More Than I (Or You) Ever Wanted To Know About Spending Variance Vs. Fail Rates.

I got a really interesting result the other day when I was shaking out some of the newer spending variance features[1][2] of the simulator I recently rebuilt. But I had forgotten, for a moment, my two primary rules of financial modeling:

2016 - Systematic Risk Strategy in Annual Isolation...

2016 looks like it has been a good year so far. I've heard of some folks hittin' 30% this year (I'm always curious about their variance; I resist the impulse to ask for a time-weighted monthly series) but that, without any question whatsoever, is not my game.  But this is:

- Green: me
- 60/40 is SPY/AGG (orange)
- Benchmark is AOM (purple) , flawed index for comparison but it's easy...and free
- Hedge Fund index (pink) is Barclays Hedge, flawed but hey, it's free
- I have < 15% stuff in GMDII that acts kinda like private equity where
  the risk, like it is in the rest of life, is not so much "variance" but rather
  the permanent loss of capital. So take that x axis with a <15% weighted
  grain of salt.

As long as I was on a roll in R...

I rewrote my mean-variance mapper/plaything in R, too.  That's it for R before Xmas.

This chart is: a 2 asset (SPY AGG) EF and a 5 asset (SPY AGG EFA IYR GLD) EF from Jan. 2014 to today.  The green dot is my trading strategy (or, more accurately, systematic alt-risk "investing") over the same time frame.  A few hours of coding now saved me a few hours of monkeying around in excel each month to generate the same thing...  A fair trade-off if one assumes that generating this in the first place is a meaningful and worthwhile effort.

What Does Opening Some Floodgates On Risk Look Like In A Retirement Plan Using a Longevity-Varying Simulator

I was running some tests on some new (spend shocks) and modified (future income streams) features of my simulator as a type of programming shakeout.  Some of what I found was kind of interesting.  For example, I ran two scenarios:

Effect on Cumulative Fail Rates by Hedging Longevity Risk With a Deferred Annuity

I wasn't really expecting this chart to look like this but it totally makes sense now that I look at it again.  In this particular case I made my 'theoretical' retirement model invest into a small deferred income annuity (enough to hedge out ~90% of 85+ spending risk).  Then, in order to finance that purchase, I sucked the related capital (the stuff required to make the annuity investment) out of my "starting pile of capital" in order to buy the annuity.  My sorta-kinda-goal in this vague quasi-analysis that I was trying to do was to reduce my overall late-age spending risk by converting some of my general risk-capital from "open and unencumbered" to "closed and dedicated to after 85 spending commitments."  This chart is what it looked like in terms of the changes in fail-rate risk. I guess that one of the basic ideas here is that one can't create something from nothing. In this case, in order to mitigate late life spending risk, the money has to come from somewhere. And in this case it comes from "early" consumption risk and then that is converted here to the risks that are "late."  If I had to characterize the chart, I'd have to say that the early risk-costs might have to be worth the late-age benefits. But then again, Ill have to think about this...  

Black line: my fail rate estimate before annuity hedging
Blue line: my longevity-adjusted fail rate estimate after hedging with a deferred income annuity
Personal Data...


A sharp eye will notice that while I thought at the outset that I was hedging out 90% of my longevity risk I did not nearly achieve that goal. That means that either I have a bug in my simulator, which is always plausible, or I don't really understand how much risk there is. Either way that will be another post.  Most likely, it's an artifact of a low base case fail rate. It's like one of those annoying life lessons I monologue at my kids: you can't, in the end, at the margin, eliminate all risk.


[postscript]

Here is another result that surprised me. I ran this while my kids were eating lunch.  I changed the assumptions to generic (standard stuff: age 65, $1m, 60/40, 4% spend, etc).  I expected the hedge to work but now I remember something from Pfau about how age and capital will affect whether it makes sense to hedge.  In this case here, the 65 year old has to spend 20% of his capital (200k.  This is based on a quote from immediateannuities.com for 8k of monthly income that splits the difference on the age85+ spending.  40k today at age 85 at 3% inflation is 72k/yr and at age 105 it's 130k/yr, so the "split diff" of 100k/12 ~= 8k/month...give or take) to hedge out a major chunk of late age spending.    In this example, the hedge does not look constructive when it comes to the baseline goal of life-cycle risk management...

