William Sharpe, 72, emeritus professor of finance at Stanford
University’s Graduate School of Business, won a Nobel Prize in
1990 for
his
contributions to the theory of financial
economics. He later helped
launch Palo
Alto, Calif.-based
Financial Engines, which provides
sophisticated portfolio and
401(k) analyses to individual investors.
Now he is turning his
attention to what
he calls "retirement
economics"—originally,
he says, a play on words reflecting
an
appropriate pursuit at
his age–and the question of whether the influx of
retirees in the
decades ahead will drain the U.S. economy. Sharpe spoke
with
Worth staff writer Elizabeth
Harris about measuring
future happiness while contemplating
mortality.Isn’t a $50 million account the same $50 million whether you are
young or old?  The first thing that makes the
retirement problem quite different from other financial concerns is that there
are differences in what I call "personal states." For example, I could be alive
and in fairly good health, or alive but in such poor condition that I reside in
a skilled nursing facility, or I could be dead. So that’s three. Wealth means
different things to me according to my personal state.
Economists use a concept called "utility functions" to
summarize how you think about money. You talk about what utility I will get from
my money in 2016. You try to measure how much happiness it gives me today to
contemplate the fact that if I’m alive in 2016, I’ll have a certain amount of
wealth. You are going to make some decisions today that will determine, in part,
how much money is going to be available to you, to your spouse, to your heirs,
in whatever personal states you may find yourself in the future. It requires
that you bring together a whole spectrum of considerations, from insurance to
investment planning. It’s always good to hear a dismal scientist talking about how to
measure happiness. Have your personal demographics contributed to your interest
in retirement economics? Well, yes. I wanted software to
figure out my needs, but nobody has provided it. By the time we got Financial
Engines to the point where it could really help people in their 40s or 50s, I
was in my 60s. The rule of thumb for withdrawal rates in retirement is that you
can conservatively spend 4 or 5 percent per year. This is inexact. Why haven’t
academics offered any alternatives? Probably because productive
academicians are young, at least from my vantage point. Their students are even
younger. It is partly a matter of what attracts one’s attention. Moreover, the
practical importance of dealing with these issues has increased relatively
recently. In the old model for handling retirement via social security and
defined benefit plans, your retirement income was mostly or completely insured.
You were guaranteed a level of income no matter how long you lived. But we now
rely more on 401(k) plans. The majority of people with such plans take lump-sum
distributions at retirement and bear the risk that they may outlive their
assets. But unless you are as happy to have your kids spend your money as to
spend it yourself, it may make good sense to buy an annuity with some portion of
your wealth. An interesting question is this: Why did we as a society think that
people should get annuity incomes from public and private retirement plans, only
to find that when we gave people a choice, they mostly chose to bear the
longevity risk themselves?
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