Introducing the Retirement Wealth and Affordability Indices
January 27, 2015
by Wade Pfau
Carlson Capital's Double Black Diamond fund added 3.09% net of fees in the second quarter of 2021. Following this performance, the fund delivered a profit of 5.3% net of fees for the first half. Q2 2021 hedge fund letters, conferences and more According to a copy of the fund's half-year update, which ValueWalk has been Read More
We face intense vulnerability regarding our lifetime sequence of market returns. This is an important theme that my research about retirement income planning explores. Market performance in the years just before and after our retirement date has a disproportionate impact on our lifetime financial outcomes. For people who plan and save in the same responsible way, some will be able to sustain a high level of spending over their retirement, while others will not. Strong market returns in the years around the retirement date is fortuitous; we have no control over what these returns will be.
How can you help clients determine if they are retiring at a good time or not? I aim to answer that with my recently developed Retirement Accumulation IndexTM and Retirement Affordability IndexTM. I will update these indices frequently at the new Retirement Dashboard on my website, so that you can better benchmark your clients’ relative situations regarding an upcoming retirement.
Let me explain how those two indices work and how you should use them with clients.
Retirement Wealth Index™
Saving 15% of one’s annual salary during the final 30 years before retirement would be a responsible strategy in theory. But in practice, how successful will this strategy be? What would a client’s wealth accumulation be at their 65th birthday? The Retirement Wealth IndexTM provides a basic answer to this question.
The index must be customized for a benchmark client, as obviously each client’s personal situation will differ. But the purpose of the index is to highlight the impact of a client’s personalized sequence of returns on their financial success. Advisors who have guided clients toward better outcomes than suggested by the index can also be confident in the value of their services. Though situations will vary, actual client outcomes will at least be correlated with the benchmark retiree in the index. It is either a good time to retire or it is not.
The benchmark retiree saves 15% of their salary each month between their 35th and 65th birthdays. This is a 30-year accumulation period. Salary grows at 1% annually in inflation-adjusted terms from ages 35 to 59, and then stays level in inflation-adjusted terms for the final five years of work through age 64.
This individual invests in a portfolio of large-capitalization stocks (the S&P 500) and 10-year U.S. Treasury bonds. I use the data from Robert Shiller’s website to calculate total returns for both the stock and bond indices. I calculate bond returns from their yields assuming a bond mutual fund with equal holdings of 10-year bonds from each of the past 10 years. For asset allocation, I assume that the individual invests in a target-date fund whose by-age asset allocation is the averages in the 2014 Target-Date Series Research Paper by Morningstar. These are the averages across the available target-date fund families in 2013. I use age 65 as the retiree’s target date.
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