Another Stab at a Longevity Hedge Analysis Using Simple DIAs

Amateur's Abstract:  Using my "hacker's" assumptions and methods on my own personal data, it is probably fair to say that buying a simple deferred annuity at my current age to hedge out a lot of late-life longevity risk vis-à-vis spending will reduce my fail rate risk by some amount that might be "worth it," it is not fair to say that it matches, dollar for dollar in present value terms, the gain in spending capacity that it (the deferred annuity purchase using my own assumptions) engenders. In other words, when it comes to buying a deferred annuity, the risk reduction benefits might have a case but spending increases might not given how I'm looking at it.

Sheer Proximity or The Purpose Of An Early Retirement

I've more often than not had a serious amount of second guesses (not the same as regret, btw) on my partially voluntary decision to retire early around age 50.  When I read about early retirement in the media and in misc blogs the sense I get, and the way it is framed verbally, is that it is all about financial independence.  An early retirement blogger that I like to read a lot, financialsamurai.com, puts it this way (indirectly because here he is talking about prestige -- but his point, I think (or am I projecting), is that prestige is a block when it comes to early retirement and that financial independence is a "good"):  

MC sim V2.201 complete and I'm done messing around with it

Ok, this sim project was fun enough but my kids are hungry and the dirty laundry is piling up. Don't ask about the sink.  In the final stretch I added a feature for a couple future streams of income like SS or annuities. On the other hand, I don't have any features for separate taxable and non-taxable portfolios or IRA start dates and the like. Anyway, I finished up. I cleaned off the desk and ran it on myself.  Before I show the image, note that: a) six or seven years ago I had fail rates that were in very high double digits, b) I started building this not because I am enamored of simulators but rather I was both ticked off at my fee-charging planner and I also wanted to learn some modern software development skills, and c) I'm not webifying this thing or making it available for commercial use.  This is just for me for the heck of it.  Now, if you were to want to send me a check or a series of checks, that's another matter altogether.  My latest version:

-fail rate under 2% for this run after a half-provision for SS was added
-30,000 sim runs; took about 7 minutes
-assumptions are private and the term. wealth axis blanked out

Here is Another Way to Look at Fail Rates

Once you let a simulator vary longevity by actuarial-type tables additional ways to view retirement fail rates become available.  Here in this post is one more way.

For example, let a simulator, given some overly simplistic and generic assumptions[1], blow out some random versions of the future  (say 10k of them) based on what little it knows, and you can get a sense of how fail rates might change with longevity expectations.  I hadn't thought of this particular one before but I've added it to the repertoire of charts I'll keep an eye on.  While personally I usually plan for the worst (worst? really?) case of 95 or 105, reality tells me that earlier ages will make more sense when push comes to shove, if you will.

This effort here, fwiw, is another way of helping me not obsess about future-risk so I can play a little harder today...rather than live like a monk fearing an uncertain future.  My SO frets that I overdo this stuff but little does she know that she will benefit if I can spend more today due to my ocd over-analysis.

Left axis - fail rate for given longevity expectation
Right axis - freq distribution of terminal age in simulation. Matches SS tables
Points - the change in fail rate expectation for increases in longevity expectation












--------------------------------------------------------------------------
[1] age 60, $1M, 4% constant spend, 60/40, some taxes and fees, no outside income, etc. etc.

Contemplating a Terminal-Age-Weighted Retirement Sim

Two things before I get to my post:

1. I'm not totally sure this advances, in any significant way, any one real person's (even my own) real retirement, and

2. Everyone and their brother -- or at least among leading personal finance researchers like Milevsky, Pfau, Blanchett, Kitces, Dirk Cotton, and a bunch of others -- have all weighed in at one point or another over the last couple years on the weaknesses and misdirects and emptiness of retirement simulators, a point of view I happen to agree with.

But...I just felt like playing around with this one more time.  In this particular case I wanted to layer in realistic probabilities for longevity into a working retirement sim and see how it goes.  I had that last year, too, but I did not have a good platform on which to play around with it. Now I do.

