With all the recent discussions about Withdraw Rates - I would like to call attention these items:#1 Today I received a Special Issue of Businessweek magazine which is largely devoted to Retirement and the changing retirement environment. Items include health insurance, rates of return, withdraw rates, etc.#2 Within that article is reference to www.BillBengen.com -- this is the same William Bengen who did the seminal work on withdraw rate studies. I urge you to explore the website.I have downloaded a Toolkit from the website which is very interesting for me. Like many toolkits, just grabbing a tool and using the tool can have either good or bad results -- depends on the tool, the luck of the user as well as the user's skill, judgment and believe it or not knowledge. One should not say "Hammers are bad." just because you hit your finger with a hammer!Anyway from the portion of the downloaded material I included below is an interesting comment about Withdraw Rates. Bengen writes, "Just remember- as has been remarked about pilots, there are old withdrawal plans and there are bold withdrawal plans, but there are no old bold withdrawals plans. I strongly recommend that you encourage your early retirement client to adopt a conservative approach (within the context of his or her nature). The time for conservatism is now, when the plan is being drawn up, not ten years later, when a risky plan forces uncomfortable life style decisions on your client." GordonAtlanta, GAAlso see: http://en.wikipedia.org/wiki/William_Bengen The following can be found at:www.BillBengen.comUSER’S GUIDE TO “COMPANION TOOLKIT” TO“CONSERVING CLIENT PORTFOLIOS DURING RETIREMENT”©By William P. Bengen Introduction My book, “Conserving Client Portfolios During Retirement”, (CCPDR) published in May 2006, provides a conceptual approach for creating withdrawal plans for retirement clients. Some of the main ideas of the book were illustrated with a limited number of black-and-white charts. Subsequently, in an article appearing in the August 2006 issue, of the Journal of Financial Planning, I assembled several of the book’s ideas into a metaphorical framework I called the “Withdrawal Plan Layer Cake.” The Layer Cake was intended to provide a visual reference for all the elements which contribute to the computation of a client’s initial portfolio withdrawal rate. This article was also illustrated by a limited number of black-and-white charts. Since those two works were published, however, fellow advisors have made it clear to me that, as nice as the concepts may be, a set of tools was needed to make them truly useful in their practices. Software tools were needed to allow users to easily compute the layers of the “cake,” as well as color charts to present the withdrawal plan to clients. The intent of this CD is to provide some of those very tools. I hope you find them helpful in your practice.. Ideally, I would have liked to have created comprehensive software for advisors, which would allow them to input values for the variables applicable to a particular client, and then instantly generate color charts to fit each client’s unique profile. Unfortunately, that software is not yet available (ultimately I believe it will be developed). In its place, I have created a multitude of color charts which cover a wide range of variables, which should apply to more than 95% of the client situations an advisor might encounter. By interpolating between the charts, excellent withdrawal plan solutions for just about any client can be obtained. A simple worksheet tool for constructing and printing the “layer cake” is also provided.Tools included in this toolkit Following are the three elements of this toolkit:• A Microsoft Excel spreadsheet file for assembling and for printing out in glorious color a client’s “layer cake.”• 72 color charts, consisting of 24 groups of three, which contain the raw data for computing the layers in the “cake.” These charts are stored in a Microsoft PowerPoint presentation file.• A copy of the “Layer Cake” article from the August 2006 issue of the Journal of Financial Planning (PDF file). No copy of my book CCPDR, is provided in this toolkit. Please purchase a copy to satisfy my publisher’s insatiable appetite for book sales.Below is a more detailed description of each tool:Excel spreadsheet (“Layer cake”): This simple tool consists of two worksheets: a “Client Preferences” page, and the “Layer Cake” diagram. The Client Preferences page is used to store the client’s choices for various parameters which define a withdrawal plan, including the values of parameters selected from the charts in the PowerPoint presentation. This data is automatically transferred to the “Layer Cake” diagram, so when the Client Preferences page is completed, the client’s “Layer Cake” is ready for viewing and printing.PowerPoint charts: The 72 charts are organized into six main groups identified by a client’s time horizon: 15, 20, 25, 30, 35 and 40 years, respectively. For easy identification, the charts in each group share the same color scheme. The PowerPoint presentation is organized so that all the charts of the same group appear together. Within each color group, the charts are further subdivided into four sub-groups of three charts each, which are distinguished by four different portfolio tax rates: 0% (tax-deferred and tax-free), 20%, 30% and 40%. An explanation of the applicable tax rate of a portfolio is provided in Chapter 2 (pp. 24-27) of CCPDR. The intent is that for any one client, only one group of three charts is required, and these charts will appear sequentially in the PowerPoint presentation, for ease of access. The only exception would be a client who has both substantial tax-advantaged and taxable accounts, in which case two groups of three charts may be required. The three primary chart types found in this tool are as follows:• “Success rate” chart. This chart identifies the “SAFEMAX’, or “safe” minimum withdrawal rate, for a portfolio with the applicable longevity and tax rates. The chart also identifies the probability of higher withdrawal rates successfully negotiating the client’s time horizon.