Distinguished Professor Emeritus Peter Forsyth, Professor Ken Vetzal from the School of Accounting and Finance, and Graham Westmacott, portfolio manager at PWL Capital, have received the 2021 Brockett–Shapiro Actuarial Journal Award from ARIA — the American Risk and Insurance Association.
The prestigious annual award, which is conferred for the most valuable contribution in risk management and insurance, recognizes “Management of Portfolio Depletion Risk through Optimal Life Cycle Asset Allocation,” a paper they published in the North American Actuarial Journal in 2019.
With increasing longevity coupled with uncertainties in market returns, government benefits, and the rise in the cost of living in the years to come, many retirees are understandably concerned they may outlive their money. Known as portfolio depletion risk — the chance of running out of your retirement savings — this is particularly a concern for retirees with defined contribution pension plans because such pension holders typically use their accumulated savings to fund spending during their retirement.
The need to have retirement savings last is all the more urgent because many employers have shifted to offering defined contribution pension plans to their employees. Depletion risk is of concern to all retirees, but the risk is greater for individuals who have defined contribution pension plans.
In their award-winning paper, Distinguished Professor Emeritus Forsyth and his coauthors examined how investments can be managed by people with defined contribution plans to give them a reasonably close approximation to the retirement spending available to those in a defined benefit plan. To this end, they explored optimally investing and spending savings during retirement — or the life cycle asset allocation problem as it is known to actuaries. The authors developed a parametric stochastic model of stock and bond returns, based on almost a century of data, and then used dynamic programming to determine the optimal investment strategy. This strategy was then tested out-of-sample by block bootstrapping the historical data.
The idea is to die almost penniless, but not because the person has not planned for retirement. Rather, the goal is to have just one cent left in the retirement investment account when the retiree has passed on, or to have some amount available left as a bequest.
“By strange coincidence, I find the topic of optimally investing and spending during retirement to be of great personal interest,” said Distinguished Professor Emeritus Forsyth. “The optimal strategy here turns out to be of the contrarian type — to sell bonds and buy stocks when the market goes down, and to sell stocks and buy bonds when the market goes up. “
Distinguished Professor Emeritus Forsyth put his hypothesis to the test during the COVID market crash by selling bonds and buying stocks in April 2020. He convinced his spouse, a professor of economics, to do the same.
“After stocks rallied, I sold stocks in October 2020,” Professor Emeritus Forsyth said. “However, this time, my spouse stayed pat in stocks, noting the positive momentum signals. She sold stocks in June 2021 and her portfolio vastly outperformed mine.”
The Brockett–Arnold Shapiro Journal Actuarial Award comes with $1,000 to be shared equally among authors. The awardees will be recognized at this year’s ARIA annual meeting, which takes place virtually from August 2 to 4, 2021.
Established in 2010, the Brockett–Shapiro Journal Actuarial Award is conferred to the authors of a paper published two years earlier in either the actuarial journal Variance or in the North American Actuarial Journal.
To learn more about this research, please see Peter A. Forsyth, Kenneth R. Vetzal, Graham Westmacott. Management of Portfolio Depletion Risk through Optimal Life Cycle Asset Allocation. North American Actuarial Journal. 2019, 23:3, 447–68. DOI: 10.1080/10920277.2019.1570469
A preprint version of the paper is also available at https://cs.uwaterloo.ca/~paforsyt/lifecyle_risk.pdf.