Weekend Links - Dec 16

QUOTE OF THE DAY

“I think everybody should get rich and famous and do everything they ever dreamed of so they can see that it’s not the answer.” – Jim Carrey

CHART OF THE DAY

RETIREMENT FINANCE AND PLANNING

Retirement Isn’t Always Fair, Boston College.  Retirement experts, including economists at this Center, urge baby boomers to hold on and work just a few more years to improve their retirement finances. But less-educated older workers often have physically demanding jobs or poorer health, making this very challenging, or even impossible. “It may well be,” the researchers conclude, “that their retirement shortfalls cannot be bridged by working longer and other solutions will be needed.”  [Comment: empathy, yes, of course, but I have to say: beware the "other solutions" if they were to be in the hands of Boston College professors]  

What Does Spending Look Like In Poor, Great, And AverageRetirement Conditions? Pfau.  

[comment: there is a hell of a lot of rules and guidelines in this article.  My advice: constant vigilance and triangulation.  There are no rules that will save you.  Each year, you have to make a judgement about what you have, what you expect,  and what you plan to do this year and for a couple years looking forward based on what you think about future returns, inflation, spending, blah blah blah.  I'll do a post on this sometime because I think rules can be a distracting crutch.  Constant, vigilant adaptation is the only plan that works. That, and making sure you have enough when you start…which means that early retirement is fraught…]

What Would a Pessimistic View of Next-10-Year Returns do to Simulated Fail Rates?

In the process of running some tests on my rebuilt simulator, I ran a set of paired tests, each one with 10x1000runs[1]:

  1. Once with a slightly modified table of historical returns,

  2. A second time with same table as a source but returns are
      suppressed in the first 10 years of each sim by a couple pct.
   

The first test had an average fail rate of 9.3% [2].
The second test had an average fail of 15.8%.

-------------------------------------------------
[1] Short runs but I didn't want to wait for 10k runs. Assumed age 65, $1M endowment, 40k constant inflated spend, 60/40 portfolio, uncertain longevity using 2013 SS life table, factor for fees and taxes, etc.

[2] Seems high but note that there are taxes, fees, and fully dispersed longevity uncertainty in there. I wish I could figure out how to feather in some autocorrelation but I couldn't.

if anyone is nerdy enough to follow this blog...

For geeks only:
I just rewrote my archaic (let's just call it a slide rule or maybe two tin cans with a string or maybe an abacus) Excel 2002+visual-basic Monte Carlo simulator -- but now in R. Was I surprised at  the efficiency? No, not really.  The gain in time for 5,000-10,000 runs? let's call it around 80%. I'll bet if I hired a programmer I could tamp that 80% down even more...but I'm not going to do that...cuz I'm cheap. And lazy. I've got 99% of what I need.  

Longevity Uncertainty 3

I was trying to build enough rudimentary programming skills in R last week that I could maybe consider rewriting my Monte Carlo simulator into something other than an old version of Excel.  Using the 2013 SS table (male) to shake out something I was trying to do with nested loops and R "lists" I ended up with this chart which is a more granular version (data for each age vs every 10 years) of a previously posted chart on longevity uncertainty that used boxplots[1] (same visual, I just needed something for each age in my exercise) . I thought I'd throw it out there as long as I had it.  For retirees, the main point is probably to think more carefully about a planning horizon before just blindly sticking "30 years" or "to age 82" into an online retirement calculator that is asking for "duration."

(+/-)std = plus or minus 1 standard deviation.  I did not label the chart well but I'm not doing it over.

[1] Given the non-normal distributions involved, the quartile boxplots are probably a better representation of dispersion than using standard deviation but then my goal was "programming training" and not statistics. Also median is probably better than mean but...same excuse.

My Personal Residential Real Estate Planning Chart

(I live in South FL)

http://thisisindexed.com/2016/11/asset-liquidity/

Weekend Links - Dec 9

QUOTE OF THE DAY

“Risk means more things can happen than will happen.” -Elroy Dimson

"Uncertainty about the future does not necessarily equate with risk, because risk has another component: Consequences."  -Farnam Street

CHART OF THE DAY

RETIREMENT FINANCE AND PLANNING

How Much Wealth Will You Have 30 Years Into Retirement? Pfau.  Considering spending and wealth are both important—as retirees should not be narrowly focused on a singular goal to avoid financial wealth depletion—financial goals for retirement can essentially be reduced to two competing objectives: to support as much spending as feasible, and to maintain a reserve of financial assets to support risk management objectives such as protecting from spending shocks or otherwise provide a legacy.  

