Wise wise wise...

Fixing A Broken Retirement Withdrawal Plan
William Bengen

"This case illustrated an inflationary episode of unprecedented severity (at least for the U.S.) coupled with poor investment returns. Had no remedial measures been taken, the portfolio would have been exhausted in just 17 years. This underscores the need for early and decisive adjustments when a high-inflation regime appears. In my opinion, high inflation, not stock markets, is the gravest threat to the viability of retirement plans. This nightmare scenario of high inflation and low returns would have required an initial withdrawal rate of 3.6% to sustain the portfolio over 30 years. Had it been real, it would have redefined “SAFEMAX” (currently 4.5%) for the high-inflation regime." [my emphasis]

comments:

- I have often disdained people that suggest greater than 4% withdrawal rates for 65 and younger

- Some retirement writers are often spectacularly cavalier about 4% or even higher spend rates

- I have shown that simulated retirements that start in 1969 can suck (high inflation and crappy returns)

- I have come up with my own conservative spending rate formulas for early retirees

- I have simulated high inflation regimes that will destroy retirements

- I have pointed out, I think, that sequence of returns risk can be dwarfed by inflation effects...

So I am gratified now to see that Bill Bengen, of all people, throws out something less than 4% here.  Note that he is still talking here about a fixed period of <= 30 years.   So, what would a safe rate be if one is 50 with 50 years to go?!?  So, I guess I am feeling pretty good about my RH40 formula [age / (40 - age/3)] as an age based proxy for spending. In the case of a 65 year old it yields a 3.5% spend rate which is pretty close to Bills new estimate.  Kitces's comments on this are on the money:

...nonetheless, given that the longer the retiree waits to make adjustments, the more extreme they have to be, active monitoring to make mid-course adjustments is arguably the more appealing path.

Active monitoring, which was always the answer, shows up again!

See you in a week or so...

Happy Holidays
That's a Carleton College T-shirt, btw
Go Knights

Weekend Links - 12/21/2017

QUOTE OF THE DAY

...when you’re dealing with uncertainty and complexity, simple ideas are not dumbed-down ideas. They are often complex solutions gift wrapped for you in a way that makes their application practical and sustainable. .  Morgan Housel 

RETIREMENT FINANCE AND PLANNING

The Best Strategy for Retiring Without Adequate Savings. Joe Tomlinson

Most research on retirement strategies assumes that people have saved adequately. But data on household savings shows that many households fall short, and will need to call on relatives or other sources for support. This raises questions about the best withdrawal or annuity strategies when savings are insufficient. It turns out that which strategy works best is different than for adequately funded retirements. 

The Modern Tontine: An Innovative Instrument for Longevity Risk Management in an Aging Society; Weinert & Gründl. Goethe U

We show that partial tontinization of retirement wealth can serve as a reliable supplement to existing pension products. 

LDI Misapplied - Income Portfolios and Liability-Driven Investing, David Blanchett

Liability-driven investing (LDI)—in particular liability-relative optimization—represents a fundamental improvement over more common asset-only portfolio optimization techniques, such as mean-variance optimization. Almost all portfolios exist to pay for some future form of consumption, so liability-relative optimization is almost always more appropriate than asset-only approaches. By considering liability characteristics when solving for the asset allocation, LDI techniques take advantage of the natural hedging quality of certain investments. 

Tomlinson on hard retirements

From The Best Strategy for Retiring Without Adequate Savings. Joe Tomlinson, AdvisorPerspectives

• "Most research on retirement strategies assumes that people have saved adequately. But data on household savings shows that many households fall short, and will need to call on relatives or other sources for support. This raises questions about the best withdrawal or annuity strategies when savings are insufficient. It turns out that which strategy works best is different than for adequately funded retirements. 

• ...unlike most retirement research where we look for ideal solutions, here we will try to find the “least-bad” alternative. I’ll assume that retirement shortfalls will need to be funded by relatives. This will broaden our focus beyond the retiree, since we need to evaluate financial consequences for the contributing relatives." 

• "The lowest-risk 5th percentile balance is at 25% stocks and the additional risk from increasing the stock allocation is somewhat more severe. However, the risk at 75% stocks is not dramatically greater than at 25%, so a heavy stock allocation still makes sense, although going all the way to 100% may be too chancy." 

• "If the 5th percentile numbers based on stock/bond mixes cause too much concern, a possible strategy is to accept defeat and purchase an inflation-adjusted SPIA. In this case the relatives would pay a monthly or annual allowance to make up the shortfall...The result would be a sure loss for the relatives, but more predictable than using stock/bond mixes...The SPIA strategy clearly wins out over a conservative strategy with a heavy bond allocation, but compared to utilizing a heavy stock allocation, there is more of a risk/reward tradeoff. "

Hindsight 8: The mis-allure of the constant spending plan

This is neither a technical or an analytic post nor is it a dissection of the 4% rule, a dissection that has been done a million times before by others better than me.  And don't get me wrong, given the chance for a lifetime of constant income/spending adjusted for inflation I'd be in.  I just don't have that in my future.  Anything I make of what I have at this age is all of my own design and decisions.  The idea of any constant set-and-forget constant approach is appealing but deceiving and I've had enough time looking at retirement finance to see the mis-allure a little better.  Not perfectly, just better.  The point of the post is to provide some slightly impressionistic thoughts on why I look elsewhere for my retirement solutions.

Weekend Links - 12/14/2017

QUOTE OF THE DAY

“Nothing focuses your mind like a drawdown,”  Kharitonov in WSJ 

RETIREMENT FINANCE AND PLANNING

The Return You Need, Dirk Cotton

as the liability's due date approaches, its far safer to begin shifting to lower duration, lower yielding, liability-matching assets… You can drown in a river that averages a foot deep and you can go broke in a market that averages 9% returns over the long-term. 

When Can I Afford to Retire and When Should I Commence my Social Security Benefits? Ken Steiner

Continuing to work is generally going to be the most effective way of increasing your retirement spending budget. 

Behavioral Impediments to Valuing Annuities: Evidence on the Effects of Complexity and Choice Bracketing; Brown, Kapteyn, Luttmer, Mitchell, Samek.

This paper examines two behavioral factors that diminish people’s ability to value a lifetime income stream or annuity, drawing on a survey of about 4,000 adults in a U.S. nationally representative sample. Our first main finding is that experimentally increasing the complexity of the annuity choice reduces respondents’ ability to value the annuity. We measure lack of ability to value an annuity by the difference between the sell and buy values people assign to the annuity. Our second main result is that people’s ability to value an annuity increases when we experimentally induce them to think jointly about the annuitization decision and about the decision of how quickly or slowly to spend down assets in retirement. Accordingly, we conclude that narrow choice bracketing is an impediment to annuitization, yet the impediment can be lessened with a relatively straightforward intervention. 

Is early retirement a realistic dream? Vanguard

I don’t have any sage advice for planning a wedding. (I’m afraid I wasn’t even much help planning my own.) But I do know that when it comes to planning for an early retirement, the earlier you start, the better off you’ll be.  

Hindsight 7: Embracing both the tech and the math

I've been working with spreadsheets on and off for 30 years, literally.  In 1987 I started to use Lotus 123 for the first time in my first year of grad school. I even had one of the first retail-friendly portables about the size of a decent sized woman's purse. It had those big giant floppy disks. (usually around this time I'll mention that I had to use a slide rule in what they now call middle school; I have to go to google images to prove to my kids there was such a thing). That spreadsheet skill plus a little finance knowledge carried me pretty far through however many careers I've had so far.

