QUESTIONS ABOUT YOUR LICENSE:
I
am an advisor. One of the fellow advisors in the office asked me run the Otar
Retirement Calculator for his clients. Does my license cover that?
No it does not. Each end-user license covers one desktop computer, one laptop
computer and one advisor. Each
advisor needs to purchase one license to cover his/her own client
base.
I
am an individual investor. My neighbor, as well as my cousins want me to run the
Otar Retirement Calculator for their specific situation. Does my license cover
that?
As long as you don't receive a financial benefit for doing so and as long as you
run the programs in your computer, you can use it for your family. If your neighbor
needs to run it for his family, he needs to buy for his own.
I am a member of an investment club. Other members want me to run the Otar Retirement Calculator for their specific situation. Does my license cover that?
No it does not. An end-user license does not cover members of an organization. Each member needs to buy his/her own end-user license.
GENERAL QUESTIONS:
Will your software run on Macintosh versions of Excel?
No, PC only.
Does have to be updated yearly?
Are there any ongoing charges?
No. There are no annual
fees or charges. Each year, I add another year's market data. If you are happy with 106 years
of market history, you don't need to update it. One more year's data does not
make a dent when you are already working with such an extensive market history.
However, throughout the year, I add to my "wish list" many new ideas, some my doing, some from users. If you want the new features then you may find it worthwhile upgrading.
My equities' return is same as the index. However, my dividends amount to 3%. How do I handle that?
Set your alpha 3%.
What if I don't
know how my equities perform relative to the index?
Use alpha of 0%.
Please explain if I can
use the program to estimate better my chances of not running out of money from
my asset allocation? Also, how different is your program from , say, Sharpe's
financial engines? Sincerely,
You may be confusing the benefits of
asset allocation with the luck factor. Luck factor is the largest component of
the success of a retirement portfolio. This factor alone determines whether or
not you will run out of money during retirement. Please read my article on my
website about that. Asset allocation is just icing on the cake and not the cake
itself. Yes, in my program, with the click of a single button, you can optimize
the asset allocation that gives you: The highest dollar amount in the portfolio,
the lowest probability of depletion or the longest portfolio life, or any
combination of these three. The program will clearly indicate the optimum point.
This optimum asset mix is not based on statistics, standard deviations or other
academic jargon, or data manipulation; it is based on actual market history,
applied directly to your own personal cash flow picture. As nice as this sounds
(others would sell to you this feature alone as "the best thing since
sliced bread"), optimizing the asset mix is just one of the tools in
retirement planning in my program. My program will give you the combination of
other tools, such as any combination of investments, life annuities, variable
pay annuities and variable annuities with guaranteed pay - all in one package.
What
do you use as the fixed income return?
Nominal Bonds: The model takes the historic interest rate for 6-month deposit and
adds a premium (you can change this). It reflects approximately a
fixed income portfolio with an average duration of 5 years, held to
maturity.
Inflation-indexed bonds: The model uses historic inflation plus a percentage as real rate of return (you can change this).
What difference
does it make what my average MER is?
MER (Management Expense Ratio) is how much your mutual fund is charging you to
manage your money. It generally varies between 1% and 4%. All mutual funds
disclose this information. If you have a wrap account, add all costs, including
the WRAP fees and management fees to come up with a MER. If held for the long
term, MERs eat into your returns and shorten the portfolio life. Keep in
mind, there are several other factors, such as bad asset allocation, bad
investment selection, investor psychology to name a few, that can do a lot more
damage than MERs.
Why do you
ladder the life annuity?
Three reasons: 1. The older you are, the less money you need to buy an annuity
for the same periodic income, 2. The longer you delay buying the annuity, the
higher may be the estate value, 3. If you delay buying the annuity, your
investments may increase in value in the meantime. We use historic data to
calculate the probability of having less money in your investment portfolio in
the future, adjusted for inflation and your age. We then use this probability to
stagger purchasing annuities.
Why should I
have annuities in my portfolio?
Just like we like to diversify our
"investment portfolios" to reduce the volatility risk, we need to
diversify the source of our cash flows to reduce the risk of running out of money. A life annuity usually pays
a higher periodic income than the sustainable withdrawal income from an
investment portfolio. By placing some of your assets in an annuity, you are
reducing "the withdrawal stress" from your portfolio, which extents its
life.
