Book Review: Conserving Client Portfolios During Retirement by William P. Bengen

Big bucks but big bang. Conserving Client Portfolios During Retirement costs $65 USD but does it ever deliver value. Both the content and the presentation are superb. Bengen applies his experience as a financial planner working with real individual people to thoroughly cover the many aspects of making investment money last through retirement. He does the work of an author brilliantly, which is to be clear about assumptions and methods, state caveats and limitations but then to digest and distill the data. The result is a compact 165 page small format large print volume with dozens of tables and graphs. Those illustrations are the condensation of what he says believably are thousands of hours of calculation work. The prosaic title (the chapter headings are the same) characterizes the writing style - plain and direct but crystal clear. There is nothing fancy about the book - no jokes or coy titles, no famous quotations, no hot tips or investor alerts, no sidebars or key points summaries. You could say that it is all steak and no sizzle, except that the content itself sizzles.

The Content: Bengen's book is about the narrow but critical topic of how to get the most withdrawal cash out of an investment portfolio without exhausting it prematurely. His fundamental assumption is that the past is the best guide for the future. Using US index data for stock, bond and Treasury bills from the Ibbotson yearbook from 1926 onwards, he systematically tests how well all sorts of portfolios and strategies would have fared. The key metric is what he calls SAFEMAX - the maximum annual withdrawal as a percentage of the portfolio at start of retirement that would have ensured portfolio survival no matter what year retirement started.

The Bengen Variations (somewhat akin to Bach's Goldberg variations): these are all the conceivable options taken in turn to see what effect each has on the base case withdrawal rate of 4.15% (yup, he states two decimal points - is it obvious he started his career as an engineer?)

• asset allocation - varying proportions of asset classes - large company stocks, small company stocks (can boost SAFEMAX up to 4.55%, a 0.4% gain), intermediate term US government bonds, long term government bonds (don't help at all) and US Treasury bills (can substitute for the intermediate bonds)
  
• time horizon - in five year increments from 10 years to 50 years (a forever portfolio can sustain 4%)
  
• reduction in safety (frequency that portfolio would not have survived and shortest longevity) from higher withdrawal rates up to 8.75%, where he cuts off around a portfolio has only a 50-50 chance of surviving the target duration
• alternative withdrawal strategies - 1) withdrawing more during early active retirement years instead of a constant inflation-adjusted amount throughout (not very attractive as the later year penalty is too great); 2) fixed percentage of the portfolio every year (looks unattractive due to large variations in withdrawals); 3) floor and ceiling withdrawal amounts to take less during bad years and more during good times (looks pretty good)
• active investing out-performance and under-performance by + or - 2% per year (really gives pause to think whether any but the passive index approach is worth pursuing)
• how much to lower withdrawals in order to leave a legacy
  
• value of reducing equity allocation during retirement (not worth it)
• making adjustments to withdrawal rate during retirement (it's essential to monitor and adjust if things get too bad and it's possible to boost the safe rate as you get older and life expectancy declines) but ...
  
• bear markets "... the intervention of a major bear market does not have to undermine a client's previous plans for withdrawals during retirement, assuming he initially planned to withdraw at SAFEMAX."
• taxation of the account - using accounts whose effective tax rate was zero (the base case, like a RRIF), 20%, 35% and 45%; the tax Engen computes would be coming from inside the account, taken out of the portfolio before withdrawal
• historical fall in dividend yields from rates above 5% up to the 1950s to about 2% in recent times (don't worry, makes no difference)
• withdrawing once a year or every quarter
• retiring date and withdrawal start at beginning of year or at beginning of various quarters - " ... a difference of only one quarter in the date of retirement can have a major effect on the longevity of a portfolio"
  
• rebalancing frequency from every three months to almost 12 years (about every four years seems best)
• whether or not to shift asset allocation (e.g. more fixed income) in anticipation of upcoming retirement (read it and find out!)

The final chapter sets out three case study scenarios based on Bengen's experience dealing with his clients, showing the actual application of the principles. Due to quite different life goals, like travel, donations, inheritances, the recommended initial withdrawal rates vary considerably from and seem to be appreciably higher from the base case 4.15%. Yet Bengen obviously thinks these would work ok since he insists on the importance of leaving a substantial margin of safety in choosing how much to withdraw. There is one improvement to this chapter I'd like to see: instead of calculating a future model portfolio value using average past returns for every year, Bengen should show what happens in the worst case scenarios of past markets. People who see a projected portfolio that continues to rise in real terms with steady 8.3% in returns every year might scale back their initial withdrawal rate considerably if they see that a severe bear market combined with high inflation, such as happened in the 1970s, could bring them close to portfolio exhaustion.

Another caveat is that actual investment returns modeled on indices such as the Ibbotson data used in this book, cannot and will not be achievable. Bengen does not name any mutual funds of ETFs an investor could actually buy. Though the costs of running the mutual funds and ETFs will theoretically lower their returns by that amount and cause them to systematically under-perform the index, it seems that some funds like the Vanguard Small Cap ETF actually outperform the index (see Seeking Alpha's Indexing: Mutual Funds vs. ETFs and Beating The Benchmark). So it's hard to say absolutely that using index returns is an error.

Many mutual funds, especially those in Canada with outlandishly high fees, are wont to seriously and continuously under-perform. Bengen's chapter 7 on chronic under-performance from active management gives us a way to estimate the penalty - e.g. a 60% equity portfolio with a 30-year horizon would have to reduce the withdrawal rate by 0.3% to compensate for a 1% decrease in average stock returns.

A Canadian investor trying to emulate the same investment approach with the TSX index and Canadian bonds might not be able to achieve exactly the same returns. We could not thus expect to set a sustainable withdrawal rate quite as high as Bengen describes for US investors since Canada's real returns on equities and bonds have been slightly less than the USA's over the period 1900 to 2008 per the Credit Suisse Global Investment Returns Yearbook 2009 by Elroy Dimson, Paul Marsh and Mike Staunton.

Another limitation, which he admits freely in the book, is that other asset classes now available were excluded from the analysis due to lack of long term historical data. He does say that he believes those additional types of assets probably would benefit retirees' portfolios but they are not modeled.

A final caveat is that the scenarios assume that other sources of income, notably annuities, are taken as a given, but in fact, a key choice for a retiree is how much of a retirement account to annuitize, as Moshe Milevsky points out in his recent book Are You a Stock or a Bond? A portfolio does not stand alone as a source of returns, inflation protection or reduction of income variability.

The book is addressed to financial advisors but every individual intending to manage their own investments in retirement will benefit enormously from buying it.

My rating (à la Bengen): 4.83 basic plus 0.17 boost for the many blog post ideas it gave me = 5.00 out of five stars

Postscript: Bengen is a fee-only advisor. When I sent him an enquiry form on his website to ask about some aspects of the book, within an hour he sent an email saying I should phone, which I did and lo and behold, he was there and took my call. If he does that for a lowly blogger I bet his clients are happy, not to mention well-served by the application of the knowledge in this book.