Hindsight 6: Household balance sheet

"Finally, the rank ordering of "feasibility" [1] before "sustainability" before "investment performance" is an ongoing discussion..." Collins and Gadenne 2017

This quote is in a must-read piece by Francois Gadenne and Patrick Collins titled “The Shapes Of Retirement Planning: Are You A Curve, A Triangle, Or A Rectangle” a well informed discussion (and literature review) of an integrative proto-methodology for tying together disparate domains of retirement finance like MPT, behavioral finance, and what we can call the balance sheet approach. Their paper was also recently covered at Kitces.com here.  Now Gadenne and Collins I trust, but when they point to people in the industry (that I probably don't trust) that are debating or "discussing" the question of the primacy or non-primacy and rank ordering of something like a balance sheet (call it feasibility here) amongst other planning frameworks like sustainability or portfolio performance, my first thought was "who are 'they' and have 'they' lost their minds?  I realize here that I am conflating the household balance sheet with the feasibility studies that that instrument enables but work with me here for a minute.

Senate Tax Proposal

I detest both conflict and politics.  I will note, however, that the senate tax proposal for first-in-first-out tax treatment of capital gains would suck for retirees.  This is one time I would feel compelled to write or call my senator.  Working and saving for a lifetime and taking care of oneself thereafter does not always seem to get the respect and consideration it deserves.  Taking from the old and human-capital-less to give to the profligate seems a bully's game as it surely is.

Hindsight 5: early retirement vs not-early retirement

One of the consistent themes in my posts has been harping on the difference between two types of retirements: early and traditional.  I no longer think the differences are quite so stark as I used to at least in the private economy where I think at some point all private or independently employed retires are headed towards the moral equivalent of early retirement the way I am thinking about it: laid off early by a robot, no pension except the one you make yourself, no paid-for health care, side gigs, extreme longevity horizons, etc.  Public employees with pensions are a different story not told here.

My top 8 all-time posts in order of clicks

I don't think this is the "best of" it's just blogger.com keeping count:

• The 2017 RiversHedge 20 Best-of Awards Oct 13, 2017
• On the affinities between hurricanes and retirement Sep 13, 2017
• Bitcoin madness Nov 19, 2017
• On diminishing returns of financial modeling complexity Sep 25, 2017
• What I use in my own process - draft 1 Oct 22, 2017
• Trend Following Can Enhance Withdrawal Rates Aug 17, 2017
• Some Initial Thoughts on the "Divide by 20" Idea  Jul 6, 2016
• Seven Years of Investing in Peer-to-Peer Lending  Jun 3, 2016

Hindsight 4: The funky-ness of geometric returns in a multi-period setting

This is not a tutorial on arithmetic vs geometric returns.  For that there are some other great resources. Start with Wikipedia.  There are also a number of great covers of geometric returns. In particular I'm thinking of papers by Michaud, Mindlin, and Meucci.[1]  Even Markowitz's new book has a great cover in chapter 3 of vol 1. There are others.  My point here in this post is that it took me a while to get the hang of how geometric returns work over a multi-period time frame.[2]  I started the journey when I was creating a mean-variance thing. I say thing because it wasn't really an optimizer, just a tool to look back using historical data to contextualize some trading strategies.  At the time I didn't know if I should use arithmetic or geometric (compound) returns as input.  I asked around and got conflicting answers.  The debate, such that it was, was solved when I read Markowitz:  "[while] in the long run one gets the geometric mean return, not the arithmetic mean return...the inputs to a mean-variance optimizer must be the (estimated forthcoming) expected (that is, arithmetic mean) returns rather than the (estimated forthcoming) geometric mean returns. This is because it is true that the expected (or arithmetic mean)  value of a weighted sum of random variables is the weighted sum of of their expected values...but it is not true that the geometric mean of a weighted sum is the weighted sum of their geometric means." His parentheses and emphasis.

That settled that.  But I was interested in more and worked through Michaud, Mindlin , Meucci and some others like Bernstein on geometric frontiers .  I did some spreadsheets.  I wrote some simulation programs isolating geometric returns. I rewrote the programs to consider, like a good retiree, spending.  After that I just tried to pay attention to what I was doing and what others were writing.

Weekend Links - 12/7/2017

Reminder: Pearl Harbor Day

QUOTE OF THE DAY

Even the most pessimistic forecasts of household undersaving fall short of the most optimistic estimates of government retirement plan underfunding. Andrew Biggs 

RETIREMENT FINANCE AND PLANNING

It’s Not About the Money- On Lifestyle Diversification in Retirement, ofdollarsanddata

I understand the skepticism you may have listening to a 27 year old financial blogger tell you that retirement isn’t only about the money. However, the fact remains that once you have some base level of financial security, your day to day happiness in retirement will be more heavily impacted by your relationships, your hobbies, and your sense of purpose than your financial assets. I completely relate to this as my day to day happiness is effected far more by my dating life and blogging life than what is happening with the S&P 500. 

Hindsight 3: ruin risk as the pairing of two separate and independent things

I've spent a little bit of time over the last seven years thinking about ruin rate estimates, from the first scare I got as a novice retiree from an institutional service I used back in 2010 to playing with several different forms and styles of simulation to my recent completion (2017) of an R-script flexible ruin estimator that looks like it satisfies the Kolmogorov "lifetime probability of ruin" PDE (except I get to be a little more flexible in using non-normal return distributions).   In first-cut "hindsight" terms it's really simple: I never thought about the problem as involving two separate and independent probability distributions that represented two separate and independent real world processes:  1) portfolio longevity (with consumption) in years, and 2) conditional survival probability for a given start age.

Hindsight 2: the continuous unstable present vs the future

I used to imagine that retirement planning was all about the future.  This is a forgivable illusion of course (at least when starting out) because one is forced, when planning, to think about things like planning horizons, death dates, future long term care costs, simulations of future spending and returns, bequests to heirs at death, fear of running out of money some day, social security start dates and so forth.  It took me a while to dial back this impulse to if not try to predict at least project oneself too far into the future, a future that doesn't really exist and won't look like the future you expected if and when you get there.   This future-think is important of course and needs to be examined but once that has occurred I think the day-to-day practice of retirement becomes a different game.

Hindsight 1: Monte Carlo simulation

If I were to ever depart these blogging shores (as in leaving blogging, not dying), which is always a possibility, I would want to document, for myself, some things that I know now that I am either glad I know or wish I had known a little earlier.  I'm not sure how long of a list that is but if it gets long then it would probably be as tedious to read as I'm guessing it would be for me to sit down at one sitting and write.  For that reason I'm thinking of an open ended series of short posts I'll call "hindsight." The audience is me and the effort is intended to help me consolidate what I think I know about some stuff I've learned over the last couple of years. I'll seed the ground with the first one on Monte Carlo simulation.

Weekend Links - Thanksgiving edition 11/22/17

QUOTE OF THE DAY

“The single greatest challenge you face as an investor is handling the truth about yourself.” – Jason Zweig [delete "as an investor" and we are closer to the truth]

RETIREMENT FINANCE AND PLANNING

Robert Merton on the Promise of Reverse Mortgages and the Peril of Target-Date Funds, advisorperspectives.com

For every retirement product, Merton said, the measurement of success should be income. …“Why would think that it would be remotely possible that a single statistic – age – would be good enough to get you to a decent retirement?” Merton asked.  … “One of the biggest global issues is how to fund retirement,” Merton said. “It is faced by every country – large and small.”  … The implication of longevity means that we go from a 40-year working career and a 10-year retirement to a 40-year career and a 20-year retirement. The implication, approximately speaking, is that we must save 33% of our working earnings for retirement instead of 20%. Without reverse mortgages, the alternative, Merton said, is to reduce consumption or work longer.  … If we can find ways to get more out of the assets we accumulate, Merton said, then we can enjoy greater longevity without sacrificing standard of living…The house should be viewed as an annuity while you live in it and a financial asset that ultimately gets sold.

