What I've been using

I was on the plane back to FL from MT on Wed. (damn, I'm already ready to go back) and was thinking about my 5+ years of ret-fin blogging. With all that analytic stuff more or less in the rear view mirror (is it really?) I thought I should spend a moment thinking about what I actually use for myself. I’ll try, but fail, to keep this brief. I might've blogged on this before.

Heat Scatter of Portfolio Longevity with N=1,000,000

Just for the hell of it this is a portfolio longevity chart

- N = 1,000,000
- r = .04
- sd = .12
- spend rates are uniformly distributed between 2% and 12%
- horizon set to 100 years max where 100 is sorta infinity

Since this is one of the "shapes" of retirement that I set out to see, I wanted to see what it looked like with a really big N for the sim iterations.  Looks like the smaller N of course, just more filled in.  Also it's easier to see that 2% spend is almost, but not certainly, a perpetuity when returns are volatile. Interesting to ponder long retirements like early retirees in FIRE movement or long duration trusts or endowments.   Didn't take too long to run, just a couple minutes or so.

What an advisor might or might not tell you

Let's say, hypothetically speaking, that one's advisor is somehow deficient in speaking to "retirement income solutions" -- keeping in mind that the older I get the less outrageous of an assumption this gets -- rather than to the bread and butter of what they really do.  To be overly reductive and a bit unfair let's say what they really do is collect fees and recommend asset allocation frameworks.  If that is what they do, and if they won't broach the topic of fee negotiation -- which they usually don't...but should -- then pretty much the bulk of what you hear about in a conversation will devolve, again reductively and unfairly, to "asset allocation."

Denominator Wealth

I track my spend rate as a rate [s/W] every month as part of a statistical control process.  That means I need a denominator. I've lost track of what the "official" literature has to say on this so I'll just describe what I do.  It's easy enough to say "use the balance from your brokerage accounts" but I think that's the wrong answer.  Not all financial wealth belongs in the denominator just like not all non-financial wealth is necessarily excluded. 

I keep an enhanced version of an actuarial balance sheet akin to what Ken Steiner recommends.  That means I have assets and liabilities and I also have "flow" items like capitalized SS PV and an estimate of a spend liability among other things. I also have what I might call mezzanine liabilities that are near term 5+ year big ticket spending like college for 3 kids. I could and should do this for LTC but haven't...yet.  So, when I want a spend rate, wealth in the denominator should reflect what I can spend and I call that "net monitizable wealth."  In practice, this means:

  1- Net financial wealth: including flow items in PV form but net of both soft and hard liabilities
  2- A slice of non-financial wealth that I could monetize if I needed to consume it
  3- If I can consume it someday, it's in, if I can't reasonably expect to, it's out.

For #1, the soft liabilities are mostly made up of the estimated PV of a Tier 1 college ed, books, travel, room n board for 2 kiddos (already had one go thru Stanford).  The hard liabilities are things like a stub of a mortgage and a rolling estimate of a tax liability and a working capital LOC I sometimes keep. The spend-liability estimate proper is left out for this exercise -- but not forgotten -- since this is a spend rate effort.

For #2 the only example I have -- other than maybe a couple watches, perhaps a little silver left over from grandparents and some other trivialities like some rugs and astrophotography gear -- is a portion of my house. Some direct private investments in business ventures, valued by a model, used to be in there but I now estimate their value, not to mention monetizability, at zero.  I raised three kids in my current home and I don't need my whole house.   I'd downsize in a heartbeat but only up to a point. I figure in an extreme situation I could ditch half the value and be fine.  In practice I make maybe 30% of my house available as "monetizable" for this exercise. And, in fact, on a recent real estate scouting trip to MT, that's about the differential I think I'll see when I move. 

Brief note on some reasons for the Annuity Paradox

I was doing a little catch-up reading on the plane.  I'd been meaning to enumerate to myself some of the reasons I see in the literature for why people do not allocate to annuities despite the manifest benefits seen when only using theory to think it through. My reading gave me a starter list. Many of these reasons are my own.  Without more granular attribution, the source material are these:

- How best to Annuitize Defined Contribution Assets. CRRB Munnell, Wettstein, Hou 2019
- Annuitization and Asset Allocation with HARA Utility, Kingston & Thorp 2005
- Annuitization and Asset Allocation, Milevsky, M.A. and V.R. Young (2003)
- Optimal asset allocation and the real option to delay annuitization: It’s not now or never, Milevsky, M.A. and V.R. Young (2002) 

- Some others not listed here

The list of issues with annuities that they enumerate, if I've gotten them all, looks like this. There may be some overlap in the items. I'll add to this if I run into more:

