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Wade Pfau's Yin and Yang paper
Old 11-10-2014, 01:54 PM   #1
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Wade Pfau's Yin and Yang paper

Wade Pfau has written a glossy 32 page PDF covering a number of approaches to retirement income. Nothing new for most of us but it is a nice compendium of the thinking on the topic for those who are interested. It is available online or as a PDF at his site.
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Old 11-11-2014, 05:52 AM   #2
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It's interesting but, as you point out, nothing is earth shattering. The Austalian perspective on SWR was interesting. It did clearly identify my approach as "safety first." I have a couple of small pensions plus SS that will take care of my basic needs. I have a sinking fund set up to bridge between my retirement date and age 70 when SS will begin. My remaining portfolio is free to be used for lifestyle enhancement. My current plan is to take 5% annually from my portfolio for expenses beyond what I consider to be "basic." This would be more than I'm currently spending so I'm interested in seeing if I can rise to the challange.

As of today, I have 17 more "in-office" days until resignation/retirement on 5 January 2015.
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Old 11-11-2014, 06:38 AM   #3
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Very nice paper.

A bit heavy written for the general public, but that's not the audience.

Thanks for posting.
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Old 11-11-2014, 10:39 AM   #4
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Originally Posted by donheff View Post
Wade Pfau has written a glossy 32 page PDF covering a number of approaches to retirement income. Nothing new for most of us but it is a nice compendium of the thinking on the topic for those who are interested. It is available online or as a PDF at his site.
Thx donheff for posting this link. I'm a fan of Pfau (hey, we could start a club and call it "Phans of Pfau"! ). I can say that I already knew a lot of this but, I also learned some things, especially about circumstances in Australia. I also very much liked the 'context' provided by comparing/contrasting the entire spectrum of approaches in one paper.

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It's interesting but, as you point out, nothing is earth shattering. The Austalian perspective on SWR was interesting. It did clearly identify my approach as "safety first." I have a couple of small pensions plus SS that will take care of my basic needs. I have a sinking fund set up to bridge between my retirement date and age 70 when SS will begin. My remaining portfolio is free to be used for lifestyle enhancement. My current plan is to take 5% annually from my portfolio for expenses beyond what I consider to be "basic." This would be more than I'm currently spending so I'm interested in seeing if I can rise to the challange.

As of today, I have 17 more "in-office" days until resignation/retirement on 5 January 2015.
I'm not sure that I'm clearly safety first...yet. But, having just semi-FIREd on 1 July 2014, I have to say that I notice I'm moving closer than I was earlier. I guess it's true that, once a retiree actually experiences 'no more paychecks', the prospect of a significant portfolio decline seems more ominous. Or, perhaps I'm just reading too much "Retirement Cafe" (that's a compliment Dirk.) Table 6 in the paper is a good set of questions to help guide one on where he fits on this spectrum (Posted below for info).

My current plan is somewhat of a mix of two of these strategies:
1. Use "income layering" for essential expenses (pensions + SS)
2. Have a CD ladder and bond fund to bridge the 'essential expenses' income gap from now to age 70 & SS (two small pensions active earlier)
3. Follow Guyton-Klinger variable withdrawal method with remaining portfolio, from now through end of retirement; beginning with a a 5% WD rate based on an overall 60/25/15 AA.
4. DW have no children and no specific legacy goals.

2B: I notice some similarity btwn our circumstances. If you're willing to share, I'd like to know how you've structured your 'sinking fund' until age 70.

BTW-Congrats on only 17 work days until FIRE!


Table 6: Determining comfort with probability-based or safety-first
1. How does stock market volatility affect your sleeping patterns?
2. Are you particularly fearful about outliving your assets or having to reduce spending dramatically at higher ages?
3. Is your standard of living (as distinct from annual spending amounts) vulnerable to a large market decline? In other words, do you have limited flexibility to reduce spending and still remain comfortable?
4. How funded is the retirement plan? Could you meet your goals without market risk, or is seeking upside integral to the success of the plan?
5. Is it worth seeking greater upside potential when it exposes you to downside losses? How would you feel if your assets doubled in value? What if they lost half their value?
6. How do bequest motives compare to spending goals?
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Old 11-11-2014, 12:43 PM   #5
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Thanks, donheff. It was a good recap. Icing on the cake would be if Dr Pfau could create two or three "sample cases" of retirees, their expenses (needs, wants, wishes), their investment portfolio, their existing DB-like income streams (SS, etc), build retirement income streams for each according to the different approaches using actual available products (esp inflation-adjusted DLAs), and do a statistical analysis of results against real-world market data. It wouldn't be perfect (i.e. the "safety first" approach specifically rejects the utility of past asset performance history) and it wouldn't mirror anyone's actual situation, but it might prove to be a useful illustration of the pros/cons of the approaches.
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Old 11-11-2014, 04:09 PM   #6
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Thanks very much donheff for posting this. An excellent resource!
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Old 11-11-2014, 08:17 PM   #7
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Thanks, donheff. It was a good recap. Icing on the cake would be if Dr Pfau could create two or three "sample cases" of retirees, their expenses (needs, wants, wishes), their investment portfolio, their existing DB-like income streams (SS, etc), build retirement income streams for each according to the different approaches using actual available products (esp inflation-adjusted DLAs), and do a statistical analysis of results against real-world market data. It wouldn't be perfect (i.e. the "safety first" approach specifically rejects the utility of past asset performance history) and it wouldn't mirror anyone's actual situation, but it might prove to be a useful illustration of the pros/cons of the approaches.
I know that Pfau has created one such sample case: use of SPIAs for essential expenses and a mostly stock portfolio for the remainder. I think Kitces contributed. I believe there are threads here on it but, I know it's on Pfau's website. IIRC, the primary conclusion was that use of a SPIA enabled heavier stock weighting in the remaining portfolio.
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Old 11-12-2014, 11:31 AM   #8
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I know that Pfau has created one such sample case: use of SPIAs for essential expenses and a mostly stock portfolio for the remainder. I think Kitces contributed. I believe there are threads here on it but, I know it's on Pfau's website. IIRC, the primary conclusion was that use of a SPIA enabled heavier stock weighting in the remaining portfolio.
So much of this just seems like common sense to me. That's been my plan for the last 30 years. Make sure you have the fundamental costs covered by things like SS, pensions, annuituies....maybe even rent, and then you can aggressively invest the rest.