The Crisis in Retirement Planning, Robert C. Merton, HBR [2014]

The trouble is that investment value and asset volatility are simply the wrong measures if your goal is to obtain a particular future income. Communicating with savers in those terms, therefore, is unhelpful—even misleading. To see why, imagine that you are a 45-year-old individual looking to ensure a specific level of retirement income to kick in at age 65. Let’s assume for simplicity’s sake that we know for certain you will live to age 85. The safe, risk-free asset today that guarantees your objective is an inflation-protected annuity that makes no payouts for 20 years and then pays the same amount (adjusted for inflation) each year for 20 years. If you had enough money in your retirement account and wanted to lock in that income, the obvious decision is to buy the annuity … Ironically, therefore, laws intended to protect consumers would have the unintended consequence of prohibiting savers from holding the risk-free income asset … The seeds of an investment crisis have been sown. The only way to avoid a catastrophe is for plan participants, professionals, and regulators to shift the mind-set and metrics from asset value to income. … So what should retirement planners be investing in? The particulars are, of course, somewhat technical, but in general, they should continue to follow portfolio theory: The investment manager invests in a mixture of risky assets (mainly equity) and risk-free assets, with the balance of risky and risk-free shifting over time so as to optimize the likelihood of achieving the investment goal. The difference is that risk should be defined from an income perspective, and the risk-free assets should be deferred inflation-indexed annuities.

Bitcoin madness

In April 2014 I bought a single bitcoin.  This was not an exercise in investing or technology but just an investment in attention and education.  I knew extremely little about blockchain but I figured it would be important in the future.  Past experience told me that having skin in the game helps me focus my attention so I bought 1 coin.  For $430.  It is now worth about $8000.  By my calc that is something like 125% compound growth.

Now what? I have no idea.  I am in no mood to sell and in no mood to buy.  The original purpose stands.  I have used my position to go out of my way to read papers, articles and even standard internet dreck to update what I know and what I know is still "not much."  My position could go to zero or infinity tonight and I guess I don't care (ok, infinity would get my attention).  I will continue to keep my finger on the pulse of what is going on, though, and we'll see what happens.  My guess is that there will be volatility and uncertainty about everything (taxation, hacking, forks, fraud, illegality, etc) pretty much forever.  The big question for this blog is to ask to what extent this "thing" has anything to say to the forces of retirement finance.  For now I'd say nothing but it's possible that the future of retirement jurisdiction shopping for places that are friendly to late age retirement capital could theoretically include a blockchain component.  Who knows.  Today it's Florida.  Tomorrow...no idea....

Some thoughts on investing vs retirement wealth processes

Weekend Links - 11/16/17

QUOTE OF THE WEEK

In high school, I was a nerd and a loner.  Harry Markowitz in 2016 interview.


GRAPHIC OF THE WEEK

RETIREMENT FINANCE AND PLANNING

Deciding Whether to Take a Pension Lump Sum: The 2 Opposing Methods, Darrow Kirkpatrick.

Despite the fact that a lump sum is a losing mathematical proposition, people will still consider taking the lump sum for any number of reasons based on their personal situation. Those reasons may range from pure want to true need. In some rare cases where inflation plays a role, the math may even make sense. Other pensioners may simply not realize a lump sum comes at a discount (for the pension fund)  

Self-Annuitization, Ruin Risk in Retirement and Asset Allocation: The Annuity Benchmark, Albrecht and Maurer, Univ. of Manheim [2001]

The present paper considers a retiree of a certain age with an initial endowment of investable wealth facing the following alternative investment opportunities. One possibility is to buy a single premium immediate annuity-contract. This insurance contract pays a life-long constant pension payment of a certain amount, depending e.g. on the age of the retiree, the operating cost of the insurance company and the return the company is able to realize from its investments. The alternative possibility is to invest the single premium into a portfolio of mutual funds and to periodically withdraw a fixed amount, in the present paper chosen to be equivalent to the consumption stream generated by the annuity . The particular advantage of this self annuitization strategy compared to the life annuity is its greater liquidity. However, the risk of the second opportunity is to outlive the income stream generated by this investment. The risk in this sense is specified by considering the probability of running out of money before the uncertain date of death. The determination of this personal ruin probability with respect to German mortality and capital market conditions is the objective of the following paper. 

Annuity Valuation, Long-term Care, and Bequest Motives, John Ameriks, Andrew Caplin, Steven Laufer, and Stijn Van Nieuwerburgh Pension Research Council Working Paper [2007]

Financial security in retirement has traditionally meant having a steady flow of annuity income as long as one lives, a definition enshrined in the Social Security system. Our earlier research has stressed a more holistic approach, which focuses on the match between resources and spending needs. This formulation enables us to estimate annuity values given long term care concerns and bequest motives, where these estimated values are consistent with low observed demand for standard annuities. This chapter uses this model to value non-standard annuities with various security-enhancing features that we believe may be of value to retirees. 

Rational Decumulation, Babbel & Merrill

In particular, high levels of annuitization are shown to be rational under a wide range of risk aversion levels, even when stock market returns and annuity price loadings are assumed to be much greater than is generally the case. Ours is also the first study to model individual behavior under the possibility of default by the insurer issuing annuities. We find that even a little default risk can have a very large impact on annuity purchase decisions.  

Waiting for my DIA vs shifting longevity expectations

In this post I am wondering about the idea of waiting after my current  age (59) to hedge out longevity risk (after, say, age 85) with a deferred income annuity, a tool I know from academic papers and my own simulation that would enable me to increase consumption now for a level of risk that could be similar to that which might be held before a DIA purchase. Then I want to throw that "waiting idea" against the idea of longevity expectations increasing in the future due to something like med-tech innovations, something that has already been going on for a while now.  That would make the purchase of a DIA in the future relatively more expensive to the extent that insurers have not already figured this out...which they have. The Society of Actuaries already does something like this by providing a projection factor against its annuitant mortality tables.  Since I haven't figured out how to do that projection factor yet I'll try to look at this a different way.

Notes in a 2001 German paper about ruin estimation math

Albrecht and Maurer

I just (11/14/17) ran into the following in a 2001 German paper (Self-annuitization, ruin risk in retirement and asset allocation : the annuity benchmark by Albrecht and Maurer, Univ. of Mannheim; end of Appendix B).  It is precisely the same as what I often use here and accurately describes what I built earlier this year in my FRET algorithm...except that I am not using German actuarial tables from 1994.

Excerpt from the paper:

On the immense conviviality and generosity of the retirement finance research crowd that I've run into

Over the last several years I have gone to the effort of throwing some pretty stupid (and a few other) questions towards some of our leading luminaries in what I'll call retirement finance though really we are talking about a broader field.  I have been absolutely surprised by how generous (and fast...and real and helpful) the responses have been.  I thought there was going to be a big wall between the dumb amateur hack like me trying to wend my way through retirement finance and some leading lights in the industry.  Not a chance.  Almost all of the people I have reached out to have responded to questions I have thrown out there and have done so with vigor and wit and intelligence and grace.  Here, in short, and in no particular order, are some of the names that have been quite helpful and deserve a round of thanks and appreciation.  I know I am probably missing a few...