• “Legacy” chart: For clients desiring to be certain of leaving a portion of their retirement portfolio to their heirs, this chart computes the diminished withdrawal rates for a variety of “terminal” portfolio values, at the end of the client’s time horizon. Terminal portfolio values are provided both in nominal and real values (the first time I have provided real portfolio values in this context), as an aid in helping the client’s decision process. A steady 3% inflation rate is assumed in computing the final real values of portfolios, a necessary but not unreasonable simplification.• “Superinvestor” chart: My research computes initial withdrawal rates based on the assumption that the portfolio will earn index returns for each of its asset classes. In case either the advisor or the client (preferably both) are convinced that above-average (or below-average) equity returns are to be expected for extended periods of time, this chart provides adjusted withdrawal rates for that eventuality. Note that the appropriate “SAFEMAX” appears on each of the three charts in each sub-group, providing a unifying element for each group.Copy of August 2006 JOFP article “Baking a Withdrawal Plan ‘Layer Cake’ for Your Retirement Clients”: Although based on the book, much of the material in this article is new and did not appear in the book. A copy of the article is provided for your convenience. For those who are culinarily challenged, fear not: it has little to do with cooking. Using this toolkit For starters, I recommend that you read the article from the 8/2006 issue of the Journal of Financial Planning, if you haven’t done so already, to familiarize yourself with my “layer cake “concept. Of course, even that article may be incomprehensible without having read my book, CCPDR, so I recommend that you obtain a copy. This would not be much of a companion toolkit without its companion! Next, open the Excel “Layer Cake” spreadsheet to the Client Preferences page. This tool is intended for mutual use with your client. You must first agree with your client on their time horizon, which may not be as simple as it sounds. Clients are renowned for lacking accurate information about their date of death. After consideration of the client’s health, family history, lifestyle, mortality tables, and possibly a neighborhood psychic, you may agree on a reasonable estimate of life expectancy. As I state in CCPDR, I recommend you add 10 years to that estimate, as a safety margin. Hopefully your estimate of client life expectancy will match one of the groups of charts in the PowerPoint file: 15, 20, 25, 30, 35, or 40 years. If, instead, you have arrived at some oddball number such as 28.5 years, please don’t throw this toolkit away. After all, you paid good money for it! I recommend that you round-up your estimate of life expectancy to match one of the time horizons in the PowerPoint charts. For the example just mentioned, 28.5 years would be rounded upward to 30 years. Rounding upwards introduces a conservative element into the planning process, which I believe is appropriate. For time horizons less than 15 years, or greater than 40 years: please wait for the next edition of this toolkit, as I intend to expand the data ranges in future editions. The next important parameter on the Excel Client Preferences spreadsheet is the tax rate for the portfolio. Defining this parameter is usually much more straightforward than negotiating the time horizon. I refer you to my detailed discussion of portfolio tax rates in Chapter 2 (pages 25-28) in CCPDR for a definition of “portfolio tax rate”. It is worth mentioning here that my research up to this point contemplates only what happens within a portfolio (such as dividends, interest, growth of capital, and amounts withdrawn for spending or taxes), and not what happens to money after it is removed from the portfolio. Therefore, for the purposes of my analysis, the portfolio tax rate may differ from the client’s personal income tax rate (especially in the case of tax-advantaged portfolios, whose internal tax rate is defined as zero.) What if your estimate of portfolio tax rate differs from the four choices on the PowerPoint slides: 0%, 20%, 30% or 40%? I recommend that you use the chart for the tax rate closest to your estimate. If your tax rate falls almost exactly between two PowerPoint tax rates, you may either round upward (for safety), or interpolate between two sets of charts which bracket your portfolio tax rate. Once the time horizon and tax rate issues are resolved, it is time to open the PowerPoint slide presentation. To complete the remainder of the Excel Client Preferences form, you need to switch back and forth between it and the PowerPoint slides, so it is useful to have them both open in separate windows on your computer. The specification of the client’s time horizon and portfolio tax rate will narrow your focus to a group of just three PowerPoint slides (or six slides, if interpolation is needed). These PowerPoint slides contain the information required to develop the layer cake, layer by layer. Just follow the remaining