Retirement Planning: The Volatility-Adjusted Coverage Ratio

The important decisions that retirees have to make to try to achieve their financial goals during retirement often stem from models used by financial planners. Despite the important role it plays in many of those models, the failure rate has several limitations and many alternatives have been proposed. This article introduces a new metric, the volatility-adjusted coverage ratio, which incorporates the benefit (the coverage ratio) and the cost (the volatility of the portfolio) of the strategies considered. Application of this new metric, which improves upon both the failure rate and the coverage ratio, is illustrated by determining the optimal asset allocation, for several initial withdrawal rates, for twenty-two global markets. The overall results show that maximizing the volatility-adjusted coverage ratio typically yields optimal asset allocations that are, first, more conservative than those stemming from maximizing the coverage ratio or the expected utility of the coverage ratio; and second, more consistent with those featured by target-date funds.