Moshe Milevsky, PhD
Gordon Irlam, aacalc.com (big  help on my backward induction engine)
Joe Tomlinson
Darrow Kirkpatrick, CanIretireyet.com
Dirk Cotton, theRetirementCafe.com
Tadas Viskanta, abnormalreturns.com
Wade Pfau, retirementresearcher
Evan Ingliss, Pension section of SOA
David C, PwC (my one of two readers, I think)
Tim Taylor, conversableeconomist.com
David Blanchett
Michael Finke
Michael Kitces
Corey Hoffstein. ThinkNewFound
Larry Frank
James Picerno, capitalspectator.com
Javier Estrada
John Walton
Bo Boland
Barton Waring
Luke Delorme
Ken Steiner
Attilio Meucci ARPM

Ben Carlson
Andrew Clare, City U of London
Dante Suarez
and others....who am I forgetting???

Here, on the other hand, and for the record, is who has not been helpful -- in case anyone was wondering about the dark side...there is always a dark side, right?

I live in south Florida.  Not a single person to whom I have reached out to in the area of finance anywhere in South Florida (FAU, Broward College, Nova Southeastern, UM, etc etc) has responded to a single question or email I have ever sent to anyone...ever.  Hmmm.  But I guess based on my experiences in the grocery stores here and on the road, I am not  totally surprised.  I once even had a short 10 minute "date" with a relatively well known finance professional down here and THAT is a story worth telling some day.  I've always told myself that the state motto or the logo on the FL flag should be "self interest above all else." (Hence my plans for a future move back to CO or MN). But hey let's end positive...

Regards to my helpful interlocutors...totally appreciated.

A quick, dirty, amateur look at DIAs

A reader asked me recently why, if I had (sorta) proven to myself that by hedging out age 85+ lifestyle with a deferred income annuity (DIA) I could probably increase current spending by up to 15%, I didn't pull the trigger and do so immediately.  No idea, really. I am guessing it is some combo of behavioral reasons and ignorance of the product/concept.  I thought I'd start working on the latter first.  This is my new project: understanding the pros and cons of pooled risk as well as what the annuity paradox means to my own personal planning.

Weekend Links - 11/9/2017

QUOTE OF THE WEEK

...for many entrepreneurs, they spent a lifetime reaching just beyond their grasp, always reaching for the next goal, he said. “It’s a really lucky person who can say I have enough. I am comfortable with what I have.” NYT on wealth anxiety 

IMAGE OF THE MOMENT

may daughter's cat sitting next to me helping with the weekend links...

RETIREMENT FINANCE AND PLANNING

Does Failed Retirement Income Planning Really Result In Bankrupt Financial Ruin? Derek Tharp at Kitces.com

This declining rate of bankruptcy in among retirement-aged individuals is notable, because the greatest risk for retirees is outliving their money. Yet with bankruptcy rates decreasing among older adults, the data suggests that bankruptcy in retirement may not be (at least primarily) the result of depleting a portfolio due to longevity or inadequate savings going into retirement! A 2010 study from Deborah Thorne at the University of Ohio on the interconnected reasons that elder Americans file for bankruptcy found that credit card debt and illness/injury (which can trigger substantial medical expenses, which may subsequently turn into unpayable medical debts) were the two leading causes of bankruptcy among the elderly (based on self-reports from those who had filed for bankruptcy). As Dirk Cotton has pointed out, sequence of return risk does not appear to be a significant contributor to bankruptcy among the elderly, as only 6.7% of filers reported “retirement” as the source of their bankruptcy, and again bankruptcy rates are highest in the early years of retirement—when failures due to sequence of return risk (based on reasonable withdrawal rates) are mostly non-existent.  

The Shockingly Simple/Complicated/Random Math Behind Saving For Early Retirement

EarlyRetirementNow.com

How sensitive is the savings horizon to different rates of returns? What happens if we use historical returns instead of one specific expected return assumption? How important is the asset allocation (stock vs. bond weights) on the path to early retirement? How much does the equity valuation regime (e.g. the initial CAPE ratio when starting to save) matter? 

Annuities and Trusts, John L. Olsen, Michael E. Kitces, Thinkadvisor

In the following discussion, we will examine some of the problems advisors may encounter when annuities are owned by, or made payable to, a trust, and the rules (i.e., the tax rules and the contractual provisions and administrative policies of annuity issuers) that are not well understood. 

Playing around with an EOYS free boundary sustainability metric

EOYS stands for what I want to call getting to the "edge of your seat" and is more or less what Patrick Collins suggests one do when one's retirement consumption portfolio starts to approach the boundary between feasible and infeasible a little too closely or maybe a little too fast[1].  Most of the following is just me parroting or trying to internalize what he is saying and then expressing it in some software and in a metric designed to gauge risk or sustainability in a way that might be more useful than probability of lifetime ruin. Or at least maybe this can be something that augments the sense of sustainability over time. I recommend the paper over this post; this is just me teaching me the concept.  Also much of this may be of no interest to those that are substantially over or under funded.

To visually paraphrase part of his paper, I have illustrated the basic idea like this:

To quote directly:

"Although penetrating the boundary is not an event that generates an explicit signal—there may be many thousands of dollars remaining in the portfolio at the time the boundary is breached—it nevertheless is an event that the investor should not take lightly. In terms of portfolio management, it is perhaps the single most critical piece of information that the investor should know. The existence of the feasibility condition puts a premium on intelligent monitoring. It is crucial to know how likely it is that even a one standard deviation move to the downside of the forecasted mean return could prove to be an economically non-survivable event. The investor needs to know whether they are in trouble, not whether their equity position has outperformed the S&P 500...This is a solvency question; or, in terms of the free boundary problem, it is the amount of wealth that separates the region of feasibility from the region of infeasibility. It is not a future oriented prediction; it is a question of the adequacy of current resources. Determining shortfall risk and quantifying solvency by locating the free boundary are both important components of risk assessment, and both provide important feedback regarding asset management dangers and opportunities."

Prototype of an "annuity price as a proxy for a free boundary" concept

Inspired by a recent reading of a Patrick Collins paper[1] on the concept in the title above (he's got some good stuff out there, by the way. Another paper of his on total return trusts[2] is one of the better descriptions of the "retirement problem" I've read out there) I decided to prototype a "free boundary" visualizer similar to something he had in his paper.  The idea here is that rather than wait around for ruin and bankruptcy, which is no fun at all, one might rather consider (if one has the capacity to do so) locking in a pooled risk lifestyle (by way of a single premium immediate annuity, say) if one is approaching the boundary where a portfolio might fall below the cost to "lock-in" a preferred lifestyle and also if one is uncertain, if the portfolio were to fall below the lock-in price and no lock-in were to take place, whether the portfolio would ever recover enough to maintain a tolerable lifestyle.  Since that boundary will move around with age and prevailing interest rates among other things this would be more of an exercise in ongoing portfolio monitoring rather than a specific concrete answer to a specific question but probably something worth knowing along the way.

Walking back my comment on fail magnitude...