elements on the Excel Client Preferences form, referring to CCPDR as required. Once the Excel Client Preferences form has been completed, the “layer cake” diagram is simultaneously finished. With a bit of fanfare, you can switch to the layer cake page, where the client’s gross initial withdrawal rate, composed of all factors previously analyzed, is revealed for the first time. If the client is satisfied, your can print the layer cake page, and your work is done. If the client is unhappy with the withdrawal rate, you can begin the process all over again. Or, perhaps more effectively, you can review together the key elements on the Client Preferences page and make adjustments which will accommodate the client’s concerns, creating a new layer cake in the process. Just remember- as has been remarked about pilots, there are old withdrawal plans and there are bold withdrawal plans, but there are no old bold withdrawals plans. I strongly recommend that you encourage your early retirement client to adopt a conservative approach (within the context of his or her nature). The time for conservatism is now, when the plan is being drawn up, not ten years later, when a risky plan forces uncomfortable life style decisions on your client. The sample Excel spreadsheet In order to better illustrate the process of developing a “layer cake” withdrawal plan using this toolkit, I have created a sample case study using, of all people, the eponymously named “Mr. and Mrs. Client”. Together, let’s walk through the steps of developing a withdrawal rate for them using the tools in the toolkit. First, let’s open the Excel “SAMPLE” spreadsheet to the “Client Preferences” worksheet. Note that the client couple’s name has been entered in the “Client Name” field. Mr. and Mrs. Sample are both 60 years of age, and have elected to plan for their retirement out to age 95. This corresponds to a time horizon of 35 years, which has been entered in the corresponding space. The Samples have no tax-deferred accounts, but do have a taxable account with a balance of $1 million. The advisor determines that the effective tax rate of the portfolio is 29% (federal and state). This is rounded upward to the 30% tax rate which appears on the Client Preferences form. At this point, the PowerPoint presentation should be opened and the appropriate sub-group of 3 slides located. To do so, page through the slides until you come to the group of slides featuring 35-year portfolio longevity. All the slides in this group have a purple color scheme, to distinguish them from the other five groups. Within the group of purple slides, advance forward until you reach the “Success Rate” chart for the 30% portfolio tax rate. This is the first of three consecutive slides which will apply to the Samples. The Excel Client Preferences form asks for the “SAFEMAX” from the “Success Rate” chart. This is the withdrawal rate to the extreme left of the chart, with a corresponding 100% success rate. The SAFEMAX for the Samples is 3.71%. That number should now be entered in the Client Preferences form. Observe that this withdrawal rate is carried down to three other locations on the Client Preferences form. This serves as a default value of the withdrawal rate which can be overridden simply by entering new values over the default. Note that the withdrawal scheme embodied in all the PowerPoint slides is the “Lifestyle” scheme. Essentially, that scheme applies a percentage (e.g., 5%) to the starting value of the investment portfolio, which yields a dollar withdrawal for the first year (after an inflation adjustment- please see discussion of this withdrawal scheme in CCPDR, page 12). After the first year, the percentage is no longer used to compute withdrawals. Instead, the first year’s dollar withdrawal is increased each year by the amount of the prior year’s inflation (i.e., CPI). This is not the only withdrawal scheme possible, and in my opinion, not necessarily the best one. I discuss several other withdrawal schemes in CCPDR, including the “Floor and Ceiling” scheme, which I believe has significant advantages. However, the Lifestyle withdrawal scheme is probably the most prevalent in our profession at the present time. In addition, in an effort to get this toolkit out in a timely fashion, I felt it necessary to confine my efforts to that one option. I am hopeful that, if there is enough interest in other withdrawal schemes, I can include them in future editions of this toolkit. Note that each PowerPoint slide has an accompanying asset allocation for Large Company stocks (LCS), Small Company Stocks (SCS) and Intermediate-Term Government Bonds (ITGB). This asset allocation was optimized to achieve the highest possible SAFEMAX. Asset allocations which depart from the optimum allocation may cause reductions in the SAFEMAX. Tax-advantaged portfolios are less sensitive to this effect (refer to the “magic plateau mentioned In CCPDR), but as the portfolio tax rate increases, the sensitivity of SAFEMAX to the asset allocation increases. In this case, the recommended allocation consists of 84% in equities. That may sound extraordinarily high for a retirement portfolio. However, stock index mutual funds are usually considerably more tax-efficient than taxable bond funds. As a result, the additional portfolio volatility inherent in a high equity allocation is offset by the lower income taxes paid by index stock mutual funds. The long time horizon of 35 years also favors a higher equity allocation. The “Success Rate” chart also provides information for the next decision on the Client Preferences form: what degree of risk is the client