The 'Never-Retirement' Plan: Many Millennials Plan To KeepWorking, Survey Says.  Forbes  

Optimizing Retirement Income Solutions in DefinedContribution Retirement Plans A Framework for Building Retirement IncomePortfolios. Pfau, Tomlinson, Vernon. SoA.org.   [Individual retirees can jump to page 43 first. I might've linked this before]  

Women Face 20% Higher Health-Care Costs in Retirement, SurveyFinds, WSJ.  Longevity seen as the reason for the gap with men. 

Cage Match: PMT function, RMD formula, and Divide-by-10 Rule

The other day a former colleague posed a hypothetical question related to teasing out ideas for a trust rule that would provide for an orderly, sustainable and mostly full disgorgement of assets later in the life of a beneficiary if anything sizable enough were to be left at that age for him or her.

Crude Futures Options Volatility Surface

This is another one of those unnecessary visualizations.  I was reading about vol surfaces and decided to see if I could create one for something I was trying to trade (near dated short crude calls) to see what it looked like.  This is what it looked like; first chart uses delta while the second uses strike price:

A Quick Visual of the Anatomy of a 3D 5-Asset Mean-Variance Map

I'll assume you know the principles here and some of the math. I just wanted to run through a step-wise visual of the internal structure of a 3D 5-asset mean variance map the way I've been looking at it lately. I have no idea how easily this might be discredited.  I did this for myself to make sure I understood a previous post and I'm putting it here just for the heck of it;  I'm not so sure there is any practical purpose here, this is more just-for-fun.  The charts use AGG SPY EFA IYR and GLD for the asset classes and the time frame is 34 months in 2014-2016. Returns are annualized total returns. Std dev is annualized from a monthly series. This timeframe (and data) is (are) pretty arbitrary; I happened to have done some other study earlier this year that used this same data and I was too lazy to build something different.

3D Efficient Frontier

I realized I probably got a little ahead of myself in a previous post .  Kicking out a 3D scatter-mass for 5 asset classes in return-deviation-diversification space is a bit much.  I went back and looked at just bonds and stocks (aggregate bond or AGG, and US large cap in SPY form) over 34 months in 2014-2016 to create a standard efficient frontier for two asset classes.  The allocation ranges from 100% AGG to 100% SPY.  This is similar to what you see in  most finance textbooks.  Allocating between the two adds efficiency in return and standard deviation which can be seen in how the curve bends up and left as one adds stocks to a 100% bond portfolio.  Nothing new here, I just added a third dimension that gives some depth to the allocation dimension.  The start of the GIF is what it looks like in 2D. There is not much to say here, just showing what it looks like...

Weekend Links

QUOTE OF THE DAY

"...the world is not a predictable casino game…All we can do is make intelligent estimations, work to get the rough order of magnitude right, understand the consequences if we’re wrong, and always be sure to never fool ourselves after the fact."  Shane Parrish farnamstreetblog.com

"You should fret less about getting any particular decision precisely right, and instead worry about whether you’re tackling the right range of issues." jonathanclements.com

CHART OF THE DAY

3D visualization of mean-variance-diversification for ~4500 out of >4.6M combinations of 5 asset classes (large cap US, aggregate bond, international developed, gold, and real estate) over 34 months in 2014 to 2016.  A diversification function with respect to the relative concentration of the allocations is used for the z axis.  I had the main post here. Had to give myself COTD, right?

RETIREMENT FINANCE AND PLANNING

The Five Types of Retirement, MoneyBoss.com.  You see, while the idea of retirement might be relatively young, it’s achieved a level of complexity that I find fascinating. Retirement is no longer one thing. It’s many things. Or many possibilities. I thought it might be fun to visualize what I consider the five most common kinds of retirement in our current economy. 

