Weekend Links - 6/29/2017

QUOTE OF THE WEEK

No matter how you build your portfolio, hindsight will show it to be the objectively sub-optimal decision if your goal is only to maximize returns. Corey Hoffstein 

MAP OF THE DAY

RETIREMENT FINANCE AND PLANNING

Chapter 19: Individual Biases in Retirement Planning and Wealth Management, independent.  This chapter … describes giving nudges to help individuals close the savings, investing, and behavior gaps that will improve their total wealth and wealth-transfer picture. 

The Most Important Factor in Determining Your Retirement Withdrawal Rate, retirementreseacher.com.  Blanchett found the level of guaranteed income to be by far the most important factor in explaining optimal spending rates from investments. Withdrawal rates were up to four percentage points higher across the range of guaranteed income levels he examined. …Optimal success rates vary based on individual circumstances, but as a general rule of thumb, Blanchett finds a 75 percent success rate is generally a more acceptable target than one of 90 or 95 percent…A simple focus on a retirement income strategy that applies a low failure rate for the investment portfolio is woefully incomplete….An over reliance on only spending at a “safe” withdrawal rate may unduly sacrifice lifestyle in early retirement. 

SS Claiming

Because I am 58 and because I am not part of a married couple and because I think SS is going to either break or be means-tested in the future I have not thought much or counted much on SS as part of my plan (I heavily discount a PV calc). But I know it's there and will have some impact. Dirk Cotton had a good article on SS claiming recently, a topic over which much ink has been spilt. In that piece, without getting too analytical, he comes up with several reasons why someone might claim early such as:

• you have a bunch of money so SS is more or less irrelevant
• you think SS is going to go bankrupt 
• you are a lower earning spouse 
• your longevity expectations are lower because of poor health
• you need the $ right away 

Most articles I have seen make a strong case for delaying SS benefits and in the end Dirk's article is no different: "All things considered, I still believe that most retirees should delay claiming Social Security benefits for as long as they are comfortable doing so. Delaying claiming is simply transferring some income from early in retirement until late in retirement for the benefit of those of us who do enjoy a very long life. It is the cheapest longevity insurance you can buy."

Some Differences Between Open-ended MC Simulation and Historical "Closed" Sims

One of the smartest early retirement blogs around these days is earlyretirementnow.com.  This is a guy with skin in the game because he wants to retire early.  He has also put some of his prodigious PhD skills to use in doing the homework necessary to get ready.  He does stuff that I can't touch or sometimes even understand.  I tried to play around with (abuse might be a better word) some of his math here because I liked the elegance of the approach although it took me a while to figure it out.

Because he likes to share what he has learned in his ER journey, ERN now has a spreadsheet that takes some of his math that I was playing with (link above) and that he had originally worked into some GNU Octave code (which is like matlab according to ERN; I have to imagine it is not too different than R). The spreadsheet does what I want to call a type of historical rolling simulation (not exactly, I think, like what others mean when they use that term but very close) starting with data from 1871.  The tool also allows one to look at subset "runs" such as "since 1950" or CAPE <=20 or CAPE >30, etc.

RH40 in "multiplier" terms

I started my journey into questions on retirement finance a little late. So late, in fact that it was well after my career which is why I have not spent much time thinking about "multipliers." These are rules of thumb for how many multiples of your spend rate one needs to have in order to retire. I've seen numbers like 25 or higher tossed around. 25 happens to be the 4% rule (1/.04) where the other, higher, multiples are more conservative reflecting our current environment or maybe younger ages. I have also seen high multiples excoriated for being too conservative and a buzz-kill on retirement planning and consumption. I disagree with the latter comment but let's ignore that debate.

Instead let's say that multiples are merely inverses of spend rates (true) and that they should probably be age and/or risk-aversion tweaked as well. Let's also aver that a conservative result is good if for no other reason that it might be a good starting point to which other considerations can then moderate it later. Let's also assume that my RH40 formula (spendrate = Age/(40-(age/3))) is useful for at least one person in the world (prev posts). Then, if all that is accepted it is easy enough to invert the RH40 rule into an age and risk-aversion adjusted "multiple."

The basic concept in its super reductive form is this:

1. A well known academic researcher in the area of personal and retirement finance systematically simulates a whole bunch of retirement scenarios that cover a broad spectrum of assumptions,

2. The guy in #1 reduces the effort put into #1 into a regression formula that explains a very high percentage of #1's results,

3. A pension expert and comes up with a rule of thumb that is easy to remember, is age adjusted, and that has at least two modes: conservative and risky. He writes an article in a Society of Actuaries newsletter that explains the economic rationale,

4. An amateur hack (me) converts #3 into an alternative single age-and-risk-adjusted rule of thumb formula by going from pretty darn conservative when youngish (say 55-60) to risk accepting when older (say 95) and then sees that the simple formula fits the curve implied by #2 for at least one conservative "success rate" assumption between the ages of 60 and 95,

5. Now invert #4 into a "multiple" rule of thumb. Assume it is pretty conservative so maybe only represents a starting point for discussion. A lot of factors might influence one's judgement on this, the availability of Social Security or other permanent income not the least of them.

The inverted rule of thumb might look like this where A is age:

RHMultiple = (40/A - 1/3) x 100

or, more accurately, it might look like this:

Multiple = Min[50, RHMultiple]

Behold: an age and risk-aversion-adjusted multiplier rule of thumb.



Postscript 7/6/17:

Reflecting on this further, I realize that this is all a little silly.  If the goal is to come up with an age-based rule of thumb that is easy to remember, by creating another formula as a "multiple" version is kinda stupid.  Instead of that, just remember the RH40 formula [ A / (40 - A/) ] and if you need a multiple, just invert it [ 1 / RH40 ]. Much much easier to remember.  

