Faculty Retirement
Briefing
Prepared by
Dale Rude
Department of Management
drude@uh.edu
Disclaimer
 The
purpose of this presentation is to
provide University of Houston Faculty
with educational information about
investing.
 The underlying assumption is that if
you provide smart people with useful
information, they will make good
investment decisions.
 The presentation is not endorsed by
the University of Houston.
Four Important Questions for
Faculty
 How
long will I live?
 Where should I invest my retirement
money?
 How much money do I need?
 What is risk? What kinds of risk do I
face? How can I manage them?
How long will I live?
 At
age 65, one’s probability of living
until
– Age
Men
 70
0.89
0.85
0.55
0.34
0.15
 75
 80
 85
 90
Women
0.93
0.90
0.67
0.49
0.27
How long will we live?
 For
a same-aged couple at age 65,
the probability of one or both living
until
– Age
 70
 75
 80
 85
 90
Probability
0.99
0.98
0.85
0.66
0.38
Where should I invest?
Part II
 The
work of two Nobel prize winners
in economics (and a likely future
winner) guide these efforts:
– Eugene Fama, 20__?
– Harry Markowitz, 1990
– William Sharpe, 1990
Eugene Fama: The Creator & King
of the Efficient Market Hypothesis
Joke Told by Economists
 After
an economics class, an A
student and a C student are walking
out together.
 A $20 bill is laying on the floor
outside the class room.
 Which (if any) will pick it up?
 The
C student. The A student knows
the market is efficient and that a $20
bill would have been picked up
already.
A Metaphor for Actively Managed
Mutual Funds
 We
have a map telling us where the
$20 bills can be found. No one else
has the map nor can see the $20
bills. The $20 bills are automatically
replenished.
I-45 in Advance of Hurricane Rita
From Malkiel (2005): Reflections
on the EMH-30 Years Later
Implications
 It
is extremely difficult to beat the
stock market long term because
there is intense competition among
investors.
 Consistently beating the market
requires knowing something that
other investors don’t and keeping it a
secret.
 Index funds are a useful way to
invest.


"It's amazing how difficult it is for a man
to understand something if he's paid a
small fortune not to understand it."
- John C. Bogle< retired CEO of Vanguard
The Little Book of Common Sense
Investing
Which funds should I invest in?
Harry Markowitz-Creator of Modern
Portfolio Theory and Winner,
1990 Nobel Prize in Economics
Modern Portfolio Theory
 For
different age groups, MPT
informs investors how to use
diversification to optimize their
portfolios.
Advice to Faculty
 Use
modern portfolio theory to guide
placement of funds into low cost
index mutual funds.
 Target date funds are an easy way to
invest using modern portfolio theory.
(Fidelity allows access to Vanguard
and Fidelity target date index funds
through its BrokerageLink.)
Recommendations from Princeton
Economist Burton Malkiel
Vanguard Target Date Fund
Asset Allocations(3/31/2011)
– Year
–









2015
2020
2025
2030
2035
2040
2045
2050
2055
Stocks
Bonds
58.4%
66.4%
73.9%
81.5%
88.9%
90.0%
90.0%
90.0%
90.0%
41.6%
33.6%
26.1%
18.5%
11.1%
10.0%
10.0%
10.0%
10.0%
Short-Term
Reserves
0.0%
0.0%
0.0%
0.0%
0.0%
0.0%
0.0%
0.0%
0.0%
Fees Are Critically Important: The
Case of the Average Assistant
Professor at Doctoral Institutions
The average new faculty member is
making $65,424/year (Chronicle of Higher
Education).
 Assumptions:

–
–
–
–
–
15% of pay is saved for retirement
3% annual inflation
1% merit increase per year
35 year career
The market is efficient and returns 10%. Index
funds are best.
The Impact of Mutual Fund Fees
Annual
 Fee
Total $
Annual Ret.
At Retirement Income
(5% draw)
 .2%
$4,346,113
$217,305
– (.2% is fee for many index funds.)
 1%
$3,523,080
$176,154


2%
$2,872,047
$143,602

3%
$2,355,796
$117,789
How Much Money Do I need to
Save for Retirement?
William Sharpe
1990 Nobel Prize in Economics
Financial Engines
 This
application was developed by
Sharpe and his colleagues. It uses
Monte Carlo simulations and
historical data to estimate the
chances of running out of $ using
varying investment strategies and
withdrawal rates.
A Student Version of
Financial Engines
 This
simulation is built in Excel.
 For the example:
– Investment is $1 million.
– Portfolio is 50% in stocks and 50% in
bonds.
– Withdrawal rate: 5%.
– Inflation not included.
The Results
 The
simulation is run 250 times.
 With this portfolio and withdrawal
rate, one has an estimated 90.9% of
not running out of money.
 Estimated amounts left at the end of
25 years:
– Mean
$ 2,105,000
– Median
$ 1,651,000
– Maximum $11,603,000
Monte Carlo Simulation
$14,000,000
$12,000,000
$10,000,000
$8,000,000
$6,000,000
$4,000,000
$2,000,000
$0
1
($2,000,000)
2
3
4
5
6
7
8
9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25
A More Sophisticated Version of
Financial Engines Is Provided by T
Rowe Price


https://www3.troweprice.com/ric/ric/publi
c/ric.do?src=Media_Near_or_In_Retireme
nt&scn=Tools
(Go to www.troweprice.com and search
for retirement income calculator.)
Daniel Kahneman
2002 Nobel Prize in Economics
Prospect Theory
 Every
day is a new day and we start
at zero.
 Losses hurt more than gains feel
good.
 These cause us to be overly sensitive
to losses and to be loss averse.
How to Handle Losses: Prospect
Theory Implications for Sticking to
Your Investment Plan
 1)
When the market is going down,
do not look at balances.
 2) If you do look, aggregate losses
by thinking of total sum of losses.
 3) Think of losses relative to net
worth.
What You Can Do
 Review
your own retirement
investments and encourage your
colleagues to do so, as well.
Useful Books
Ferri, Richard (2006). All about index
funds. New York: McGraw-Hill.
 Malkiel, B. G. (2003). The random walker
guide to investing. New York: W. W.
Norton and Company.
 Malkiel, B. G. (2011). A random walk
down Wall Street (10th edition). New
York: W. W. Norton and Company. This is
a challenging read for the novice investor.
 Stanley, T. J., &, Danko, W. D. (1996).
The millionaire next door. New York:
Pocket Books.