How to Understand the ‘Probability of Success’ Metric forRetirement, David Blanchett in the WSJ.  The simplicity of “success” in this metric belies the complexity of “probability.” Because no one can predict the future, this approach requires a bunch of random projections that can be used to estimate a probability.  A better name for the metric would probably be “educated guess,” but that doesn’t sound as mathy.  

Visualizing A Missing Piece of Monte Carlo Simulation in 3D

Running out of money at 75 and living to 95 is much more catastrophic than depleting savings at 84 and dying at 85, but both cases are treated the same in determining failure rate. - Joe Tomlinson

One of the many and manifest shortcomings of doing MonteCarlo simulation -- along with: a) the opacity of the meaning of a fail rate, b) the insufficient acknowledgement of likely behavioral changes in the face of an early fail warning, and c) the usual lack of a proper "triangulating context" ... among other things -- is the failure to quantify or visualize the magnitude of the "fail:" what age, how long, how much, etc.  This is often commented upon but I have never seen it visualized.  It may be out there, I just haven't seen it.  So with my new playthings (beginner-level R and scatterplot3D) I thought I'd throw a visualization out there just to see what it looks like.

3D Mean-Variance-Diversification Model 2014-2016

This was kind of fun.  This is the mean-variance space for portfolios of SPY AGG EFA GLD IYR ~2014-thru-Nov2016 but with a third dimension added based on a diversification function (e.g., low value is concentrated 100% in one asset class; a high value would mean the allocation is spread evenly across 5 asset classes). This 3d space is an efficient frontier using something like 1% of possible allocations of 5 assets if done in 1% allocation increments (~4500).

Book Mention: Quantitative Momentum by Gray and Vogel

This does not rise to the level of a "review" so we'll call it a mention.

Quantitative Momentum (Wiley Finance, 2016. 208 pages)  is a great new work on momentum investing by Wesley Gray and Jack Vogel. It follows a previous work (not read by me yet) Quantitative Value.  QM is a well researched and appropriately analytical contribution to the literature on the momentum anomaly.  It is good, as would be expected, at giving a background and rationale for the momentum effect.  The book also makes a good case for the place for momentum in a portfolio while also being particularly helpful with some of the concepts of implementation.  It is not over-the-top technical in terms of academic finance and mathematics (no calculus or limits or summation notation as far as I saw in a brief read) and I think it is approachable to a retail investor who has at least a little background in or exposure to the various concepts involved in understanding alternative risk.  

Simple Deterministic View of the PV of Spending Rates vs Longevity

I had no real reason for doing this other than I was curious what it looked like plus my SO forced me to think about this after I got a "don't worry, pat on the head" kind of thing.  No one seems to think much about longevity uncertainty these days except the academic researchers.

Weekend Links - Thanksgiving Edition

QUOTES OF THE DAY

More technically, to implement the portfolio construction suggested by modern financial theory, one needs to know the entire joint probability distribution of all assets for the entire future, plus the exact utility function for wealth at all future times. And without errors! … We are lucky if we can know what we will eat for lunch tomorrow –how can we figure out the dynamics until the end of time?
   --Nassim Taleb 

Efficiency is Beauty.  -- Mr. Money Mustache

CHART OF THE DAY

RETIREMENT FINANCE AND PLANNING

Joe Tomlinson on Variable Withdrawal and ImprovingRetirement Outcomes, my post on his post...  Optimal asset allocations for variable withdrawal strategies are quite different from the research findings and rules of thumb based on fixed strategies. Indeed, the implications go beyond asset allocation and show, for example, that equity glide paths in retirement are relatively unimportant. 

Savings after Retirement: A Survey, Nardi et al.  NBER and Fed (Chicago and Richmond).  The saving patterns of retired US households pose a challenge to the basic life-cycle model of saving. The observed patterns of out-of-pocket medical expenses, which rise quickly with age and income during retirement, and heterogeneous life span risk can explain a significant portion of US saving during retirement. However, more work is needed to distinguish these precautionary saving motives from other motives, such as the desire to leave bequests. Progress toward disentangling these motivations has been made by matching other features of the data, such as public and private insurance choices. An improved understanding of whether intended bequests left to children and spouses are due to altruism, risk sharing, exchange motivations, or a combination of these factors is an important direction for future research.  