In a recent post I played down the concept of fail magnitude. This was said in the context of times when one (me) is strictly looking at lifetime and portfolio longevity probabilities rather than when looking at the difference between a fixed planning date (say "30 years" or maybe "to age 95" or something) and when a simulator says you might go to zero or below some threshold. Without the hard stop of a specific age or a planning duration it seemed like a slippery concept.  I'm now thinking I was misguided.

In reassessing my opinion I decided to surrender and say it probably is important and I just needed to figure out how to measure it in the context/tool I was using.  If I figured this out in my traditional MC simulator, I can figure it out for my ruin estimation tool, too.

In the end it is as simple, I suppose, as just picking a threshold of interest. In the ruin tool I'm working on now, that is more or less arbitrary so I just created a boundary that I can change as needed later. In this case I decided to measure the distance in years between when the cumulative probability of portfolio failure is greater than, say, 5% and the point where the likelihood of still being alive is less than 5%. Arbitrary but it at least tells you something.

In the following chart I used some generalized placeholder assumptions (4% spend, age 60, 4% net real returns, 10% vol, modal life expectation of 90, etc). I set the threshold for magnitude at .05 for each distribution and let it run.  It looks like this. The arrow is drawn not graphed:

The lifetime probability of ruin comes out here to be 12.9% and with the threshold set as described there is a 17 year distance between the selected boundaries.  By itself that is probably not very meaningful. In comparing two strategies it might be more useful. But either way this adds a little more information, I think.  My guess is that the "area" under the green and blue would be more interesting in terms of a magnitude metric but also pretty hard to interpret.  "Years" has a more human meaning so I'll stick with that. I don't do a ton of strategy evaluation anyway so it probably doesn't matter much for now.  I also probably need to figure out a meaningful threshold level.

The other thing I want to add at some point is some type of "free boundary" measurement concept where one gauges, in any future year, the distance between some percentile in the portfolio distribution for that projected year and the cost to annuitize a baseline acceptable lifestyle at that age. The option to step out of a self-annuitization process as things go south but while one still has the capacity to lock in a pooled risk lifestyle probably has a ton of value (assuming one started with capacity, I guess). But that is another post on another day. 

On renaming my ruin estimation tool, my guess at its notation and some other considerations

The Re-naming

Have I mentioned that I do not have much formal training in statistics or calculus? I will sandbag in that area again, not as a lead-in to a humble-brag, but because my innocence in such things can lead to misleading errors or embarrassment. The latter I can handle but the former makes me uncomfortable and I think I engaged in the former by calling my recently built ruin estimation tool a "joint probability approximation" of lifetime ruin risk.  I don't think that is quite right because I am combining a pdf with a weighting factor (1 - cdf) rather than strictly another pdf. I don't know if that is a "joint" thing or not and will leave it to others that know the math better.

I had a rough idea of what I was doing when I posted the formal definitions before (when I linked to Milevsky's paper on ruin calculus[1]).  In that paper, on a recent re-read, he was pretty clear on what I was trying to do:  "One can heuristically think of the integral as ‘adding up’ the probability of [portfolio] ruin at t, weighted by the probability the individual will survive to this time." ...or the way Milevsky characterized it in the paper: "the quantity...is precisely the probability of lifetime ruin." When I spoke to him in person, I didn't ask about the joint probability thing but he did confirm that my approach was consistent with the above and was a direct expression of the P[T≥L] ruin concept which also satisfies the PDE. So, not a "joint probability approximation" I gather. It's something else. Time for a new name.

Given the opportunity to rename the tool, I first came up with the folksy sounding FRED (flexible ruin estimation device).  But that didn't hit me quite right so I shifted the last letter to a T. That gave me FRET for "flexible ruin estimation tool." That had the virtue of being both an accurate description of the software and also being an accurate description of what I do when I spend too much time thinking about lifetime ruin risk.  So FRET it is.

Alternative Option to Portfolio Rebalancing via short options strategies, AQR

This is another one of those "I haven't read it yet but looks interesting" papers.  Since I am pretty consistently short options I'll have to take a look at this when I get through the other 20 papers I have printed off for reading later....


An Alternative Option to Portfolio Rebalancing, Israelov and Tummala, AQR

We explore the use of an option selling overlay to improve portfolio rebalancing. Within a multi-asset class portfolio, portfolio weights deviate from targets as asset values fluctuate. Investors typically use a rebalancing process to bring portfolio weights back to their desired strategic allocations. However, between rebalances, investors are exposed to unintentional timing bets as weights deviate from targets. These timing bets introduce basis risk to their policy portfolio. A short option overlay can assist with hedging this unintentional exposure. We solve for the overlay construction that provides the desired rebalancing trade upon option expiration and backtest an illustrative overlay. Our analysis shows significant reduction in the portfolio’s uncompensated timing exposure. Furthermore, by selling options, the overlay earns the volatility risk premium and thereby adds alpha to the portfolio. Lastly, we show that an option overlay for rebalancing is implementable even when considering transaction costs and real-world constraints.

Weekend Links (early edition) 11/1/2017

MILESTONES THIS WEEK

These may be small beans to you but are high-water marks for me:

1. lifetime clicks went over 15,000.  First of all I know that's not all that big.  Second of all, 13,000 of those clicks were probably me, maybe 500 were my sister and the rest were Russian hacker-bots with a few left over at the end for David, Corey, and Tadas and a couple others. 

2. A single post finally cracked the 1000 click mark.  I thought it was going to be my retirement as hurricane planning post (2nd place with 862) but it was my tongue-in-cheekish 2017 Best-of awards (1002 and climbing).  I figure I could get an ad revenue stream of a few cents per month for volume like that.


QUOTE OF THE WEEK

There was another guy in the anteroom [where Harry Markowtiz was waiting for dissertation choice advice from his advisor]. He was a broker. We started talking about why we were there, and he said, “Why don’t you apply mathematical and statistical techniques to the stock market?” Some biographer later wrote, “That’s the best advice a broker has ever given.”  Harry Markowitz in 2016 interview. 

WEEKLY  GRAPHIC

Kelly allocation bet with regime suppression?

I think I tried something like this before but I am still not sure if I have this right or if this is a corrupt way of applying the principle but since I am neither academic nor practitioner I can proudly wear my amateur hack hat (I should make some real RiversHedge amateur hack hats for give-aways) just to play around and see what happens.  Now that I have a few more readers, maybe someone can step up and guest-post some better math for us if they think I am too far off track.

Here is the basic setup for the baseline (if I am taking us in the right direction).  I have some annual S&P data from Stern which I mainly use because its in an excel sheet on my PC where I can remember to find it, which is why it is still only current to 2015.  This is convenience data not rigor-data.  I split it into two: winner returns and loser returns.  That allows me to get a win rate and lose rate 73%:27% and an average win .208 and loss -.137.  Now I normalize the odds to 1.52:1 and calculate the edge as 1.52*w% - l% or .834. Edge/over odds is 54.8% so, if I am doing it right, I'd allocate ~55% of my wad to equities in a series of bets (here's where that sequential-independent thing might give me pause...)

Now I want to go darker or at least more conservative.  To do that I: 1) clip the 5 top returns from the win pile to take out some of the odd ducks from the early 20th century as a conservatising assumption , 2) I subtract an arbitrary .02 from both piles because all those genius pundits tell me I should expect lower returns for a long while, 3) I move any wins that are now losers to the lose pile, and 4) I recalculate.  w/l = .67/.33, avg win is .175, avg loss is -.1405, normalized odds are calculated as 1.25 rounded, edge as 1.25*w% - l% = .516.  So edge over odds in this darker regime suppression scenario would be .413 or a ~41% allocation "bet" on the risk asset. 

