Improving the Outlook for a Successful Retirement: A Case for Using Downside Hedging

Abstract

Successfully translating an investor's savings over a lifetime into a reliable source of sustainable income in retirement is a daunting challenge. Indeed, for millions e x H i B i t 1 0 Costless Collars: Comparison of the Downside Risk for a Traditional and Hedged Strategy 65-Year-Old Male and 15% VolatilityNote: The analysis assumes the retirement portfolio is invested in assets with a 6% real return and 15% volatility. The returns are collared with the purchase of a 12-month put option with a strike price of 0.95 and the sale of an appropriate call option. The individual retires at age 65 and begins withdrawing funds at the noted initial spending rate per year adjusted for inflation. The analysis ignores taxes and transaction costs. Mortality is modeled with a Gompertz-Makeham fit to the Social Security Administration's 2005 Period Life Exhibit. Note: The analysis assumes the retirement portfolio is invested in assets with the depicted expected real return and volatility. The returns are hedged with the purchase of a 12-month put option with a strike price of 0.95. The individual retires at age 65 and begins withdrawing funds at the noted initial spending rate per year adjusted for inflation. The analysis ignores taxes and transaction costs. Mortality is modeled with a Gompertz-Makeham fit to the Social Security Administration's 2005 Period Life Exhibit.