What is
reverse-dollar-cost-averaging?
It is taking income from your investments on a periodic basis. You may have
heard of dollar-cost-averaging; investing periodically over time.
Dollar-cost-averaging reduces the average cost of your investments because it
takes advantage of price fluctuations.
The reverse-dollar-cost-averaging works against you. Because, once you sell part of your investment to provide you the periodic income, and if it is a bear market, then your losses are permanent. When the market comes back, you no longer have that part of your investment to participate in the rise.
My estimations show that whatever benefits dollar-cost averaging has through a bear market, the reverse- dollar-cost-averaging has about three times as much of a detriment to your portfolio for the same bear market. Therefore there are two things you have to be very careful of:
1. Always take your income from the least volatile investments, such as money market,
2. Do not rebalance more often than what is required for an optimum portfolio. For more info on this, read my award winning article.
If
I understand your software correctly, it gives us a representation of what might
of occurred if an investor had invested/withdrawn assets over a given period of
40 years, i.e. it starts at 1900 through 1940 and plots out the effect on
capital, then 1901 through 1941 , 1902 through 1942 etc. and gives us a sense of
how that portfolio performed during those historical periods through to the
present. How does it deal with recent periods, say 1994 to 2004, which is less
then the projected period?
The time period studied is the
lesser of 40 years or -for retirement years after 1966- it is the number of
years up to and including 2006.
If one retires at the beginning 1995,
there are only 12 years of history ( 1995, 1996,1997, 1998, 1999, 2000,
2001, 2002, 2003, 2004, 2005,2006). To see the 1995 retirement line on the chart (see
"Chart1"), move the mouse pointer to one of the lines on the
chart and a message box will pop up to indicate the starting year of that
particular line. Hint: Look for a
line that ends at around year 12 of retirement. Or you can just bring the slider
on the bottom of the chart to read 1995. This will give you all the historic
numbers starting in 1995.
In the instruction manual
it states inflation is not a needed input. How does the calculator handle the
affects of inflation? Are historical inflation rates used each year and the
amount needed to be withdrawn is increased accordingly? I guess I am asking in
the “Tables" tab on the schedule that states how much is withdrawn each
year, how does the program decided how much to increase the amount needed?
The program uses the historic
inflation for each year since 1900. Between 1900-1913, it uses the US Bureau of
Labor Statistics wholesale price index. After 1913, it uses the Consumer Price
Index ( Note: The Consumer Price Index did not exist prior to 1913). The program uses
these for indexing the periodic withdrawals/deposits for each age and for each
year starting with the current age and ending at the specified age of
death.
In the Tables page, because of space limitations, we don't show these numbers (withdrawals/deposits, annuities etc) for each year of retirement / for each age / for each year since 1900. Doing so would take 106 extra pages which is probably not necessary for a routine retirement plan. So, only the averages for each age are indicated in the "Tables" page.
If you want to see the outcomes for inflation other than the historical rates, go to Comparison sheet. There you can enter your own "assumed" inflation and see the difference, available starting in the 2008 edition.
I have been reading
The Misbehavior of Markets by Benoit Mandelbrot and some of his premises and
conclusions seem similar to the premises and conclusions underlying your
Retirement Optimizer software. Would you say that your software is an
application of Mandelbrot's multi-fractal model of market behavior (chaos
theory)? Do you know if his mathematical model has been incorporated into any
retirement planning software?
I don't remember seeing any
retirement calculator based on chaos theory. Mine is based on actual market data
and I don't intent to curve fit it to anyone's model. I am uncomfortable taking
historic data and describing it in some statistical equation, I rather use the
actual data.
Why can I not enter both
my data and my spouses data separately?
That would double the program size
and the resource use. The program is already near the limits of the spreadsheet
program. Just base the income needs on one (primary person).
How
and where do you take account of taxation of investments and incomes?
Taxation is another expense. There is
no separate tax entry. You must include all tax expenses in addition the all
retirement expenses in the "Total Periodic Income Required after
Retirement" box. In other words, income required after retirement is pretax
income.