What is synthetic tenure, and why is it important? Benefitnews.com  

Retirement Spending, the RMD, and the PMT() Function. Blanchett, Maciej, and Chen (2012) and Sun and Webb (2012) both studied the RMD rule as a spending option and found it to be a reasonable strategy that roughly approximates more sophisticated attempts to optimize spending... Though these methods are more sophisticated, the underlying PMT formula remains as the philosophical core of the spending recommendations.  [comment: I have posted on this (i.e., PMT()) before in a discussion of Waring and Seigel's Annually Recalculated Virtual Annuity(ARVA)]

On Being Careful - Dividends, Part 2

I wanted to take one more look at this question of dividends that I started to address in a previous post On Being Careful… .   And it is not because I am a partisan of dividends or because I wholly buy the party line of dividend-growth-ers. In my calmer moments I still feel that total return is a game to aspire to especially if one has very long timeframes and does not have a large spending requirement, requirements that if turned the other way around might actually give me pause when contemplating concepts like MPT and total return .  I want to take a look at this again because the "emphatic absoluteness" of the statement by an industry expert (“there is literally no logical reason for anyone to have a preference for dividends”) is still ringing in my ears.  

Joe Tomlinson on Variable Withdrawal and Improving Retirement Outcomes

I might have linked to this article before but Joe Tomlinson, in a recent article at Advisor Perspectives (How Variable Withdrawals Improve Retirement Outcomes, Joe Tomlinson. 10/17/16), had a nice distillation of his recent thinking and research on variable withdrawals, asset allocation, and the use of annuities to improve retiree outcomes in terms of consumption, shortfall risk, and legacy planning. I thought I'd add a little personal commentary.  It is a short article that is easy enough to read and it probably does not require a set of bullet point extracts but here they are anyway:

Weekend Links

QUOTES OF THE DAY

Those that prosper consistently will think deeply, reevaluate, adapt, and continually evolve. That is the nature of a competitive world.  -- Farnham Street, Moneyball edition  

“No one can afford anything anymore.” SquaredAway Blog


CHART OF THE DAY

RETIREMENT FINANCE AND PLANNING

U.S.Life Expectancy Now 6 Months Shorter, FinancialAdvisor Mag.  The average 65-year-old American man should die a few months short of his 86th birthday, while the average 65-year-old woman gets an additional two years, barely missing age 88. This new data turns out to be a disappointment. Over the past several years, the health of Americans has deteriorated—particularly that of middle-aged non-Hispanic whites. Among the culprits are drug overdoses, suicide, alcohol poisoning, and liver disease, according to a Princeton University study issued in December…This is bad news for almost everyone but pension fund managers…Still, the bottom line is that longevity’s rise has slowed way down.    

A New Tool to Visualize Retirement Planning, Bob Veres.  

The Other Inflation

The results are in for 2017. All I have to say is that if you have an ACA subsidy or if you are employed or if you are over 65, go hug your family and tell them it could be worse.  Me? The spread between health care inflation and "normal inflation" for early retirees who are on their own without a subsidy means they need to take money from one pot (let's say kids or future retirement capital or current lifestyle for example) to pour into another (incremental increases in health care costs under the ACA).  And this time its not pretty.  I finally get, viscerally, the concept of inflation as a tax. Here's what it looks like for me going as far back as 2010:

The top is time series change of costs since 2010. That's regular inflation in red (CPI-U inflationdata.com) and average employer based insurance, single coverage, in grey (Kaiser Family Foundation Survey 2016). My health data is in dark blue.  The bottom in light blue is year over year % change.

My 2016-2017 % change: ~47%
My 2010-2017 annualized rate: 16.3%

Yield Curve 2016 YTD

An Epidemic of Despair

"Quiet ‘Epidemic’ Has Killed Half a Million Middle-Aged White Americans"

"Despite advances in health care and quality of life, white middle-aged Americans have seen overall mortality rates increase over the past 15 years, representing an overlooked "epidemic" with deaths comparable to the number of Americans who have died of AIDS, according to new Princeton University research."

