Sustaining retirement income has been a hot topic among advisors since the publication of Bill Bengen’s original 1994 research on safe portfolio withdrawal rates. The debate over income modeling approaches, portfolio construction and withdrawal rates continues and Wade Pfau, Ph.D., CFA, is one of leading researchers in the field. Pfau is a professor of Retirement Income in the Ph.D. program for Financial and Retirement Planning at The American College in Bryn Mawr, Pennsylvania, and I recently asked him for his thoughts on some of the key discussions in retirement income planning today.
Safe or Sorry?
There are two distinct schools of thought on retirement income planning emerging, Pfau says. He explains the difference with an example. Imaging that an advisor runs a Monte Carlo simulation that shows a client’s retirement plan has a 90 percent chance of success. (Success is defined as the client not running out of money during his or her lifetime.)
That result would satisfy an advisor (and client) comfortable with a “probability based” approach, says Pfau. While the client might have to make some changes if the portfolio encountered problems, the advisor would still be confident about the plan’s likelihood of success.
In contrast, an advisor or client taking a “safety first” approach would not accept the same 10 percent risk of failure. In other words, a safety-first advisor or client could not tolerate a chance of failure, even at the relatively low 10 percent level. “You can’t allow that to happen,” Pfau says. “For basic spending needs you have to have no chance for failure.”