Weekend Links

QUOTE OF THE DAY

Google-Image search him, and you’re likely to see him smirking, with a boarding school-worthy forelock of hair and bow tie that combine to frame a perfect strike zone for your fist.  --Sam Grobart on someone or other...

CHART OF THE DAY

RETIREMENT FINANCE AND PLANNING

How to Get More Pleasure Out of Retirement Spending, WSJ.  … retirement planning is far more complicated than choosing which chocolate to eat. Yet, they do have something important in common: in both instances, we’re trying to maximize the pleasure of a scarce resource.  

Child Labor

From OurWorldInData.com

Highway 12

For all of my two, maybe three, readers: if you missed my "weekend links" last week that is because I was on the road.  US highway 12 to be specific.  Why 12? Well, because when I was a kid, before I94 even existed, US12 was the main (only) east-west highway going through Minneapolis.  It was like a river (had to throw than in for "RiversHedge" sake) flowing west.  When I finally figured out later that it went from all the way from Detroit to the Pacific, that particular fact tweaked my imagination and I decided I wanted to drive it all the way to the end some day, which I did, finally, carbon-shame notwithstanding, last week (except for the DTW to MSP leg which I had already driven). 

I won't describe the entire drive here as a blog post but my advice for anyone that has not seen the US or for anyone that has not gone west of the 100th meridian is to consider the Hwy 12 route/methodology.  This is for several reasons which I will describe here:

Recalling 1987

Yesterday's correction made me think about the 1987 crash especially after I tried to convey the sense of radical shock to my college-age daughter.  I'm not sure I communicated it well so I came back to look at it here.  I told her that I was in graduate school at the time and that we all stood in front of TVs more or less slack-jawed and agog at the "market chart line" that was not just straight down but relentlessly going further down every minute, every hour, every day.  I had a friend that had been in the workforce for a while and had accumulated a decent pile of retirement savings.  He turned to me and said at one point after a couple days (2 days?!) "I think I just lost half of everything I ever saved." Me? I had only pennies to my name so all of this was more or less abstract to me but I could feel the fear emanating from those around me.  On the other hand it all turned out ok so I guess that was the real lesson rather than "the world was ending" or as a trading mentor later told me in 2009 "the American economy is NOT going out of business" which is why I feel like I can afford to be a little blasé about these assertive moves that come and go over the years.  

Just for fun, though, and I don't think I got the scale right, but this is what it looked like, 1987 on the left, 2016 on the right.

On the Virtue of Risk Management Rules

About 10 years ago I gave over my trading to a systematic, rules based approach.  That helped turn the corner for me on trading i.e., from loser to profitable.  Fear and greed yielded to zen-ish disinterest and the impact of individual trades became only mildly interesting to me as a vague concept that was somehow related to the marginal economic impact of risk/return on a continuous trading system or a perpetual trading "machine."  I was reminded of the benefits of rules-based systems again today.  Since I run a strategy that shorts volatility by selling options on futures -- what I call a type-2 system: probability rich but with inverted risk return -- I tend to have high probability trades that are exposed to enormous risk for any given dollar in expected profit.  This week I happened to have a short put on the e-mini (ES) S&P futures Sep16 contract.  The strike was 2135 and at the time the trade was opened I believe that the option strike was > 2 standard deviations from the price level prevailing at that time (depending, that is, on one's assumptions about volatility and fat tails and such) so probability was in my favor, all else being equal.  All else was not equal because the market knew I was going out of town (ok, I don't really anthropomorphize the market and I take responsibility for my own trading decisions and risk...but this is a blog...) and decided to school me in risk just for the hell of it.  This is what it looked like today (as of 4pm ET). Keep in mind that low-probability-of-being-reached 2135 strike:

Now, without rules this would have been agony and as it was it wasn't all that much fun to have my expectations broken but at least I didn't get taken to the cleaners and the loss didn't bother me all that much. A 2:1 or 3:1 inverted risk:return realized via a rule could have turned into something like 20:1 and ruined my trading machine which I kind of want to keep around for a while.  So, the rules are the key -- and here it really doesn't matter what they are: chart based, premium based, indicators, whatever -- because they allow one to detach and dispassionately pull the safety triggers when all hell is breaking loose.  If it's a system, follow the rules.