Comments on Ritholtz's review of William Sharpe's RISMAT

I tried the other day to read and comprehend William F.Sharpe's Retirement Income Scenario Matrices (RISMAT.  Tipped off to this by David Cantor at PwC). I tried…and failed.  It was a little heavy on things that were opaque to me.  But I also happened to read Barry Ritholtz's ThinkAdvisor piece on Sharpe's RISMAT method Tackling 'Nastiest, Hardest Problem in Finance' that gave me a fresh angle.  

Here is a digest of the Ritholtz article (in single quotes, between the dashed lines):  

Weekend Links - 6/8/17

QUOTE OF THE DAY

If we were indifferent to risk, much of finance would collapse. Mihir Desai 

CHART OF THE DAY

Pension fund funded ratios for single 

employer, multi-employer and large 

city public plans 

RETIREMENT FINANCE AND PLANNING

Monte Carlo Investment Assumptions In Your Retirement Planning Projections, Kitces.com if you don’t recognize how high the correlations really are, you end up grossly overstating how much diversification is actually helping you, and understating the risk. Which ironically means, if the reason you don’t like doing things like Monte Carlo analysis in the first place is you don’t think it takes into account the risks of the marketplace when you try to add in more investments, then adding more investments without accounting for correlations, actually makes it worse. 

Kitces on Simulation, RiversHedge.  Well…maybe not in his software… 

Society of Actuaries Confirms Impact of Continuing to Work on Spending Budget, Ken Steiner.  

Managing Retirement Decisions, Society of Actuaries.  

The Difference Between ‘Safe’ and ‘Optimal’ Withdrawal Rates for Retirement Spending , Pfau.  Also, instead of focusing on the traditional objective of worrying only about using a low failure rate, we sought a better balance between two competing tradeoffs: (1) wanting to spend and enjoy more while you are still alive and healthy, and (2) not wanting to deplete the investment portfolio and rely only on non-portfolio income sources in later retirement… In practical terms, retirees who are more longevity-risk averse and less flexible with spending would like to smooth spending over retirement… someone with greater spending flexibility and more outside sources of income may be willing to accept rather high failure rates as a part of balancing these competing tradeoffs… we found that with those capital market expectations, the 4 percent retirement withdrawal rate strategy may only be appropriate for more risk-averse retirees with moderate guaranteed income sources… there is an important point to re-emphasize here. In one case in the article we identify a 7 percent withdrawal rate as “optimal.” That is not a “safe” withdrawal rate [comment: no sh*t…unless you are about 85 or older]. With the market assumptions in the article, the 7 percent withdrawal rate has a 57 percent chance of failure over a thirty-year retirement. 

Kitces on Simulation

In a recent post on Monte Carlo simulation on Michael Kitces site (Monte Carlo Investment Assumptions In Your Retirement Planning Projections) he describes some of the counter-intuitive effects of adding more and more asset classes to simulation (from a planning perspective one can inadvertently understate risk too much) and the importance of understanding asset class correlation. That was fine and interesting and important and useful and maybe even a little obvious if one has worked with simulators.  That was not what caught my eye, though. It was a comment later in the article on another topic:

But unfortunately, there’s no Monte Carlo software that can actually show that, what I like to call regime-based retirement projections. Where we’re in a low return regime for a decade and then we normalize. It’s possible mathematically to do it, the software just doesn’t do it now. Which means, the only alternative is to haircut long-term returns, which is what we actually do in practice. We reduce long-term returns by about 1% or 100 basis points, recognizing some of the risk of the low return environment.

Well...maybe not in his software.

Weekend Links - 6/1/2017

QUOTE OF THE DAY

I have a different perspective. I fear it’s now so easy to avoid doing any real work on our financial planning that many of us have lost – or never gained – a real understanding of how and why all the numbers fit together. -Monevator 

CHART OF THE DAY

RETIREMENT FINANCE AND PLANNING

Importance of Individual Account Retirement Plans and Home Equity in Family Total Wealth, ERBI. …when measuring families’ financial asset holdings at retirement, it is overwhelmingly the case that just IA assets plus home equity represent almost all of what families have for retirement outside of Social Security and defined benefit pension plans. 

A Proven Way to Budget Clients’ Spending, Ken Steiner at advisorperspectives.com.   Using Monte Carlo modeling to develop client spending budgets is an effective approach but not a perfect solution. In addition to using historical data to forecast future investment performance, many clients don’t fully understand the probability-of-success output. Some advisors use even less effective approaches to develop spending budgets for their clients, such as adding “safe” withdrawals from an investment portfolio to income from other sources. Rather than requiring clients to have faith that these approaches will produce results consistent with their financial objectives, advisors should supplement their current approach by calculating and communicating an ABB to enable their clients to make better budgeting and investment decisions. Adding this additional data point to advisor-client discussions will reduce your fiduciary risk and will result in better informed and more satisfied clients.      [comment: Ken Steiner is on solid ground.  In a future post I'll try to explain why Ken's actuarial method is one of at least three main legs of a retirement "table"]

3 Ways to Manage Retirement Planning Stress, ERBI.  

Taking Portfolio Spending into the Real World For Retirees, Pfau.  The authors [Milevsky and Huang] summarize the rational investor’s decision-making process as, “Wealth managers should advocate dynamic spending in proportion to survival probabilities, adjusted up for exogenous pension income and down for longevity risk aversion.”  … both of these factors will be tempered somewhat to the extent that a retiree is particularly fearful of outliving their financial portfolio. Greater longevity risk aversion requires spending less in order to maintain the portfolio over a longer time horizon.