Another thing I did was to go into retirement with no debt and no mortgage which reduces my need for income.
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Old 11-12-2014, 12:11 PM   #9
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The article is aimed at Australian advisors and investors, in my opinion. The article is longer, I feel, in that the authors take some time to explain the research on US investors, for example, and then need to apply the results to Australian investors, who have access to SuperAnnuation (SA).

I was distracted by the references to "account-based pensions" - that concept is explained in this link. Not sure if it is close to the U.S. Roth-IRA, but that's my interpretation.

The presentation is ok, and if you have the time to read it, it gets you thinking about the different approaches to retirement savings.
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Old 11-12-2014, 12:43 PM   #10
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The article is aimed at Australian advisors and investors, in my opinion. The article is longer, I feel, in that the authors take some time to explain the research on US investors, for example, and then need to apply the results to Australian investors, who have access to SuperAnnuation (SA).

I was distracted by the references to "account-based pensions" - that concept is explained in this link. Not sure if it is close to the U.S. Roth-IRA, but that's my interpretation.

The presentation is ok, and if you have the time to read it, it gets you thinking about the different approaches to retirement savings.
Thx for the "account-based pension" link. I also didn't understand this until reading your link.

I also found it interesting that pensioners are rather quickly means tested out of the "age pension." But, it seems there are no "age pension" contributions. The Ausie system has three tiers as described below, with a structure slightly different than here in the US.

Pension System Design
Australia has a three-pillar pension system. The first, public pillar, is composed of a means-tested, tax-financed Age Pension that provides basic benefits. The second pillar forms the backbone of the Australian pension system, and is made up of funded individual pension accounts provided by superannuation funds. The third pillar involves individuals contributing to their superannuation funds or to Retirement Savings Accounts (RSAs).
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Old 11-12-2014, 01:08 PM   #11
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2B: I notice some similarity btwn our circumstances. If you're willing to share, I'd like to know how you've structured your 'sinking fund' until age 70.

BTW-Congrats on only 17 work days until FIRE!
My sinking fund is just extra CDs in my asset allocation. I take the required sinking fund balance (SS, pension deferral and extra health care costs over Medicare) and subtract that from my investable assets. I then rebalance based on 50%. The sinking fund is then added to my fixed income (primarily CDs). That skews my AA to a more conservative tilt. The sinking fund reduces my equities to approximately 45% at the near beginning of my retirement. My recent review with the Vangaurd CFP convinced me to increase my target allocation to 50%. He seemed somewhat surprised by the sinking fund concept and said it made sense.

Yep, 17 "in-office" days left after today. I'm still on track to resign/retire on 5 January 2015. I've planned 3 weeks of PTO between now and then. I'd be gone already if I wouldn't take such a tax hit by not leaving at the start of a year. Depending on my project load at that time, I might have a few final weeks to wrap things up and/or pass off longer term items. I plan on being reasonably flexible since I've been treated so well here. I plan on putting 100% of my pay into my 401k to reduce 2015 taxable income. Hopefully, there won't be a need to work longer than the max contribution.
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Old 11-12-2014, 01:26 PM   #12
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Yes, thanks for this link. It's seemed to me that Pfaul was trying to make at least some of these points over the course of many blog posts. Nice to see them all in one place with more depth. In the safety-first camp I'm surprised he didn't mention Kotlilkoff since Pfau made nods to other academics.
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Old 11-12-2014, 04:04 PM   #13
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The article is aimed at Australian advisors and investors, in my opinion. The article is longer, I feel, in that the authors take some time to explain the research on US investors, for example, and then need to apply the results to Australian investors, who have access to SuperAnnuation (SA).