willing to accept in order to obtain a withdrawal rate higher than SAFEMAX? In the case of the Samples, they felt that they would need to withdraw $50,000 from their portfolio during the first year of retirement, and increase that amount annually with inflation. Since their portfolio has an initial value of $1 million, that corresponds to an initial withdrawal rate of 5%. The “Success Rate” chart shows that a 5% withdrawal rate has an 83% chance of success over a 35-year time horizon. This degree of risk was acceptable to the clients, so both the 5% withdrawal rate and the 83% success rate were entered in the Client Preferences form. The next consideration on the Client Preferences form is the “Legacy penalty” option. Does the client wish to ensure that his portfolio will provide funds for heirs after his or her death? Remember, as per CCPDR (Chapter 8), in the worst case, a client’s retirement portfolio may fall to zero value at the very end of his life. If the client wants to be assured of leaving money for heirs, the withdrawal rate must be adjusted downward to provide for this legacy. The larger the legacy, the greater the required downward adjustment in the withdrawal rate. The next PowerPoint slide, titled “SAFEMAX vs. Desired Legacy” provides several options for the client to consider in this vein. Essentially, new SAFEMAXES are calculated for the portfolio, each corresponding to different “guaranteed” non-zero values at the end of the time horizon. Since no one knows what the inflation rate will be in the future, the final portfolio value is characterized in nominal terms, with no inflation adjustment. Please see CCPDR, Chapter 8, for a detailed discussion of these concepts. Each of the “Legacy” slides in the PowerPoint presentation assumes an initial portfolio value of $100,000. It is easy to scale these charts to any size portfolio, however. For example, the Samples have a $1 million portfolio. For their purposes, all numbers in the chart are multiplied by 10. After studying the “Legacy” chart, the Samples decided that they wished to leave a portfolio with a nominal value of $1.5 million, larger in nominal terms than their portfolio today. However, the chart shows that, assuming 3% inflation for the next 35 years, that $1.5 million portfolio would have a real value of only $533,080, in terms of today’s dollars. The actual real value will depend on actual inflation rates over the next 35 years, of course, but this hypothetical real value provides a frame of reference which may help the client’s thinking about this complex issue. In order to leave a legacy of that magnitude to their children, the Samples must reduce their SAFEMAX from 3.71% to 3.39%. This adjusted SAFEMAX is entered in the Client Preferences form. The third PowerPoint slide addresses the issue of the “Superinvestor”: can the Samples’ money manager deliver equity returns consistently higher than an equity index fund? This topic is discussed in detail in Chapter 7 of CCPDR. The Samples believe that their money manager can, indeed, consistently beat index equity returns by 1% per year. Consulting the “Superinvestor” slide, that corresponds to a SAFEMAX of 4.08%, which is about 0.4% higher than their original SAFEMAX. The 4.08% adjusted SAFEMAX is entered in the Client Preferences form. It is possible that money managers may be encountered who can “beat the market” by more than the upper limit of 4% indicated in the PowerPoint slide. To account for such superior performance, note that the relationship between “incremental return” and SAFEMAX is very close to linear; the chart can be extrapolated to the right for a considerable distance with a reasonable degree of accuracy. Just make sure you also extrapolate the limits on your EEO policy at the same time! The final entry on the Client Preference form does not require the use of the PowerPoint slides. It concerns the increase in SAFEMAX which may be achieved by lengthening portfolio rebalancing intervals from one year to four or six years. Chapter 13 of CCPDR explains this phenomenon. Note that the benefits of extended rebalancing periods are not particularly great, and this feature may be ignored altogether. The Samples elected to accept 4-year rebalancing, and as a result an additional 0.1% was entered in the Client Preference form to reflect that choice. The Samples Withdrawal Rate computation is now completed. The worksheet containing the “Layer Cake” diagram can now be revealed to the client. At the top of that diagram is the gross withdrawal rate, reflecting the sum of all the client’s choices: 5.3%. This satisfied the Samples’ express need for at least $50,000 per year from their investment portfolio, so the plan is approved, and copies of the Client Preferences form and the Layer Cake diagram are printed for the client. Had the Samples felt that the withdrawal rate was inadequate, the Client Preferences page could then be revisited for possible adjustment to some of the parameters. Perhaps they could reduce their intended legacy. Alternatively, they could locate a money manager who generated even higher equity returns than their current manager. Or they could decide to accept a lower “success rate” in order to elevate their SAFEMAX. Naturally, although the client is in charge, the advisor must be dutiful in explaining the risks of using higher withdrawal rates. Most clients, of course, own both taxable and tax-advantaged accounts. A layer cake can be created for each type of account, and a weighted average of withdrawal rates used to arrive at an overall withdrawal rate.
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