Even if that is not legit, it is not totally out of the bounds of reasonable experience I think.  That's also roughly about the shift I made in mid 2007 which saved me a bundle going into March 2009 even though I had no idea what a Kelly criterion was back then.   Maybe I should think about trying that shift again. 

Perfect withdrawal rates, trend following, and stochastic longevity

In the post right before this one I linked a paper from the cfa inst. by Andrew Clare and his collaborators on sequence risk and trend following.  I have to admit I haven't read it yet but I have printed it off so I can read it later on a plane flight because I think it'll be interesting.  But before I read it -- since I know he uses the perfect withdrawal rate method (PWR: what withdrawal rate given a particular sequence of returns would work out perfectly to result in a FV of zero, I think is the right way to put it. I'll check on that later) -- I wanted to run a little test with my own PWR tool and my own strategy's trend-informed return distribution to make sure I understand what is going on before I actually start reading.  I figure it'll help me get what he is saying more efficiently.  In addition I want to add an embellishment that I have not seen him or anyone else use: I make the periods over which PWR is calculated stochastic in a way that matches actuarial longevity similar to what is in the SOA annuitant table for me at age 59.  This is not a rigorous analysis by the way, just a quick-hit to see what happens.

Reducing Sequence Risk Using Trend Following and the CAPE Ratio, Clare et al. 2017 CFApubs.org

Reducing Sequence Risk Using Trend Following and the CAPE Ratio, Clare et al.

[abstract] The risk of experiencing bad investment outcomes at the wrong time, or sequence risk, is a poorly understood but crucial aspect of the risk investors face—particularly those in the decumulation phase of their savings journey, typically over the period of retirement financed by a defined contribution pension scheme. Using US equity return data for 1872–2014, we show how this risk can be significantly reduced by applying trend-following investment strategies. We also show that knowing a valuation ratio, such as the cyclically adjusted price-to-earnings (CAPE) ratio, at the beginning of a decumulation period is useful for enhancing sustainable investment income.

http://www.cfapubs.org/doi/abs/10.2469/faj.v73.n4.5

Portfolio longevity, defective distributions and some small thoughts on fail magnitude

It's possible that I am skating on thin ice here but I wouldn't even be on this part of the lake if Prof Milevsky hadn't encouraged me a bit.  In particular, when we were talking about portfolio longevity he schooled me on defective distributions and the effects of things like returns and vol on that type of distribution.  I mean I'm in my 60th year and he pressed and quizzed me like a sophomore in the second row of an intro finance class and it was just the two of us in a hotel coffee shop.  "What is the name of this distribution?" [mumble] "try again" [mumble] "try again" [pause] "the answer is that it is portfolio longevity in years...now what happens to the shape if we increase vol?" [uh, it shifts left?] "ok but what happens to the defective right side where we count the number of occurrences of infinite longevity?" [uh, it goes down?] "yes, now again, let's look at...." I didn't think I was going to sweat but it was like being 19 again in the crosshairs of the seminar prof. Whew.

Some thoughts on investment horizons

The fact that stocks usually go up makes permabulls look like idiots once in a while and permabears look like geniuses once in a while. -- Michael Batnick

Michael Batnick is one of the better bloggers writing out there today.  I think the Rithotlz org must force their crew to write and write well.  It must be some kind of organizational totalitarian positive force thing.  In this post "Playing the Odds" Michael's main point, to which he is taking the other side, a view of which -- the other side that is -- I am sympathetic, is that if you (you who are selling investment or advisory services) say the sky is falling often enough, when the sky falls just a little bit, not only are you vindicated but your marketing is now officially effective for the next 10 years. 

My thoughts were elsewhere, however. I was thinking about investment horizons.  Here is one of the post's charts with some emendations. To quote Michael on his intro to the chart "Sam Ro is fond of saying “stocks usually go up.” The *chart below supports the statement that historically over time, stocks usually did go up. This is why it makes good sense for financial pundits to play on the bullish side." :

What I was thinking about when I looked at this were two scenarios: A) investment horizon of greater or equal to 20 years with no spending constraint, and B) investment horizon of less than 20 years but more than 10 and there is a spending constraint[1].  It is a little ambiguous, given the chart and the setup, on what to think about these scenarios.  Scenario A is probably similar to a young person accumulating or an institutional investor.  Scenario B is more like a 60 year old that plans to annuitize some or all of a portfolio at around age 75.  Both scenarios can likely handle a decent amount of equity risk but Scenario B probably needs to think pretty hard about the plan or at least "plan B[2]" if bad things happen in the intervening years.   

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[1] Maybe also throw in something like our current market environment with iffy return expectations.

[2] no idea what plan B is, just pointing out some horizon risk.

Weekend Links - 10/26/17

QUOTE OF THE WEEK

In the middle of the 20th century, the US economy had the enormous advantage that its workforce was by far the most skilled in the world. That advantage has largely dissipated. Tim Taylor 

GRAPHIC OF THE WEEK

RETIREMENT FINANCE AND PLANNING

Replacing the Failure Rate: A Downside Risk Perspective, Javier Estrada

The variable proposed here, downside risk‐adjusted success (D‐RAS), addresses this shortcoming by taking a downside risk perspective, measuring risk with the semideviation, and therefore with volatility below a chosen benchmark. This modification leads to the selection of more plausible strategies than those selected by both the failure rate and RAS. 

The 3 Great Misconceptions About Retirement Saving, Darrow Kirkpatrick

What did we give up to retire early without having several million on hand? Two things, primarily: owning a large home, and international travel. Yes, home ownership is very important to many people, part of their vision of the “good life.” Just understand that owning a plush home is an emotional need, and often an expensive one at that. Likewise, international travel is a prominent image in retirement scenarios: white-clad seniors frolicking on exotic beaches. For me, at least, this too is an emotional or symbolic need. I’ll get a lifetime of enjoyment playing in our western mountains, mostly within a day’s drive of our home in Santa Fe. And, if you’re willing to search carefully, and visit when the crowds are gone, you can even find an exotic beach in the U.S.

In Search of the Optimal Retirement Planning Strategy, Ken Steiner

In his post, Mr. Kitces deftly summarizes the three Collins/Gadenne geometric metaphors and his understanding of the benefits and limitations of employing each type of retirement planning strategy.  In response to his question “What is the optimal shape of retirement planning?” Mr. Kitces concludes that the best approach for retirement planning may involve incorporating elements from all three shapes.  

What I use in my own process - draft 1

[Note: I say draft 1 because I know the second I press the publish button, things will change.  I say process because that's what retirement is.]

Back in July (2017) I started to write a post about the story of how I ended up in a semi-voluntary early retirement at age 50 which is part of the backstory on why I do this blog at all. That was fun for a while but after about 7000 words and 14 pages of unstructured nonsense even I started to lose interest.  I couldn't imagine anyone else slogging through it for more than a page.  While the story itself is pretty good if told right, and could maybe fall somewhere between tabloid grocery-store-style gossip on the one hand or maybe Dostoevskian-like pathos (I'm thinkin', though, that maybe bathos is a better word) on the other hand -- and keep in mind, this is a story that probably should be told at some point -- I still had two problems:  one, most of the protagonists of my story are still alive so maybe now is not the right time to open up on that front and two, I lost track of the main reason I was creating the post in the first place.   The main reason at that time was to delineate, since I am trying to write a retirement finance blog, the main tools I personally use to navigate this stage of retirement (before age 65) that I have been in for a while.  I was assuming that that might be useful to someone else, but in the end who knows?  We all have different situations, capabilities, and inclinations.   

