA Wade Pfau, Ph.D., CFA on March 9, 2015 at 11:06 am

          Aaron, Thanks for writing. At this stage, I think David’s point thus far is that it isn’t necessarily a good idea to be heavily allocated to longer-term bond funds when interest rates are very low. Michael and I actually make this point as well in our new March article. We suggest using shorter-term bonds instead. I think David is now working on a follow-up with shorter term bonds to see what happens with his methodology.

  10. […] To Rise or Not Rise: Stock Allocation During Retirement from Wade Pfau […]

  11. Avatar Billkirkland on March 29, 2015 at 1:53 pm

    Hi Wade,

    I’m a newcomer to your writings who stumbled into your blogs during my quest for information that has bugged the heck out of me in recent days. Specifically, I consider myself a novice when it comes to financial planning in general but specifically when it comes to the subject of personal financial planning. I will start by giving a brief synopsis of my financial situation and then follow that with a question pertaining to an area that I am trying to gain a better understanding involving a specific issue. So here goes:

    My wife and I are 69 and 70 y.o. respectively. We both are employed and our combined salaries equate to about $125K annually. We both collect SS that comes to about $3600 per month and other pensions that comes to about $1500 per month. We have about $40K of cash that is held in a readily accessible savings account. We have combined 401K savings of about $350K. [Note: careers faltered at times over the past several decades requiring that we draw on our savings to weather the storm(s).]

    We maximize our contributions to our 401Ks each pay period but don’t do any additional saving even though we could easily do with a few lifestyle changes. We choose “living” versus adopting some austere existence.

    With that background in mind, we recently decided to purchase the car my life is currently leasing. The lease ends in a few weeks and we plan to purchase the vehicle at the residual price of about $25K. We have decided to borrow from our 401K rather than getting a traditional loan: we don’t have sufficient equity in our home to get a preferred home equity line of credit at this point.

    Friends, acquaintances, and professionals I have read take a negative view of such borrowing under most circumstances. I see it differently and here’s why:

    Most advisors recommend that a person approaching or near retirement should have a significant portion of his/her 401K monies in bonds or other less volatile investments. At our ages (still working) I suspect the typical advisor would recommend that we have no more than 40% of our 401K assets in stocks and the remaining 60% or so in bonds or other less volatile investments.

    We both have rather secure jobs, are in good health, and plan to continue working for another two (2) years, at least. We project our 401K holdings will have risen to about $500K when we leave the workforce. My current job should afford me with additional pension income in the amount of $600-$700 monthly once we’re retired. It seems to me the $25K loan from our 401K should be viewed as nothing more than a portion (12%) of the bond allocation that we otherwise would follow. We plan to repay the loan on an accelerated basis to make certain it is fully paid at the time of our retirement.

    Given the scenario I’ve outlined above, why is borrowing from ourselves such a “bad” idea.Given the 40/60 ratio I cite above, why wouldn’t the loan be viewed as a reasonable part of our asset allocation strategy.

    I would greatly appreciate any insight you might offer. It’s frustrating to be confronted with such a “contradictory” viewpoint when mine seems the right thing to do.

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