"The results are published in a new paper in the Proceedings of the National Academy of Sciences from Anne Case, the Alexander Stewart 1886 Professor of Economics and Public Affairs, and Angus Deaton, the 2015 Nobel laureate in economics and the Dwight D. Eisenhower Professor of International Affairs and professor of economics and international affairs."

                                               
The items above are from "Rising morbidity and mortality in midlife among white non-Hispanic Americans in the 21st century" Woodrow Wilson School, Princeton

from Proceedings of the National Academy of Sciences

[Comment: This graph above is one of the more interesting, if not startling, ones I've seen this year]

Weekend Links - Election Week

QUOTE OF THE DAY

After all, civility doesn’t require consensus or the suspension of criticism. It is simply the ability to disagree productively with others while respecting their sincerity and decency. That can be hard to do when emotions run so high. But if we understand better the psychological causes of our current animosity, we can all take some simple steps to turn it down, free ourselves from hatred and make the next four years better for ourselves and the country.   - Jonathan Haidt and  Ravi Iyer in the WSJ


CHART OF THE DAY

RETIREMENT FINANCE AND PLANNING

How to Navigate and Prep for a Surprise Early Retirement, WSJ.  Understanding where you are financially will give you a sense of control amid a retirement that may be out of your control, financial advisers say. 

A Portfolio Approach to Retirement Income Security, Steve Vernon.  With the decline of traditional pensions, many older workers and retirees urgently need to decide how to make their retirement generate income that lasts for the rest of their lives. With retirements that can last 20 to 30 years or more, this is indeed a daunting challenge for those fortunate enough to have significant savings by the time they retire. 

Before Retiring, Take This Simple Test, WSJ. Many choose to retire too early, much to their regret financially  

Retirement health care estimates vs. reality, financial-planning.com.  Health care costs are one of the largest—and potentially most variable—expenses in retirement. Unfortunately, many clients either ignore these expenses when they make a retirement income plan or make woefully inadequate estimates. A study of almost 2,000 adults by Fidelity Investments found that 48% of respondents estimated they would spend $50,000 per person for health care in retirement. That's a low number according to most published research. Most data illustrates a starkly different scenario, suggesting substantially higher costs.  

The Downside of Retirement, Darrow Kirkpatrick.  Yes, retiring is great fun for most people, at first. 

On Being Careful - Dividend Edition

"In theory there is no difference between theory and practice. In practice there is."

            -- Generally attributed to Yogi Berra

I think that really smart guys that have a little above average visibility in the financial blogosphere have a slightly higher bar than others when it comes to being careful in their commentary.  Me? I could sling whatever I want around my blog and it means almost nothing.  This thought came to me as I was listening to a blog/podcast at Meb Faber's site that consisted of a conversation between Meb (a blogger I like and respect and whose blog I read often -- co-founder and the Chief Investment Officer of Cambria Investment Management) and Larry Swedroe (another guy I like and respect -- principal and director of research for Buckingham, an independent member of the BAM Alliance and a contributor to many finance conversations, especially at ETF.com) on dividend strategies.   

What got me going was the title of the podcast: Episode #28: Larry Swedroe “There Is Literally No Logical Reason For Anyone To Have A Preference For Dividends” November 9, 2016.    My first reaction was not necessarily that I disagree, it was that as an early retiree I know that a few holes can be punched in the absolute apodictic certainty of the tone of that title. Let's try to lay out what I think I mean here.

Longevity and Uncertainty 2

I was looking back at some of the longevity stats in my previous posts and realized that the mean and standard deviation are less helpful in non-normal distributions -- the distribution implied in the SS tables is clearly not normal -- so I thought I'd recast it in quartiles to see what it looks like.  Not sure if I got this completely right; maybe some math-enabled person can correct me at some point.

Polling gap

This is already 24 hrs old but I thought it was interesting going into today's final lap.

Longevity as a Moving Target

I've seen this (and posted on it) before elsewhere but this is what happens to your longevity estimate in your retirement plan when you get the good news you have survived yet another year. This ignores medical advancements that will change the equation, too. Don't forget that if you have some socio-economic edge, the estimates will nudge up as well.

