Weekend Links - Fri Nov 4, 2016

QUOTE OF THE DAY

The future always will be uncertain. With the progression of time, the expected outcome is overruled by the realized outcome. Goals evolve. Longevity expectations change. Returns are realized—above or below prior expectations. In reality, we must adapt to new information. Recourse decisions are made in the future based on information that becomes available only in the future. -- Peter Mladina

CHART OF THE DAY

RETIREMENT FINANCE AND PLANNING

Retirement Income Showdown: Risk Pooling vs. Risk Premium, Wade Pfau; ssrn.  Abstract: The retirement income showdown regards finding the most efficient approach for meeting retirement spending goals: obtaining mortality credits through risk pooling with an income annuity, or investing for upside growth through the stock risk premium. Analyzing the question involves understanding how clients view a hierarchy of retirement goals related to spending, liquidity and legacy. Client attitudes toward longevity risk aversion also matter: how fearful is the client of outliving their investment portfolio? Risk pooling offers a unique source of returns not available from an investment portfolio: those in the risk pool who experience shorter lives subsidize the payments to those in the pool who experience longer lives (mortality credits). Risk pooling may provide a cheaper way to meet a spending goal, leaving more assets to cover contingencies and support legacy. The primary advantage of an investments-only strategy is that it can support greater legacy in the short-term compared to a partial-annuitization strategy that uses risk pooling to meet spending goals and investments to meet liquidity and legacy goals. Risk averse retirees, though, may feel obligated to earmark a larger portion of their portfolio to spending goals, which leaves less true liquidity, while also exposing the spending goal to the risk of portfolio depletion. The advantages of risk pooling include a contractual guarantee to support lifetime spending, the ability to meet spending goals with a smaller portion of assets that creates greater true liquidity for the retirement income plan, and the potential to support a larger legacy in the event of a long life. 

Health Care Costs Taking a Bite Out of Retirement Savings, NAPA.net.  The increasing cost of health care seems to be coming out of retirement’s pockets, according to a new survey. According to the 2016 Health and Voluntary Workplace Benefits Survey (WBS) conducted by the non-partisan Employee Benefit Research Institute (EBRI) and Greenwald & Associates, half of all workers report having experienced a health care cost increase in the past year, and of those, more than a quarter (28%) state they have decreased their contributions to retirement plans. 

Is it Time for a 2016 Spending Check? Ken Steiner.  Before you generously shower gifts on your family and friends this year, you might want to check to see how you are doing so far with your 2016 spending and investments. 

Housing Bust Still Plagues Pre-Retirees, Boston College.  In other words, had the housing bubble and subsequent crash not occurred, fewer households would be at risk of having insufficient retirement income. 

Ratcheting Up Retirement Spending, Wade Pfau.  When retirements are not on track toward worst-case outcomes, spending can increase, and the ratcheting rule provides a systematic mechanism for managing such spending increases. 

Using Age Banding To Estimate How Spending Will Decline InRetirement, M Kitces.   [comment: I generally agree with this and have planned in a manner consistent with this for ~10 years. I wrote on it here ]

6 retirement strategies from a local pro, Steve Vernon, CBS.   [comment: about as grounded as it gets.  This is the middle way and worth listening to before one gets into any kind of complexity ]

Cumulative Prospect Theory, Deferred Annuities and theAnnuity Puzzle, Chen et al City U London.  Abstract: During the past few decades, there has been a steady shift from traditional defined benefit (DB) pension plans to defined contribution (DC) pension plans. In a DC pension plan, retirees have to make decisions on how to spend their accumulated retirement funds. Although it has been proved theoretically that annuities can provide optimal consumption during one’s retirement period, retirees’ reluctance to purchase annuities is a long-standing puzzle. Cumulative Prospect Theory (CPT), which considers both loss aversion and a probability transformation, can explain the low demand for immediate annuities during retirement. It also shows that retirees would be willing to buy a long-term deferred annuity at retirement. By considering each component in CPT, we find that loss aversion is the major reason that stops people from buying an annuity, while the survival rate transformation is an important factor affecting the decision of when to receive annuity incomes. 

The biggest benefit to building a diversified portfolio isan increased safe withdrawal rate—meaning additional spending in retirement. Cordant.  

You Risk a Ragged Retirement If You’re Counting On TheseNumbers. Bloomberg.  Women in particular need to look out. These rules of thumb are often inadequate to the reality of their shorter careers and longer lives.1 Women who are widowed are twice as likely to be living in poverty as their male counterparts, according to the National Institute on Retirement Security. 

Life Expectancy and Uncertainty, Me

MARKETS AND INVESTING  

Shift From Active to Passive Investing Isn’t What It Seems, Bloomberg.  

Don’t Count on Hitting Your Return Target: ResearchAffiliates, CIO.  According to a combination of industry surveys and retirement calculators cited by West and Masturzo, the average and median annualized long-term expected returns were 4.6% and 4.4%, respectively, after adjusting for inflation.  But after modeling risk and return forecasts for several mainstream portfolios, the pair found that it was extremely unlikely investors would achieve these returns.  A classic 60/40 portfolio of stocks and bonds, for example, had just an 0.2% chance of hitting the 5% return target.  

Millennials and Women Redefine What It Means to be aReasonable Investor, Institutional Investor.  