I'm
planning to work on a case with one of my long distance clients. Will I be able to e-mail her pages out of the workbook as we
change scenarios. So far I haven't
had success trying this. Suggestions?
If you want to email pages as a pdf file, then you need to have pdf file writer
installed on your computer. With that software installed, after you load the
ORC, then set your default printer as "pdf writer" (or something like
that) then click on the print entire worksheet button on the main page, and the
entire workbook will be saved as a pdf file. You can then send it to your client
with your email.
I
load the program, but once I enter my figures, all of the probability of
depletions on the main page are 100%. Why?
In some language settings, the decimal point in North American English way of
writing is a comma. If this applies to you, just set your numeric format to
international.
The lucky column on the optimization page changes depending on my
inputs in the asset mix column on main page. I am reading this table incorrectly?
The
program may choose a different age to calculate these values at depending on the
asset mix entered. If you use 100%
equity, then the portfolio will run out of money sooner, so the age at which the
scenario tables show the asset values are at a lower age. If you start with an asset mix that is closer to
the optimum, that will allow the optimization routine to calculate the asset values for an older
age.
I
have a concern with how we are computing the MRDs so that the client has
adequate funding for living until 100. As an example I have a client with his
only asset is an IRA at $3.3 mil and needs $170,000 per year to live. This
$170,000 needs to be adjusted for inflation. How do we explain the higher
withdrawals and taxes? I think I know but would like to know your thoughts.
The
program does not increase withdrawals to account for the increased tax burden
for the MRD.
There are two situations when MRD kicks in: 1. When the withdrawal rate is less
than the sustainable withdrawal rate and 2. When the retiree gets lucky and
catches a secular bullish trend throughout his retirement.
In your example, his withdrawal rate is over 5%, so the MRD will not kick in.
That leaves only the second situation; retiree getting lucky. This would happen
in 15% of the cases. Otherwise, you don't need to worry about MRD.
Why
can’t I “optimize” a portfolio for an 81+ year-old person?
Program keeps saying “not sufficient time horizon available"
Program
needs a time horizon of 15 years or more for optimization to run. Just increase
the age of death (design until age) so that it is at least 15 years higher than
the current age.
Will
you allow us the ability to illustrate for a certain timeframe (i.e. S&P
from periods 1995-2005, or 1970-1980) to give the client an idea of what certain
periods could mean to their portfolio.
The program shows the best and
the worst and everything in between during the last century. You cannot pick and
choose the time frames to suit your preferences. Allowing this may open the door
to potential abuse of selective-results-presentation to clients. If you want to
know a performance in a particular year, just go to the Chart1 page and move
your mouse over the gray lines.
I’m
not quite sure I fully understand the Annuity Ladder section under the
“Annuity” sheet. (a) When I
press 1, 3, or 5 (or whatever number from 1-6), are you saying that the amount
of $ listed there is the amount of money to be “infused” from an external
source of fund to generate a Lifetime Income SPIA based on the figures I input
under age 60, 70, and 80? (b) Or,
is the amount of money listed there, the money that’s to be “extracted”
from the total portfolio I have listed in the “Main” sheet?
SPIA: (annuity page): Annuity ladder
in the annuity page uses the funds in the account stated on the Main page.
Variable Annuity: User selectable.
When we
"optimize" a portfolio, the spreadsheet shows values and allocations
at age 75. We are not clear why that age appears and is apparently unchangeable?
Also, when we "optimize" a portfolio, we have input a certain initial
allocation (for example 85% equity, 10% FI, 5% IIB). Does the new optimum
allocation start then at age 75, or has that been reset to the very beginning or
the calculations?
When optimizing, the program will
look for an age as close to age of death as possible. If you entered age 95 as
age of death, the program will start there to optimize.
However, if there is no money left in the portfolio at age 95, then there is nothing there to optimize. Then it will automatically reduce the optimization age by 5 years and then look for numbers to work with, and so on. It will reduce the age for which it optimizes the asset mix until it finds numbers it can work with. You cannot arbitrarily change this number. Behind the scenes, it is a complex linear programming process at work.
When you run optimization for the first time, the portfolio longevity will likely be improved from what you have initially entered. This improvement will allow the program to work with an age of optimization closer to age of death. Therefore, after the first optimization, the age of optimization will likely be 5 or 10 years higher than the original "non-optimized" portfolio.
