Practical Applications of Replacing the Failure Rate: A Downside Risk Perspective

Abstract

<h3>Practical Applications Summary</h3> In <b>Replacing the Failure Rate: <i>A Downside Risk Perspective</i></b>, published in the Spring 2018 issue of <b><i>The Journal of Retirement</i></b>, <b>Javier Estrada</b> (<b>IESE Business School</b>) suggests a new metric for evaluating asset allocation and withdrawal strategies for retirement planning. He proposes replacing the widely used “failure rate,” with a measure called the “downside risk-adjusted success” ratio (D-RAS). The failure rate indicates the frequency with which a strategy fails to supply a retiree with a sustained stream of withdrawals for his full retirement period (e.g., to age 95). A shortcoming of the failure rate is that it does not distinguish among strategies based on how badly they fail-that is, by the average number of years that they fail to sustain withdrawals during retirement. By contrast, D-RAS reflects the frequency with which a strategy succeeds in providing sustained withdrawals, the average number of shortfall years when the strategy fails, and the downside variability of failure. A key feature of D-RAS is that is focuses only on the downside variability of a strategy’s performance. Unlike other measures, it does not penalize a strategy for producing upside variability (e.g., large bequests at the end of the retirement period). <b>TOPICS:</b>Retirement, risk management, analysis of individual factors/risk premia