Weekend Links

QUOTE OF THE WEEK

Most of the best financial decisions are slightly uncomfortable at the time you make them. -Ben Carlson


CHART OF THE WEEK

RETIREMENT FINANCE AND PLANNING

Prepare for the Rising Cost of Living in Retirement, US News. the average annual inflation rate since the government started keeping track in 1913 is approximately 3.2 percent. That doesn't sound too bad until you realize that at that rate, prices will double every 20 years. The fact is that everything will be more expensive and that needs to be factored in when determining how much you really need to save. 

How Much You Should Spend In Retirement Depends On How LongYou Think You’ll Live, Retirement Researcher (McDonald).  Using the RMD rules to set withdrawal rates for each year of retirement presents a viable alternative to using constant inflation-adjusted withdrawal amounts.  

Recommended Assumed Annual Rate of Investment Return LoweredAgain, Ken Steiner.  Based on the data in the table above, I have decided to lower my recommended discount rate and inflation rate by 0.5% to: Recommended discount rate: 4.0% Recommended inflation rate:2.0%  

One View of Simulated Return-Sequence Risk

I thought I'd take a quick look at what sequence risk looks like in my simulator.  To do that I compared the compound annual geometric return for the first 10 years of simulated return data to the simulated end state terminal wealth (net of consumption) in terms of the compound annual growth rate for the number of years lived in the model.[1]  I ran 10,000 simulations. It looked more or less like this:

This was not an "everyman" or every-person type analysis, though.  This was a custom simulation tuned to some particulars I happened to be looking at.  Assumptions of note included:

-Age 58 start with stochastic longevity within a Gompertz distribution (87.5/9.5).
-Constant spend with probability based step-downs at age 68 and 85
-Spend rate of initial step is unusually low (<=3%)
-Inflation random, bootstrapped off history
-Stock/Bond returns random, boostrapped off history[2]
-Stock/Bond Return Correlation
-Allocation: 60/40 stocks/bonds, 70/30 tbills/tbond
-.6% fees and simulated tax drag
-Longevity capped at 105
-Tactical suppression of near term (10 years) returns

The fail rate, for what it's worth, was 4.1%.[3]

Weekend Links

QUOTE OF THE DAY

Sometimes to understand more, you need to know less.  

     -- 1483, Sir Thomas Lemuel Hawke of Cornwall, 20 Rules for a Knight

CHART OF THE DAY

RETIREMENT FINANCE AND PLANNING

The Intertemporal Persistence of Risk Tolerance Scores, Grable, Heo, & Kruger.  The results from this study suggest clients’ financial risk tolerance attitudes, as measured by a valid and reliable test, exhibit some degree of persistence over time. This finding aligns well with similar reports by Gerrans and his associates (2015) and Guillemette and Finke (2014). Findings also provide support for the notion that financial risk tolerance is much more akin to a trait than a passing emotional disposition (Eysenck and Eysenck 1977), and that previous criticisms of risk tolerance tests in general may be overstated.  

The Perils of Early Retirement.  RetireBy40.org I’ve been retired only 4 years and I’m already skeptical about the 4% SWR.  

Should You Plan On Your Retirement Lasting 30 Years Or 40?  Pfau at Forbes.  “What possible sense does it make to tell your client that she can spend more money now because you’re assuming in some of the Monte Carlo iterations that she’ll die early? How does a person die ‘some of the time?’”   

On Hacking Out A Home Brew Version of Interactive Brokers Probability Lab

I trade options every now and then for a variety of reasons and I often use Interactive Brokers to execute.  They have a relatively new (late 2013) feature called the Probability Lab.  I like, but don't exactly love, their implementation and even if I did I probably would not need it to be super precise for what I personally do since I am not trying to land a manned-module on the moon,  I am just trying to sell a few options here and there and I am trying to get the expected value of my trades as high as I can get and my risk as low as I can go per dollar of return.  While they (IB) seem to have a great thing going and it is probably helpful to the people engaged in complex combination trades it sometimes bothers me that I can't extract their data to do my simple thing on my own  (I like to do things myself). So, a few weeks ago I thought I'd try to hack out my own version to see if I could even get close.  My main goal was just to see if I could do it while my secondary goal was to add another tool to the tool belt that helps me manage finite resources for my family over an uncertain future without being beholden to someone else's black box.