| Issues with existing tools |
| It is widely understood that when preparing for retirement, future retirees have to regularly adjust their retirement portfolios in accordance with their age. More focus has to be placed on avoiding risk than on growing their investment. The general explanation of this phenomenon relies on the natural assumption that older people have less time to recover from possible financial shocks than younger people. |
| A number of rules of thumb propose formulae for asset allocations based on the age of the future retiree. The aging approach to asset allocation is the core idea of target date funds that are very quickly growing in popularity. These funds are designed to make retirement asset allocation easier providing more conservative assets as the investors get closer to their retirement age. Yet,none of the popular retirement planning software products do not provide financial advisors and retirement planners with ways to build from asset classes, to analyze and optimize retirement portfolios with variable asset allocation. |
| How could such discrepancy happen and where do its roots come from? The answer to this question is the absence of effective methodologies and algorithms for solving the optimal dynamic asset allocation problem. |
| Faced with this problem, leading retirement planning software vendors work around it by oversimplifying retirement plan portfolios that they call "optimal". Actually such portfolios are far from optimal because the optimization in this case does not take into account the final retirement goals and produces non-changeable portfolio for the entire retirement phase. This work around simplifies the construction of retirement portfolios but significantly decreases their quality. It can be described as the sequence of three steps: |
| Step 1. Measuring user tolerance At this step, the account owner fills in some form/questionnaire. It includes questions related to the owner’s investment objectives and experience, time horizon, risk aversion, and financial situation. |
| Step 2. Based on information from the questionnaire, a retirement plan portfolio is calculated, where asset allocation remains the same for the entire pre-retirement period (static portfolio). Depending on the particular software product, the resulting portfolio can be an "optimized" portfolio, or a portfolio from a predefined set, or a static portfolio that is built based on some proprietary rules. |
| Software products claiming optimization of retirement portfolios usually use the most basic one-period mean-variance optimization approach, where the risk is directly associated with the standard deviation of the portfolio, not with the actual retirement goal. |
| Step 3. Retirement plan risk valuation. This step applies the Monte Carlo methods to evaluate the risk of success of the retirement goal for the static portfolio obtained in Step 2. |
| As you can see, both Steps 1 and 2 above inherit the pattern used in short-term investing. The asset allocation decision (Step 2) does not take into account the risk valuation calculated in Step 3. Inflation, additional contributions, withdrawal, risk valuation of the planned investment strategy, and the final goals are all ignored during the optimization. Hence the resulting asset allocation is neither efficient nor reliable. |
| Monte Carlo risk analysis that usually takes several seconds to analyze a scenario with the constant portfolio becomes too slow if you want to analyze a variable retirement portfolio. This is another reason why current software products are not designed to support dynamic scenarios of asset allocation. See the Monte Carlo trap none for more details. |
| The modern tendency of delivering software services online requires very effective algorithmic and numerical solutions. Online users do not want to spend minutes and hours waiting for results. |
| Without efficient technology, retirement planning software vendors significantly decrease the quality of retirement planning solutions in an attempt to deliver at least something on time. This explains why many professional retirement planners still do not use professional software products and rely on their home-made approaches, spreadsheets, and rules of thumb. |
| The biggest loser here is the future retiree. She follows the advice of a professional retirement
planner who uses software that delivers low quality retirement solutions. So, while the client loses her money, the
advisor and the software vendors get theirs. Welcome to the today’s world of financial services. |
| The only currently publicly available software that provides the effective solution for variable asset allocation optimization (Retirement Glidepath Optimizer) is currently available online on this site at no cost. It can be easily integrated with any retirement planning software product to provide truly optimal dynamic asset allocation to its customers. The risk valuation of optimized retirement plans is an integral part of the Retirement Glidepath Optimizer. |
| Conclusion |
Today’s retirement planning software products:
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| Absence of these features significantly decreases the quality of the delivered retirement plans. Integrating Retrian’s components solves this problem. |