I was distracted by the references to "account-based pensions" - that concept is explained in this link. Not sure if it is close to the U.S. Roth-IRA, but that's my interpretation.

The presentation is ok, and if you have the time to read it, it gets you thinking about the different approaches to retirement savings.
The UK system is going through a lot of change right now. It's change that is similar to what happened in the US when 401ks started to replace DB plans. Until recently most UK plans were based on annuities and unless you were able to satisfy some fairly complex rules you were forced to buy an annuity when you retired. The poor quality of these annuities and a more liberal attitude has brought about a lot of change and now people can choose to how invest their retirement money. Also in the UK you can take 25% of your retirement funds as a tax free lump sum.

The new legislation has also introduced automatic DC pension deductions for employers and employees who earn above a certain minimum income. If your employer is too small to have their own plan there is a Government sponsored plan called NEST (National Employment Savings Trust) that you can use. You can opt out of the scheme, but you have to do that actively and prove that your employer is not forcing you to opt out.

Finally the UK SS system has also recently changed: retirement dates have gone up by a couple of years for middle aged and will probably go up more for younger people; the pension increase for deferring retirement has gone down; and the amount of the basic pension has increased and is now calculated simply on years of contributions and not on income. So those on low wages see a big increase that is being funded by those earning more. The logic behind this is that low wage earners have less disposable income to save for retirement and so a larger SS pension will help them to avoid poverty in old age.
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Old 11-12-2014, 06:32 PM   #14
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Have not seen a better single source overview. Interesting info on Aussie system/markets and how they contrast with US.
Thanks for the link!
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Old 11-13-2014, 11:55 AM   #15
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Finally got through the whole paper. What's interesting, and new AFAIK, is his grouping of all the various retirement-income strategies into two distinct groups, or at least two extremes between which each strategy falls.

Pfau does his best to be objective, but it's clear throughout IMO that he favors the "Safety-First" side.

Even his names for the two camps, "Probability-Based" and "Safety-First," make the latter sound a lot better.

Well I'm squarely in the former camp, so let's spin that wheel, shall we?
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Old 11-13-2014, 02:30 PM   #16
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Just got through it all last night, and this quote on page 11 was the standout for me:

"In 1991, Nobel laureate and MPT founder Harry Markowitz wrote about how MPT was never meant to apply to the investment problems of a household. Rather, it was for large institutions with indefinite lifespans and no specific spending objectives for the portfolio. This should have been a Eureka moment for the retirement income industry."

That's a pretty stinging indictment of the probability-based approach, it seems to me.
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Old 11-13-2014, 02:56 PM   #17
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Finally got through the whole paper. What's interesting, and new AFAIK, is his grouping of all the various retirement-income strategies into two distinct groups, or at least two extremes between which each strategy falls.

Pfau does his best to be objective, but it's clear throughout IMO that he favors the "Safety-First" side.

Even his names for the two camps, "Probability-Based" and "Safety-First," make the latter sound a lot better.

Well I'm squarely int the former camp, so let's spin that wheel, shall we?

I thought the most valuable aspect of the paper was putting it all in one location

I noticed the same thing regarding preference from several phrasing choices. But, I think Pfau is pretty straight forward about his preferences though.

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Just got through it all last night, and this quote on page 11 was the standout for me:

"In 1991, Nobel laureate and MPT founder Harry Markowitz wrote about how MPT was never meant to apply to the investment problems of a household. Rather, it was for large institutions with indefinite lifespans and no specific spending objectives for the portfolio. This should have been a Eureka moment for the retirement income industry."

That's a pretty stinging indictment of the probability-based approach, it seems to me.

I also did not know that. I don't think it eliminates probability based approaches but, it changes the risk context IMO.


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Old 11-13-2014, 03:24 PM   #18
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It seems to me that an individual investor has to be pretty lucky to learn about the safety-based approach that Pfau, Kotlikoff, Bodie et al recommend. I've only been with Schwab and Vanguard, but what I've gotten from their advisors has been pretty much by-the-book MPT based stuff.

If anything, it would appear that computer-driven probability approaches to retirement are going to become even more prevalent, due to the sea change at the big firms in response to the so-called Robo investment companies.

FWIW, here's a link to the approach they're taking at Betterment, which seems to be one of the most sophisticated of these companies (their offerings are also being offered by Fidelity, and Schwab is coming out with their own version early next year):

https://www.betterment.com/resources...ule-is-broken/
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Old 11-13-2014, 04:15 PM   #19
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While I follow and enjoy his work, there is a serious, persistent problem with Mr. Pfau, as anyone who has seen his videos will acknowledge: he is quite simply the geekiest man alive, and for this I cannot completely forgive him.
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Old 11-13-2014, 04:56 PM   #20
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While I follow and enjoy his work, there is a serious, persistent problem with Mr. Pfau, as anyone who has seen his videos will acknowledge: he is quite simply the geekiest man alive, and for this I cannot completely forgive him.
Whoa, Man. Geeks have their place in the world, too.
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