samedi 24 février 2018

ADD Strategy - A ruin free Accumulation-Dynamic Decumulation strategy

Ever wonder if it was possible to remove the ruin risk from your decumulation strategy? The safe withdrawal 4-4.5% is based on historical data only. If the future is worst, the "safe" % will become your ruin. Instead various other withdrawal strategies lets you avoid that risk entirely.
The easiest to implement this is the constant % withdrawal strategy. It lets you take x% per year out of your fund instead of only looking at the initial value. The downside is high withdrawal volatility.
I've created a new withdrawal strategy that allows you to harness the power of constant % withdrawals while lowering the volatility. Please consider the Accumulation-Dynamic Decumulation for your withdrawal strategy. It may allow to retire earlier if you are willing to switch the risk of ruin for a risk of withdrawal volatility.

Please consult the full study for more details.

Here's a nice graphic of what the decumulation looks like through various date at "6.5% ADD withdrawal rate using 100% equity"

As you can see it's way more stable (nominal terms) than other method. The straight line are due to unfavorable, but substainable level. For most, instead, we see a nice upward looking with various curvature. None show the typical high volatility withdrawals that Variable Percentage Withdrawals(VPW) and other shows.

Comparions for VPW:

Comparions for Constant % withdrawals have a similar shape but with less growth near the old age:

Executive summary

Study of an Accumulation & Dynamic Decumulation (ADD) strategy. The strategy is based on dynamic percentage which is applied on current Asset instead of the Safe Withdrawal Rule (SWR) which is applied on Asset as Date of Retirement (DoR). By construction, ADD removes the possibility of ruin. However, it creates the risk of volatile withdrawal not linked with general inflation. The risk management focus is switch to manage these volatilities.

Three strategies to reduce the volatility of withdrawal are used in the ADD strategy.
·         Smoothing
o    This is a well establish method in the DB pension world. It can be naively explained as taking the moving average over 5 years. The advantage is to have a lower the volatility and assess more prudently the fund. It has the effect of delaying the impact of short term gains/loss, hopefully taking advantage of any reversion to the mean.
·         Increase Cap
o    Since we take a percentage of the fund each year, exceptional returns would also imply exception increase in withdrawal. Instead, we cap the increase to a maximum versus the previous withdrawal.
·         Capital Reserve
o    This technique set aside money for economic hardship. The reserve will fund the gap between 95% previous withdrawal and current withdrawal. The reserve would kick-in to fund the deficit. In economic good times, the reserve grows. The 5% gap can be seen as a bonus. Bonuses are not guaranteed. They only are often paid.

Here are the main results of this study:
1-       Ruin risk is removed with ADD strategy. None should face the risk of being destitute in retirement.
2-       ADD strategy is self-adjusting its withdrawal if conservative or optimistic assumption are used.
3-       Sequence of withdrawal is meaningless in a fully variable withdrawal. With ADD, the risk is reduced.
4-       Increase cap remove the issue of hyperinflation ruin risk. ADD mitigate hyperinflation risk in withdrawal.
5-       Smoothing reduce volatility of market on withdrawal.
6-       ADD reduces the retirement projection volatility.

In this paper, the ADD strategy will be shown to allow more than 40% more retirement withdrawal at retirement for less risk. During the 40 retirement years, the ADD strategy will be shown to allow for more than 60% increase on the total cash flow. This is possible by allowing some (about 1%) possibility to have to reduce future withdrawal by more than 90%.

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