Bill Bengen’s research calculated how much a retiree can take out safely from a generic portfolio over 30 years without running out of money. Depending on the asset allocation, the safe withdrawal rate has variously been computed at 4% of the initial portfolio, with the dollar figure indexed for inflation thereafter, or 4.5% if the portfolio is more broadly diversified.
But wouldn’t it be nice if you could take a prospective client’s asset allocation and calculate the percent of time periods since 1926 that it would have survived a 30-year retirement?
You would be able to show a client who has a high percentage of fixed income that the odds are less than she might think. Better yet, you could vary the withdrawal rates, the length of the retirement, the asset allocation or the annual portfolio expenses, all right there on the screen, and see the odds of success change instantly as you change the key assumptions.
This is not a fantasy.
For the past couple of days, I’ve been playing with something called the Big Picture App, which features monthly historical data from 11 different asset classes since January 1926. While you’re playing with the variables, you can also define the rebalancing frequency and set a dollar figure on the legacy you want to leave to heirs.
Let’s say you create a balanced portfolio which is 15% allocated to 5-year Treasury bonds, 15% to 10-year Treasury bonds, 10% to global bonds, 20% to large-cap stocks,15% each to midcap and small-cap U.S. stocks and 10% to international (ex-USA) stocks. You set the withdrawal rate at 4%, inflation-adjusted, and the system calculates that since 1926, this portfolio would have sustained that withdrawal rate over 30 years 99% of the time. Raise the retirement period to 40 years and you still have a 92% success rate, historically.
Below is the Big Picture App’s base screen: Using historical performance information, with the assumptions listed at the bottom, how often would a balanced, aggressive and conservative portfolio meet the client’s spending goals?
This assumes an overall portfolio expense ratio of 0.5%. A separate table shows that if your expense ratio were actually 1.1%, the success rate of this portfolio goes down to 81%, and it declines dramatically as the cost of managing the portfolio goes up.
Below, the Big Picture App lets you explore the impact of fees by showing a range of outcomes, depending on the current portfolio’s total expenses, plus a variety of other expense structures.
Notably, a conservative portfolio that is mostly bonds looks safe on a year-by-year basis, but only provides a 42% success rate at a 4% distribution over 30 years. Clearly this is not the safest long-term path to a sustainable retirement.
Below, the Big Picture poster of market returns provides more information than the standard Ibbotson returns poster.
The Big Picture App was created by Ryan McLean, a Canadian MBA who worked as a business and marketing consultant in Mexico City before taking a job as an analyst with Morningstar. He left to start a firm that creates investment performance charts you can hang on your wall, which display a great deal more information about different asset class returns than the Ibbotson charts that you’ve probably seen. “The charts are used in banks and asset management companies in the U.S.” McLean explains. “We created the Big Picture App as a living version of the print product.”
McLean points out that an advisor can click on the + sign in the Big Picture app and create new customized portfolios that reflect a prospect’s actual allocation, and then you can let the prospect play with the inputs: a longer or shorter retirement period, a higher or lower portfolio distribution, a different expense ratio, etc. If the prospect or client prefers, the distribution percentage can be converted to dollar amounts, showing the monthly income the portfolio would be distributing.
This answers one of the questions that came to mind when I first played with the Big Picture App: Why does it specify an initial investment? “There’s no reason if you’re just using a percentage distribution and you are indifferent to leaving a legacy,” McLean explains. “But when you convert the distribution to dollar terms, you also want to input the current or future (at retirement) value of the portfolio.” This also applies if the prospect wants to specify how much of a legacy he/she will leave to heirs: $0 (‘I’m spending my kids’ inheritance…’) on up to any reasonable figure. The Big Picture App will then calculate the chances that the portfolio will sustain the specified income (or percentage) and leave heirs with at least this much in the end.
The expense ratio variable is something that was not in the original Bengen research, and helps explain why, no matter how hard I tried, I wasn’t able to get the system to give me a 100% certainty reading at a 4% withdrawal rate. Isn’t that Bengen’s original “SafeMax” figure?
Yes, McLean responds, but Bengen’s figure was calculated without factoring in management and advisory fees. In addition, the data in the Big Picture App is more granular than Bengen’s calculations. “Bill was initially looking at annual data, and more recently he moved to quarterly,” says McLean. “This app has monthly frequency data, so we’re looking at many more rolling periods, capturing more different starting points. Since we’re capturing more data,” he adds, “we’re getting slightly more robust results than what Bill found.”
This is not a Monte Carlo tool that projects returns forward using different assumptions. The percentages are derived from historical rolling time periods – 30 years is the default, but it could be as low as a couple of years or as high as 50. That means the data behind the percentages is actual returns and inflation that were experienced by real people, with the expenses and distributions layered into the results.
The analysis carries the implicit assumption that historical data is predictive of future performance. If you believe, for example, that the sustained capital market returns will be lower than the historical data, you need to use other ways to analyze retirement results. It also assumes a fixed withdrawal strategy; current research shows that a variable withdrawal strategy increases the probability of success.
There are tools that compare a client’s risk tolerance to a client’s portfolio – both MacroRisk Analytics and RiXtrema will map a portfolio to FinaMetrica’s risk-profile score (see here). But the Big Picture App does something more fundamental: It helps clients see their actual chances of success if they make certain choices about distributions, portfolio design, expense ratios and legacy amounts.
I can picture a time when most financial planners and portfolio managers routinely use the Big Picture App to explore portfolio choices with their clients – and that will be especially true for those who use low-cost investment options, since the tools illustrates that the cost factor causes the success rate to swing dramatically. The conversations with prospects will often include the prospect looking up from playing with the mouse and saying: “Why didn’t my other advisor tell me any of this?”
Cost? Subscribers pay $29.99 a month for the Big Picture App, and get a copy of the returns data poster thrown in as a bonus. But the pricing includes “team discounts;” two individuals from the same firm can buy the service for $27.22 each, and if there are 9-16 advisors in the office, the price falls to $17.31 each.
To find out more about the Big Picture App, click here.
Bob Veres' Inside Information service is the best practice management, marketing, client service resource for financial services professionals. Check out his blog at: www.bobveres.com. Or check out his Insider's Forum Conference (for 2016 in San Diego) at www.insidersforum.com.
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