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- W3122384127 abstract "Abstract This paper advances the literature on the sustainability of retirement income by making consumption a stochastic variable instead of a constant real value, as previous papers have done. The paper continues to make the rate of return and date of death stochastic variables, as Milevsky and Robinson (2000, 2005) do. The sustainability of retirement income depends on the nature of the lifestyle that the retiree chooses. The difference in probabilities or risk of ruin between the variable cases and the fixed consumption case is significant, and so the adviser needs to take this into account. The difference in probabilities between making consumption a nonconstant but deterministic amount, and making it also stochastic, is not as important, because it does not reduce risk enough to make more aggressive consumption rates secure. Finally, making consumption correlated with the rate of return, which implies the family adjusts consumption as its wealth changes, reduces probabilities to a moderate extent. In general, an initial consumption of more than 4% of initial wealth is not sustainable for any likely set of conditions. In the very best case, an initial consumption rate of 6% is sustainable, but we think that case will fit very few people. © 2010 Academy of Financial Services. All rights reserved. JEL classification: D14; D91; G11; C63 Keywords: Probability of ruin; Stochastic present value; Sustainable retirement; Stochastic consumption (ProQuest: ... denotes formulae omitted.) 1. Introduction One of the most important and difficult questions a financial adviser faces is how much a client can spend in retirement and not run out of money. As the baby boomer cohort starts to retire in large numbers, at the same time as traditional defined benefit pension plans are disappearing, this problem becomes even more significant. The typical analysis makes assumptions about how long the person will live and the rate of return, along with a fixed spending amount. The answer is then a simple yes or no based on the present value of the retirement spending, compared with the expendable wealth the client has at his or her retirement date. The adviser then explains that this plan does involve some risk - living too long, earning a lower rate of return, a difference in the spending pattern. Researchers have improved on this model by recognizing that the rate of return and the date of death are variables with statistical distributions. They have then modeled the variables to obtain the of running out of money before natural death (the shortfall or probability of ruin), given a fixed consumption rate, a lognormal return distribution, and either a range of dates of death or some approximation of mortality statistics. Milevsky and Robinson (2000, 2005) model it analytically, with some assumptions, to incorporate rate of return and mortality into an analytic solution that yields a of shortfall. They conclude that a retiree age 65 is most likely not able to spend more than 4% of an initial endowment annually in real terms, without facing a significant of shortfall. Bengen (1994), Cooley et al. (1998), Guyton (2004), Ho et al., (1994), and Pye (2000) have run financial experiments or simulations using historical returns to quantify the sustainability of specified ad hoc spending policies and consumption rates for retirees. They generally find sustainable rates of 4% to 6%. All these papers are assuming a fixed consumption throughout retirement in real terms, and that is also the basic assumption of most financial advisers' solutions. This assumption ignores the reality that retirees do not all follow the same pattern of spending throughout retirement, the spending may be uncertain for any pattern applied and retirees can and often do adjust their spending to some extent to respond to changes in their endowment because of higher or lower than expected investment returns. …" @default.
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- W3122384127 date "2010-10-01" @default.
- W3122384127 modified "2023-09-26" @default.
- W3122384127 title "Sustainable Retirement Income for the Socialite, the Gardener, and the Uninsured" @default.
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