The optimum asset mix allocation always starts at the current age, not some time after retirement or some years from now.
I
am a financial advisor in the U.S. - found your website and have been
devouring your articles. I am ready
to buy the retirement calculator but I'm wondering if you have an explanation
for the following:
On
one of the fund sites, they have a calculator that claims to be based on actual
market history dating back to 1926. Simply
choose one of three asset allocations (Conservative, Moderate, Aggressive) and
the length of retirement, and the calculator spits back a Withdrawal Rate. The
withdrawal rates for the "conservative" portfolio (35%
stocks) are slightly higher (but pretty close) to the sustainable withdrawal
rates that you suggest in your teachings. However,
in every case their rates are substantially higher as you go to
portfolios that are more aggressive. Yet,
in your teaching, you indicate that equities above 40% will actually decrease
the chances of portfolio survival. They claim: “In this calculator,
we create 81 different simulated "time paths" for the evolution
of your portfolio by first assuming that you begin taking withdrawals at a
specific point in history (e.g., 1926, 1927, 1928). We then use the actual,
historical rates of return that occurred in each subsequent year from that point
forward, applying them in sequence to your portfolio as time rolls forward. If
such a path needs to go beyond the year 2006, we just loop back to the returns
of 1926 and cycle forward from there until either your assets are depleted or
the end of your planning horizon is reached. Given the past historical data we
use (returns from 1926 through 2006), we end up with 81 different starting
years with 81 different time paths. The monthly withdrawal amount shown by
the tool is the highest level of spending in which 85% of these historical paths would
have left you with a positive balance at the end of your chosen investment
horizon.”
What
is the flaw in such a calculator? The
typical person who uses this is going to insist on a portfolio of 65% equities
and think they can withdraw 5.25%.
As you
suspected, statistically and mathematically, I believe that this model is
flawed. The loopback assumes that after 2006, we will experience another secular
bullish trend of 1926, meaning that the cyclical bullish trend that started
after the year 2000 crash (which is similar to the 1933-1937 cyclical bull
market) will continue another three years (the loopback years of 1926-1929).
This assumption, converts the current cyclical bullish trend into a secular
bullish trend (that lasts 9 years) similar to 1920 to 1929 trend, ending with
another crash, like the 1929 -1933 crash. Is that possible? I suppose it is
possible. Is it probable? Never in history a secular bull market lasted over 20
years, and this flawed loopback simply makes the secular bull markets of 1982 to
1999 to turn into an unusually long secular trend of 1982 to 2010, i.e. 28
years, ending with a 1929-style crash.
Next: Probability
of depletion used: It appears that they are using 15% probability of
depletion (POD). This is too high. I limit the POD at 10%. Using the actual
historic data, I find that once you cross over the 10% POD, then
irreversible events can happen. There is a big difference in the ability of
salvaging a portfolio to create a lifelong income, when one uses a probability
of depletion of 15% instead of 10%, if you are retired already.
However,
market risk only one of the three risks in retirement planning:
1.
Market risk : which is the probability of portfolio depletion by the age of
death. As stated above, 10% is my limit.
2.
Longevity Risk : which is the percentage of surviving clients at a given age: My
limit is 15%. Which means generally , use age 95 as age of death
3.
Inflation Risk - the withdrawals not keeping up with inflation. My limit is 15%,
i.e. the purchasing power must go below 85% of the requested amount in any
of the portfolios that are subject to rules one and two. (i.e. even if the
criteria for the market risk and longevity risks are met as per stated
thresholds in #1, and #2, the loss of purchasing power must not exceed 15%. This
becomes important when we talk about variable annuities or EIA.
You
are concerned that the typical person might insist on using this seemingly
flawed mathematical model. Please don't be concerned at all. Because you don't
want to have typical clients, you want smart clients who will follow your
advice. The fact that you even noticed and raised this concern proves that your
life, your energy, your time is too precious to waste on clients from Mediocristan.
The markets are designed in such a way that the house usually wins at the
expense of the clients from Mediocristan. If you don't know what this means,
please read the book "The Black Swan", by Nassim Nicholas Taleb, cover
to cover, several times if necessary. You'll know what I mean. Regards, Jim
.