But, let's give it a shot.  Here, then, in short form, or at least shorter form than I first tried, are the main things I bring to bear on my own situation, which at age 59 is starting to look a little more like a normal retirement rather than what felt like a too-early retirement at age 50 when I started back in 2008-2009: 

Some effects of longevity assumptions on ruin estimates

In shaking out my lifetime ruin approximator tool, the one that mimics the Kolmogorov differential equation for evaluating the lifetime probability of ruin (LPR), I had forgotten to look at the effect of longevity assumptions on ruin estimates.  I know from some past posts that, for a 60 year old, if I plug in mode (M) and dispersion (b) parameters of 85 and 10 it more or less closely fits the Soc Security life table for someone my age (keep in mind that that is a "hacker close fit" not an actuarial science close fit) and that the parameters 90 and 8.5 roughly fit a curve derived from the Society of Actuaries Annuitant mortality table for someone my age.  The former can maybe be characterized as an average expectation across all of us while the latter is an expectation for a generally wealthier and theoretically healthier cohort that self-selects themselves into annuities.  They tend to live longer, hence that becomes a "real world" conservative assumption, data-set or baseline.

I'll use those two assumption sets (SS and SOA)  as my boundaries for an "average" longevity assumption and "conservative" longevity assumption.  Or at least for when we are working with stochastic longevity.  In real life I often use a fixed age of 95 or more if I want to be both simple and hyper-conservative.

Weekend Links - 10/19/17

QUOTE OF THE WEEK

…for psychologists seeking to understand the apparent nexus of success and abuse, Weinstein’s apparent downfall is just the tip of an analytic iceberg.  -- Persaud & Bruggen   

GRAPHIC OF THE WEEK 

RETIREMENT FINANCE AND PLANNING

Why a Retiree Might Keep Going Back to that ATM, Dirk Cotton

Households with limited savings, on the other hand, may well find that their non-discretionary spending gradually overwhelms their portfolio spending. Even though the portfolio would be doomed by continued spending, they will still need to pay for groceries and housing and may have little recourse other than to keep spending and pray for a tremendous bull market. They may find themselves in a “spending trap” in which they must sustain their level of spending simply to meet non-discretionary spending demand with the knowledge that doing so will most likely soon bankrupt them…Sometimes a retiree may keep returning to that ATM for as long as possible because she has no better alternative. That's rational.  

Life-Cycle Finance in Theory and in Practice, Zvi Bodie [2002]

The paper suggests ways that advances in the theory of finance combined with innovations in financial contracting technology might be used to improve social welfare by designing and producing a new generation of user-friendly life-cycle products for consumers. It contrasts the old Markowitz single-period paradigm of efficient diversification with a new Mertonian paradigm that takes account of multi-period hedging, labor supply flexibility, and habit formation.  

Last ruin game (with CBOE iron condor index)

This is an abbreviated post. All assumptions are as in previous posts.  This time I am putting a normal return series (8% nominal with 10% sd) against the CBOE iron condor index (~7% nominal, 7.2% sd) which represents the concept of putting on a bull put spread and a bear call spread to get relatively high probability returns in low vol environments. I have no opinion on this strategy I am just using it as an alternative return profile to see what happens in a ruin probability experiment. 

Another game with non-normal returns (CTA index)

When I met with Professor Milevsly, one of his comments was that my code -- the code that replicates the Kolmogorov equation for the lifetime risk of ruin by a brute force application of the core probability principle -- has at least some advantages over the PDE because I can model non-normal returns. This, like the last post, is another turn in that game just to see how it goes.  His example at the table was a collared portfolio but one can just as easily demonstrate the principle with any distribution that leans away from Gauss. Here I am going to look at the CTA index and add it to a blended portfolio, a little like I did in 2010 in real life with some private placements.  According to the last paper I read on momentum I might be able to do this with a continuous distribution using chi squared math since that seems to have some affinities with trend following returns.  But that is some other day...

What would happen if I allocated 100% to my alt-risk strategy (in terms of ruin risk)

Here was an interesting little exercise with results I guess I wasn't expecting.  None of this is very real so I don't know if I can attach much meaning to it.  The question I asked myself was what would happen to my ruin estimate if I allocated 100% to what little I know about my private Alt strategy's too-short return profile.

First, without getting too far into the nitty gritty, my alt strategy is something like 30/50/20 credit risk, fixed income momentum, and volatility risk via short options -- though that internal structure changes and drifts a little more than I might want.  The goal was to get a moderate return and low vol profile that is at least as efficient or more so than a plausible multi-asset allocation when looking backwards at history. The purpose was to nudge my overall efficiency up and left a little bit. This I have mostly achieved since the beginning of 2012 shortly after I started this thing. I'd love a little higher return but it is what it is. The idea of allocating 100% to my Alt came to me just as a fake hypothetical in order to explore some things I've been working on related to ruin estimation processes.

For comparison I'll use the Vanguard 60/40 mutual fund since it might represent a reasonable baseline allocation like my own might be in practice.  This is a convenient fiction for posts like this so I'll go with it.

Paper on Momentum and Trend Following

Understanding the Momentum Risk Premium:An In-Depth Journey Through Trend-Following Strategies, Jusselin, et al. September 2017. 102 pages. SSRN


From the concluding remarks: "The momentum risk premium has been extensively documented by academics and professionals. There is no doubt that momentum strategies have posted impressive (real or simulated) past performance. There is no doubt that asset owners and asset managers widely use momentum strategies in their portfolios. There is also no doubt that the momentum risk factor explains part of the performance of assets. With the emergence of alternative risk premia, momentum is now under the scrutiny of sophisticated institutional investors, in particular pension funds and sovereign wealth funds. Therefore, Roncalli (2017) supports the view that carry and momentum are the most relevant alternative risk premia since they are present across different asset classes, and must be included in a strategic asset allocation. Nevertheless, the development of alternative risk premia has some big impacts on portfolio construction, because the relationships between these strategies are non-linear. In this case, the traditional diversification approach based on correlations must be supplemented by a payoff approach. However, most risk premia have a concave payoff. The momentum risk premium thus plays a central role as it exhibits a convex payoff, and we know that mixing concave and convex strategies is key for managing skewness risk in bad times. Sophisticated institutional investors need to profoundly understand these new risk premia in order to allocate them in an optimal way."

From the Abstract: "Momentum risk premium is one of the most important alternative risk premia. Since it is considered a market anomaly, it is not always well understood. Many publications on this topic are therefore based on backtesting and empirical results. However, some academic studies have developed a theoretical framework that allows us to understand the behavior of such strategies. In this paper, we extend the model of Bruder and Gaussel (2011) to the multivariate case. We can find the main properties found in academic literature, and obtain new theoretical findings on the momentum risk premium. In particular, we revisit the payoff of trend-following strategies, and analyze the impact of the asset universe on the risk/return profile. We also compare empirical stylized facts with the theoretical results obtained from our model. Finally, we study the hedging properties of trend-following strategies."

Random Quote: "In fact, we think that there is a misconception about CTAs. Many people think that CTAs are good strategies for hedging the skewness risk of the stock market. In reality, trend-following strategies help to hedge drawdowns due to volatility risk. For instance, CTAs did a very good job in 2008, because the Global Financial Crisis is more a high volatility event than a pure event of skewness risk. However, it is not obvious that CTAs may post similar performances when facing skewness events. For instance, the performance of CTAs was disappointing during the Eurozone crisis in 2011 and the Swiss CHF chaos in January 2015. "

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Most of the paper is over my head but it was still worth reading the few parts I could understand.

