Journal of Financial Planning: December 2007
Executive Summary
- The purpose of this paper is to determine the optimal allocation strategy (referred to as the distribution glide path) for a portfolio subject to withdrawals. But unlike most previous research, which uses static allocations, the paper includes a dynamic allocation methodology. It also introduces a methodology to incorporate risk into the decision process.
- Using historical data from four asset categories from 1927 to 2006, 43 different distribution glide paths were considered for 21 different time periods and 61 different real withdrawal rates.
- Despite the expected benefits of more sophisticated dynamic distribution allocation strategies, static equity allocations proved to be remarkably efficient.
- The most optimal glide path from a pure probability-of-success perspective was the 100/0 (100 percent equity and 0 percent fixed income/cash) static allocation portfolio. But due to the underlying variability of a 100/0 portfolio, it is unlikely that this allocation will be appropriate for most retirees.
- The absolute differences in the probability of failure among glide paths for shorter distribution periods and lower real withdrawal rates (less aggressive scenarios) were minor.The absolute differences for longer distribution periods and higher real withdrawal rates (more aggressive scenarios) were considerable.
- The paper introduces a risk-adjusted measure called the Success toVariability ratio in order to incorporate portfolio variability (standard deviation) into the optimal glide path decision process.
- When considering a variety of distribution periods and real withdrawal rates, as well as the probability of failure and the Success to Variability ratio, a balanced static allocation, such as 60 percent equity and 40 percent fixed income/cash, is likely one of the most efficient portfolio allocations for retirees.
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Topic
Investment Planning