Field Work

Retirees: Focus on the Monthly Check

To help retirees choose the best way to spend down the 401(k) savings they have built up over a lifetime, Nobel Prize laureate William Sharpe urged them to focus on a single outcome: the size of their monthly check.


This video was created by Professor William Sharpe of Stanford University.

Financial advisors should say to their clients, “Don’t worry about the strategy or model. Look at the outcomes that matter: what you can spend year by year in retirement,” he said.

Speaking at a conference this week at Boston University’s School of Management, which brought financial practitioners together with top minds in academic finance and Washington think tanks, Sharpe said advisors should present clients with various payout schedules and then explain the probability of success for each one they’re considering.

A professor at Stanford University, he said the challenge for today’s retirees is that Wall Street is increasingly churning out highly complex new products to attract the 10,000 baby boomers retiring every day.

“An awful lot of stuff is being thrown at the wall,” he said. “This is my new work: to help the investor differentiate from a huge profusion of products and services.”

Sharpe used annuity-like products currently on the market to demonstrate this approach, illustrating it with a thicket of probability tables for each product.

Fidelity Investments’ Income Replacement Fund, for example, attempts to create regular monthly benefit checks that keep pace with inflation. The mutual-fund-like product has the advantage that money can be taken out at any time – unlike annuities, which are extremely unpopular among retirees because they force them to surrender their money permanently to an insurance company.

But Fidelity offers no guarantees. So the financial advisor can plot, over 30 years, the chances each year that the client will receive the benefit check he or she expects. For example, there is a 90 percent probably of receiving one dollar benefit, and an 80 percent probability of receiving a smaller one. Because the portfolio moves from more stocks to more bonds as the retiree ages, the planner can also show how the variability decreases in a retiree’s later years.

Another example, Vanguard’s Managed Payout Fund, generates monthly benefit checks that reset each year. Sharpe said Vanguard attempts to stabilize the size of each monthly check by basing benefits on a three-year, rolling average of the portfolio’s performance. This strategy resembles one used by foundations to determine their annual payouts. Again, financial planners can calculate probabilities to help their clients decide which tradeoffs they’re willing to make.

Sharpe’s PowerPoint, as well as materials and papers provided by other conference speakers, are available here.

One Response to Retirees: Focus on the Monthly Check

  1. Marc says:

    This is best you can do?

    You give someone a schedule of their probabilities of running out of money? You feel this is acceptable?

    If you were boarding a plane for another country, what probability would you think is acceptable for getting there alive? Is 85% or 90% probability of living OK with you? Why should it be OK for retirees?…

    I expected better from a university. Clearly I expect too much.