The 2017 RiversHedge 20 Best-of Awards

Here are the RiversHedge 2017 "20 Best-Of awards."  I suppose the language here is a little tongue-in-cheek but I am dead serious about my recommendations. These are the people that have influenced me and made a positive contribution to me, my family and, I'm guessing, an awful lot of other people out there, too.  This is a tough domain to work and write in so all of it is appreciated.  I know some folks are flogging blogs because there is an economic incentive in there somewhere but on the other hand some are just doing it because they have something to say that is helpful or maybe because they just have curious and communicative souls.  Bless them.  Maybe next year I'll offer T-shirts or something but this year it is just for fun.

2017 RiversHedge Best-of Awards

1. Best life-cycle blogger that leapfrogs ideas from "academia and the best practitioners" straight to retail investor-retirees. This, by the way, is a serious calling in my opinion and vastly underappreciated. I aspire to be one of those that helps bridge that kind of gap.  Dirk and I have corresponded and he is a very solid and friendly guy. I read everything he posts as soon as he posts it.

Dirk Cotton, TheRetirementCafe

 2. Best real retiree that has quant chops and serious purpose. Darrow and I have corresponded as well and I think he may also win the "blogger I most want to fly to Santa Fe and have a coffee with or maybe take a hike in the New Mexico hills with" award. He can analyse with the best of them but he also lives a life of purpose.  I aspire to be like him when I'm older. Oh, yeah, that's right...I am older.

Darrow Kirkpatrick, CanIRetireYet

3. Best ETF strategist that also gets the life-cycle part of life-cycle finance.   I have corresponded with Corey and he appears to be a very qualified and insightful hard-quant strategist.  His own blog posts aren't just solid, they appear to be accelerating.  I look forward to more.

Corey Hoffstien, ThinkNewFound 

Will un-retire (work) for health insurance...

... no really, seriously, if you have any ideas or want to work something out, let me know.  Here are the last 7 years with 2018 projected. A 22% compound rate!?!  I wish I could invest!  I can't see where this is going to end.

On Wong's "Random Walk Part 4"

This is a note I jotted down after reading

Random Walk Part 4 – Can We Beat a Radically Random Stock Market?
by Theodore Wong, 10/9/17, Advisor Perspectives

This series of 'papers' on markets and vol and risk is pretty good.  It takes a fresh empirically-oriented look at how risk and return work in practice and throws in a decent dose of probability thinking for good measure.  That's always a good thing, right? This last paper ties his thoughts together.  It was pretty interesting as far as it goes but I had a tiny bit of ambivalence about it at the end and I wasn't sure why so I decided to introspect and see what was holding me back.  Here is what I think I was thinking as I hesitated to embrace it fully. Most of this is pretty minor:

Weekend Links - 10/12/17

QUOTES OF THE WEEK

"I really wish my dad had spent more time at work instead of with me when I was a kid." <-- Said no one, ever. Vhalros onRedditt

But yeah, if you aren't a raging failure of a human being and actually enrich your children's lives, then [early retirement] is definitely the best thing you can do with your time. Csp256 on Redditt

[comment - I retired early to care for my kids so this is a wee bit of self-serving self-affirmation.] 

GRAPHIC OF THE WEEK 

The Shape of Ruin Risk
60 year old with moderate assumptions for net real returns
- RiversHedge

RETIREMENT FINANCE AND PLANNING

Two smarter ways to determine how much you can safely withdraw funds in retirement, The Globe and Mail

If you want to see a group of financial experts brawl, ask them how much it's safe to withdraw from your investment portfolio each year in retirement. One of the most common answers is to suggest some variation of the 4 per cent rule. Under this guideline, a retiree would take out 4 per cent of his or her original portfolio in the first year and continue to withdraw the same amount – but adjusted for inflation – each subsequent year. The 4 per cent rule offers the undeniable attraction of simplicity. But the more you examine it, the more unsatisfactory it becomes.  

Starting to look a little closer at my normal return assumptions

I've been using in my code a convenient fiction for returns by using the R normal distribution function.  How many times have I heard from other that returns aren't normal. Of course not. I know that but "they" are not trying to code while my kids want dinner. I use it because it is easy and I don't have to think too much.  I thought I'd take a closer look with respect to my recent ruin risk estimates.  This is not scientific or rigorous this is just another one of those "what does it look like" things.

A thousand years of the 4% rule: the naked, ugly glory of it all

The Estimates

Let's start with some ruin estimates just to set the stage. Here are 5 methods of estimating lifetime risk of ruin for a plausible set of assumptions[1] for a 60 year old with a balanced portfolio and a 4% constant spend:

Method	Age	Longevity	Returns	Vol	Spend	Ruin est
sim	60	95 fixed duration	Hist 50/50	hist	4%	0.270
sim	60	Soc Sec table	Hist 50/50	hist	4%	0.100
sim	60	SOA Annuitant	Hist 50/50	hist	4%	0.142
JPA	60	Gompertz 90/8.5	4% net real	10%	4%	0.127
Kolmog.	60	Gompertz 90/8.5	4% net real	10%	4%	0.132

Ok, so there is some moderately low level of risk here, nothing too scary except maybe that to-95 estimate and even that is probably manageable with some spending flexibility, some good portfolio design, and maybe a little tactical allocation thrown in if that can actually be pulled off.

The Quiz

Tuesday with Moshe

I had the privilege and honor this morning of being able to spend a half hour one-on-one in person with Moshe Milevsky.  That was great because his book (7 Equations) more or less triggered my ret-fin explorations over the last five years as well as this blog.  I had happened to email him a few weeks back to ask what he thought my joint probability approximation[1] was actually doing in the context of his paper Ruined Moments in Your Life: How Good Are the Approximations? [2003] and he very generously offered to explain it to me in person since he was giving a presentation about 10 miles away from where I live.  That was today.

My goal was to come away with at least three things: 1) figure out where my ruin approximation approach fits into the scheme of things in terms of the ruin approximations [approximations to the Kolmogorov partial differential equation (PDE) for ruin] listed in his paper, 2) get more insight into my probability density function (pdf) for portfolio longevity since I had some confidence issues due to the fact that it had some weird properties and I don't have a formal background in stats, and 3) I wanted a better verbal interpretation of the third term of the Kolmogorov equation.  That, and I also wanted to get a selfie with him for my twin sister who's spent 40 years in the financial services industry but I chickened out on that since at the end he was moving pretty quickly towards his next meeting.

What did I get from my chat?

The Shape of Ruin Risk

Using the setup, assumptions, and conclusions from the last post (A type of heat map of ruin risk arising from: age, allocation, spending, and return distributions) I thought I'd do one of those 3D visualization things to see what it looks like using one more dimension.  This graphic is based on the return, vol, allocation, and spend assumptions in the link but here it is limited to just age 60 (I only have ~8 months to go).

The chart can be characterized as the fail rate for different allocations to risk given the parameters in the link (one blue line for, say, a .03 spend rate) and then replicated for each spend rate from .03 to .07 in .01 chunks.  It was tricky to get a decent rotational perspective.  I thought about an animated gif but decided the effort to reward ratio was not in my favor. 

Fig. 1 - lifetime ruin risk for different allocations and spendrates