Accenture Wants to Mess with Blockchain and Not Everyone isHappy.  Institutional Investor.  

Nine Fixed-Income Tips, CFA Institute.  

Minsky’s Model of Mania, The Personal Finance Engineer. The discussion is framed around a model originally proposed by economist Hyman Minsky, which offers a methodical explanation of how bubbles start, grow, peak and crash. The model itself is fairly generic and in a refreshing way contains no mathematical components–it doesn’t suffer from “physics envy.” In a qualitative sense it’s as relevant today as it was 40 years ago, and can be broken down into the following five stages: 

A LOT of inter-class correlation in October. RCM-Attain  

ALTERNATIVE RISK

The Definitive Book on Factor Investing, Adam Butler.  

Rising Correlations and Tactical Asset Allocation, Newfound.  Holding all else equal, tactical asset allocation (“TAA”) is most likely to add value in environments where diversification opportunities are scarce. 

The Rebalance Bonus For Value And Momentum Porfolios, Wesley Gray.  "Bottomline: Stop investing in “cheap” diluted closet indexing value and momentum exposures if you are trying to exploit value and momentum premiums. This is a sub-optimal approach. Instead, lean on modern portfolio theory mathematics, and invest in a portfolio that combines concentrated value and momentum exposures — you’ll give yourself a shot at earning a higher expected return and a much higher expected rebalance bonus. Win-win." 

Trend-Following Strategies Work, ETF.com.  Academic research has provided consistent, long-term evidence that trends have been a pervasive feature of global markets, not just in equities but also among bonds, commodities and currencies. Carl Hamill, Sandy Rattray and Otto Van Hemert contribute to the literature with their August 2016 study, “Trend Following: Equity and Bond Crisis Alpha.” 

Venture Capital is About Human Capital, Mark Suster.  Venture Capital is a people business. Nothing fancier. 

Value And Momentum Starting To Align, Meb Faber.  

SOCIETY AND CAPITAL

Renewables overtake coal as world’s largest source of powercapacity.  FT.com. Though coal still generates more electricity, wind and solar installations hit record   

How we live today is neatly defined by our take on mess, The Guardian.  Mess is freeing, playful, joyous, the province of people with more exciting things to do than the vacuuming; tidying looks prissy, sterile, servile by comparison. Everyone should have the freedom to make a mess occasionally, just as everyone should have the chance to live alone at some point in life. But ideally the two would go together, because the trouble with mess is that it’s so much more liberating for its creator than for anyone forced to live alongside it.   

The Damage Done by the Nobel Prize in Economics, M Edesess.  Has the institution of the Nobel Prize in economics been a cause of the global economic woes of the last 20 years – its financial crises, its economic slowdowns and its increasing intra-national inequalities? In their recent book, The Nobel Factor: The Prize in Economics, Social Democracy, and the Market Turn, authors Avner Offer and Gabriel Söderberg make a good, if somewhat haphazard, case that it has.  

Demographics and markets: The effects of ageing, FT.com   The Federal Reserve has an awful hunch. It suspects that the world’s shifting demographics, as longer lifespans and reduced birth rates combine to increase the proportion of the aged within western societies, have rendered central banks powerless to raise long-term interest rates.  

Time to Trash Discounted Cash Flow as a Valuation Tool, Columbia Law.  we should shift gears and focus on developing good tools aimed at characterizing cash flows probabilistically.  That is, at developing tools to estimate their means, standard deviations, and correlations.  Moreover, the merits of incorporating into the valuation calculation the benefits that a project could bring to the relevant stakeholders, as well as the risk tolerance of the potential investors, should be explored. 

Mathematics and economics: A reality check, TheMathematicalInvestor.  mathematical methods of economists may not be up to the task of modeling the complexity of the social institutions and the business/finance world…graph theory, topology and even information theory and signal processing may be significantly more appropriate for these models. Machine learning methods may also be useful here.

My Housekeeper Has a Nicer Car Than Me. Charles Sizemore.  So back to that whole “paradox of thrift” thing… I recommend you stay frugal and focus on debt reduction over the next few years.  It’s bad for the rest of us… but it’s a lot better for you. 

How Water Scarcity Became a Worldwide Problem, Wharton. But another way to look at it, and this is what is very exciting to me, is to ask the question, “When these landscapes were functioning, what were the different factors?” We would never think of Los Angeles as a wetland area with deltas. But that’s how it was.  

Economic inequality – Gini Index, 2014, Our World In Data.
[interactive embedded graphic. Press play to play]

Taxing the Rich, In Four Charts, WSJ.  The top 1% of households received more than 20% of adjusted gross income in 2014—and paid almost 40% of income taxes. As you go down the income scale, that flattens out, and the top half of the population pays only slightly more in income taxes than its share of earnings. 

The Consequences of Gentrification: A Focus on Residents’ Financial Health in

Philadelphia, Philly Fed and Princeton.  We find that gentrification is positively associated with changes in residents’ credit scores on average for those who stay, and this relationship is stronger for residents in neighborhoods in the more advanced stages of gentrification. 

Did China'sOne-Child Policy Really Have an Effect? St. Louis Fed.  …fertility tends to decline as countries get richer. It is well-known that China grew fast over the past 20 years. Thus, it is possible that today’s fertility rate should be low, and people may not want to have two children even if allowed.