No Reason to be so Conservative, Dr. Pfau

In
his Rethinking 65 article, Slow and Steady Wins the Retirement Funding Race, Ed Prince outlines Dr. Wade Pfau’s “conservative formula for
guiding clients to a secure retirement.” Dr. Pfau’s approach is
essentially the same as the Actuarial Approach recommended in this
website, with one fairly significant difference—it assumes all household
investments earn the same conservative bond-like rate of return. And
while you can change the default assumptions in the Actuarial Financial
Planner to accomplish this same level of conservatism if you like, we
believe higher assumed rates of return on risky investments/assets can
be justified. 

How our approaches are similar

They are much more similar than they are different. 

• We
  both determine our funding metric by dividing the present value of
  household assets by the present value of household spending liabilities.
  He calls the resulting metric the Funded Ratio, we call ours the Funded
  Status. 
• Consistent with the economic concept of Liability
  Driven Investing, we both separate household essential and discretionary
  spending and encourage households to fund essential expenses with
  non-risky assets and fund discretionary expenses with riskier assets.
• We
  both encourage households and financial advisors who use the approach
  to consider the amounts and timing of all expected expenses, either
  recurring or non-recurring.
• As discussed in our prior post, the metric is self-correcting over time and has guardrails.

How our approaches are different

We
provide an Excel spreadsheet in our website for households and
financial advisors to use to calculate the present values of assets and
liabilities.

We provide default assumptions in the spreadsheet for:

• Lifetime
  planning periods for both spouses (and for the period the couple is
  expected to be “either alive” or “both alive.” This enables households
  to determine the present values of recurring expenses after the expected
  first death within the household.
• Inflation
• Investment return on non-risky investments
• Investment return on risky investments

We
also provide opportunities within the spreadsheet to input different
rates of future increases in items not assumed to grow with inflation.

All
the assumptions can be overridden to better suit user preferences, with
the biggest difference being able to input more aggressive assumptions
for funding of household discretionary expenses based on the assumption
that riskier assets may be expected to earn higher rates of return in
the long-run.

Summary

While Mr. Prince
indicates that Dr. Pfau acknowledges that his approach is not for
everyone because it is so conservative, we believe that the Actuarial
Approach, with its increased flexibility and robustness, is a reasonable
approach that can be used for/by any type of investor/household.