Abstract

http://ssrn.com/abstract=2286146
 
 

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Asset Valuations and Safe Portfolio Withdrawal Rates


David Blanchett


Morningstar Investment Management

Michael S. Finke


Texas Tech University

Wade D. Pfau


The American College

June 27, 2013


Abstract:     
Bond yields today are well below and stock market valuations are well above their historical average. There are no historical periods in the United States where comparable low bond yields and high equity valuations have occurred simultaneously. Both current bond yields and stock values have been shown to predict near-term returns. Portfolio returns in the first decade of retirement have an outsize impact on retirement income strategies. Traditional Monte Carlo simulation approaches generally do not incorporate market valuations into their analysis. In order to simulate how retirees will fare in a low return environment for both stocks and bonds, we incorporate the predictive ability of current valuations to simulate its impact on retirement portfolios.

We estimate bond returns through an autoregressive model that uses an initial bond yield value where yields drift in the future. We use the cyclically adjusted price-to-earnings (CAPE) ratio as an estimate of market valuation to predict short-run stock performance. Our simulations indicate that the safety of a given withdrawal strategy is significantly affected by the initial bond yield and CAPE value at retirement, and that the relative impact varies based on the portfolio equity allocation. Using valuation measures current as of April 15, 2013, which is a bond yield of 2.0% and a CAPE of 22, we find the probability of success for a 40% equity allocation with a 4% initial withdrawal rate over a 30 year period is approximately 48%. This success rate is materially lower than past studies and has sobering implications on the likelihood of success for retirees today, as well as how much those near retirement may need to save to ensure a successful retirement.

Number of Pages in PDF File: 17

Keywords: retirement, asset valuations, withdrawal rates, Monte Carlo

JEL Classification: D12, D91, G11, J26

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Date posted: June 28, 2013 ; Last revised: July 1, 2013

Suggested Citation

Blanchett, David and Finke, Michael S. and Pfau, Wade D., Asset Valuations and Safe Portfolio Withdrawal Rates (June 27, 2013). Available at SSRN: http://ssrn.com/abstract=2286146 or http://dx.doi.org/10.2139/ssrn.2286146

Contact Information

David Blanchett
Morningstar Investment Management ( email )
22 W Washington
Chicago, IL 60602
United States
859-492-5637 (Phone)
HOME PAGE: http://www.davidmblanchett.com
Michael S. Finke (Contact Author)
Texas Tech University ( email )
2500 Broadway
Lubbock, TX 79409
United States
Wade D. Pfau
The American College ( email )
Bryn Mawr, PA 19010
United States
HOME PAGE: http://www.retirementresearcher.com
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