- Adverse selection price effect (fairness); healthier people buy, prices reflect the cohort
- Marketing and admin price effects (fairness)
- Capital reserve price effects (fairness)
- Diminishing utility of the product class due to levels of pre-existing wealth
- Self insurance alternatives via family
- Availability of other life income streams eg Soc Sec
- Bequest motives
- The loss of flexibility re large unexpected events especially health
- Preference to retain and control wealth (endowment effect)
- Unawareness of annuity product benefits over full lifecycle, inadequate education
- Bias for lump sums over flows (illusion of control)
- Incomplete markets: unavailability of negotiable contracts, irreversibility
- Personal evaluation of life expectancy is lower than average (related to adverse selection)
- Personal evaluation of life expectancy is higher than average
     o expectations for better returns via risk premia over time
     o expectations for falling annuity prices at later ages
- Price effects (fairness) from incompleteness maturity/contingency structure of bonds on issue
- Price effect (i.e., high) from the general rate environment (low)
- Complexity and opacity of complex instantiations of the product
- Counter-party risk; insurer bankruptcy
- Misalignment of incentives...your advisor may not be paid to sell or may resent loss of AUM
- Mortality Credits are low at early ages

Retirement finance joke...

On AQR's paper on retirement security in a low expected return world

Here an AQR 2017 paper on Risk and Retirement. 

Intelligent Risk Taking: How to Secure Retirement in a Low ExpectedReturn World, Ilmanen & Rauseo Aug 2017

Read that, then my comments are as follows. This was copy/pasted from some correspondence with DC


-----------------------------

Here are some superficial comments on the AQR paper

1. I've mostly steered clear in the blog on stuff related to portfolio optimization and design and related component analysis.  You can see this in the "5 Processes" paper I did. An optimized portfolio is "assumed" as input into my quant schema.  That kind of optimization stuff is the bread and butter of the finance industry and I don't add much as an amateur.  It is also something that is generally done before decumulation is considered (though it shouldn't be) and that's what these guys are doing at AQR. They explicitly foreswear things like decumulation and uncertain longevity somewhere in the intro.  They are instead working in the "AQR zone," which is my second point...

2. They are totally shilling for AQR. That's cool, I love AQR and they should shill.  The conclusions of the paper point directly to "buy our funds."  And a lot of retirees probably should buy AQR depending on their plan.  Doesn't mean we shouldn't guess that there is some marketing going on here.  

3. They are 100% focused on "same vol higher return."  That's only one side of vectoring an efficient frontier up and to the left.  I have this theory, that I can prove for no one but me, that before retirement I want my "EF shift" to be up, and after retirement I want it to be left, assuming "r" is adequate to the task. That vol reduction in decumulation is gold in terms of things like sequence risk and portfolio longevity with consumption present. I get why during accumulation one might make a fetish of "return for same vol" but things change afterwards. No W2-analyst or tenured academic is going to understand this in a skin-in-the-game way like I do, this feeling of the difference after the safety-net of work is gone. This sensibility is the missing link in 99% of papers I read.  M Zwecher got it in his book. 

So if I were to be simplistic, 

Before retirement:

- bias, sorta, to single period analysis and MV optimality. MPT dominates conversation

- emphasis on savings rates and the terminal accumulation value of a portfolio at horizon

- focus on returns and net growth rates and terminal value of wealth at horizon

- consumption is often downplayed or ignored and idea of consumption floors are almost unheard of

After Retirement:

- bias towards multiperiod effects, e.g., geometric mean outcomes and median terminal wealth or, say, fail rates etc, and...

- emphasis is really more on portfolio longevity and lifetime consumption utility than it is on terminal wealth (except for issues related to bequest)

- focus here is maybe more on volatility ( vs returns) as well as sequence risk

- consumption should dominate the conversation and the concept of income flooring starts to make more sense

AQR is pandering to the first of these two world's. Makes complete sense. A ton of their audience is institutional. That means fund design and fund management. Almost all of their audience knows squat about spending or annuities and the impact on retirement in decumulation.  Issues related spending and life income over a lifecycle are going to not just dominate fund-design and optimization tricks but are going to crush it.  Except at the margins, where it matters a bit.  

4. The case in the paper for alts and Risk Parity always comes back (they repeated this at least twice) to "averting capitulation and forced sales," not any inherent supremacy of the portfolio statistics over time as such though that discussion might be interesting. So, tongue in cheek here: maybe there is a fund that can be 60/40 instead of, say, Risk Parity, and then part of your 70 bps fund fee or maybe a little spiff on top of that (instead of the 1.25 one might see in an alt mutual) includes mental health and behavioral counseling.  Might be cheaper and more efficient than a RP fund...  But I guess that is what advisors are supposed to do.

On 5 years of Blogging Retirement Finance

You may have noticed that I have been remiss in attending to the blog. I have my reasons.  Among the many I can think of is the location of where I am in the lifecycle of blogging Ret Fin.  Here are the stages of blogging as I see it strictly for me: