William Bernstein’s “The Retirement Calculator from Hell”

I’m working on several different projects now, and while nothing is finished enough to post yet, I’m hoping to describe lots of interesting results in the coming weeks. 
A couple minor notes… Congratulations to Michael Kitces, who joins a rather elite list of individuals in Investment Advisor’s Top 25 list for most influential people for advisors in 2012 and beyond. 
Doug Nordman wrote a very interesting piece, “How much will military veterans leave on the table?” which explores some of the themes I’ve been describing here recently.
He also mentions William Bernstein‘s classic 5 part “The Retirement Calculator from Hell” series, which was written around 10 years ago. I finally read all of these, and they are quite worthwhile. A few comments on each:
Part I is no surprise to people who’ve been following my blog, but it certainly was big news when he wrote it. In 1998, people were rediscovering the notion that constant inflation-adjusted withdrawals above 4% were prone to wealth depletion much faster than expected. He shows examples of this. It’s all about Bill Bengen’s sequence of returns risk.
He describes about using Monte Carlo simulation as an alternative to historical simulations. Also, importantly, he suggests building in forward-looking assumptions to the simulations to account for the current return environment. He suggests using lower volatility for stocks than seen historically to account for the mean reversion in stock prices that is otherwise missing from the simulations. That is interesting, but after thinking about, I think maybe this isn’t such a great idea again because of sequence of returns risk. Even with longer-term mean reversion, the impacts of what happens in the early retirement period have the biggest impacts, and there you want to make sure your stock returns have enough volatility to show the full range of possibilities.
Maybe this is the most famous part of the series. Here he suggests forgetting about success rates above 80% when thinking about 30-40 retirement periods. Your simulations show you about the investment risk, but they ignore the various possible political, economic, and military failures that can happen over such a long period. This is a very important point.
I also like this quote, which I think ties in well with the idea that minimizing failure rates is not necessarily the most important objective for retirees:

The historically naïve investor (or academic) might consider reducing his monthly withdrawals to a very low level to maximize his chances of success. But history teaches us that depriving ourselves to boost our 40-year success probability much beyond 80% is a fool’s errand, since all you are doing is increasing the probability of failure for political, economic, and military reasons relative to the failure of banal financial planning.

This one is about demography. Raising the retirement age is the only practical solution the aging population, because even if everyone saves a lot, there is still a limited number of younger people producing goods and services for the older people to consume. Also, what matters is not just the absolute amount of your savings, but rather how much you saved relative to everyone else. Important food for thought.
This is about how happiness is related to where you stand relative to your peers, not in absolute terms. As standards of living increase, this means saving even more just to stay at the same level of happiness. If real per-capita GDP grows at 2%, then a 2% investment return is really more like a 0% return in terms of your relative position in society.



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