It's been A Long Trip Down "Trading Lane"

I remember reading "Trading for a Living" by Alexander Elder back in 2005 when I was just starting to dabble in trading systems.  I can't remember if it was in that book or in some article I read or in some conversation with a trading mentor but the prevailing idea has always been that 95% of people that attempt to trade (usually middle aged guys [and it's almost always guys isn't it], say 40-55, with a technical or professional background in engineering or software or law or medicine who think that success in one field logically and necessarily translates to the next…maybe a little like Michael Jordan trying to play baseball, for example. I fit this profile, too, btw.) fail when starting to trade and they usually fail three times -- the first time with their own bankroll, the second time with someone else's money and the third time with the last few desperate pennies extracted from the tightly closed fists of friends and family.  The idea out there was also that there was some kind of multi- year process where it took something like 2 years (maybe more) to lose money, then 2 years (maybe more) to break even, then 2 years (maybe more) to make a modest profit, and thereafter it is supposed to work out OK.  Keep in mind I am talking here about retail traders that are doing it solo without the institutional support and systems and mentorship that can make corporate 20-somethings wildly successful and rich.    I was also advised once that since people can't expect to become a successful engineer or a cardiologist or an attorney without sinking some serious time (years) and effort and money (100s of thousands in those examples) into education, apprenticeship, and career development, they can't then expect to just step right up to a computer and shake a stick at a few moving averages and make a mint.  I, of course, believed none of it.  I thought that, like an alchemist looking at a chunk of lead, I could unlock riches just doing a little magic here and there.  

Short Crude Puts Might Be Worth a Look?

Weekend Links - Fri Nov 4, 2016

QUOTE OF THE DAY

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

CHART OF THE DAY

RETIREMENT FINANCE AND PLANNING

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

Life Expectancy and Uncertainty

A better title to this post is the question I really wanted to ask: "how wide is one standard deviation in life expectancy estimates for a 58 year old guy in Florida." The answer to this kind of question is more than likely covered better elsewhere in some kind of technical finance literature.  It's probably also only one Google search away but I wanted to run it out myself just to see how it went.

Home-Rolled Systematic Alt vs. What Benchmarks?

Since my trading strategy tends to lean heavily on momentum and trend following I generally don't use the S&P500 as a benchmark since that would imply a comparison to a strategy that is 100% allocated to Large Cap US equities...which I do not do in my strategy or elsewhere. That's a comparison, though, that is always out there in the media but I happen to find it to be meaningless most of the time. When I am being honest with myself I compare my "active" self to either a mean-variance map of various multi-asset-class allocations (that's in a past post I did. It would represent a comparison to a whole bunch of asset allocations that I could do passively if I were not trying to be active) or I can compare myself to various benchmarks more closely related to what I actually am trying to do specifically. For example, for benchmark evaluations, I can compare the strategy to a particular asset allocation benchmark (e.g., S&P Target Risk Moderate Index which is something like 50-50 or 40-60 equity bond allocation -- think iShares AOM even with its imperfections) so that I can compare myself to a realistic representation of what I might have done in a passive portfolio that is more or less similar what I do elsewhere as a normal asset-allocating retiree investor.  That, by the way, is a classic comparison of "do something" (me) to a "do nothing" (target risk index) baseline which is a fair comparison and I do make that evaluation often. It sort of answers the question "am I adding any value by being active."  An alternative (no pun intended), since I do a lot of trend following, is to compare myself to the professionals running managed futures private placements or managed-futures-based mutual funds.  In this case the comparison strategies supposedly follow a rule-based and trend following template vaguely similar to what I do. That means that I think it's a fair comparison of head-to-head trading skill...or at least that's the conceit.  I make the weird assumption, though, based on very little, that these guys know what they are doing and that I, for the most, part don't. That's debatable either way, I guess.  In any case, a bad relative performance by me when compared to the MF benchmarks, net of fees, would probably lead me to drop my self-managed active strategy and then either outsource to others (if that approach were to still be accretive to my efficiency...a different analysis altogether) or retreat to an entirely passive allocation.  In other words this benchmark thing is a decision tool, and an important one at that.  This, for what it's worth, is a time series of my strategy vs. a few managed futures funds (my benchmarks):

That's me in the green.  The other three lines are two private placements in managed futures and one managed futures mutual fund.  The time frame is 2012-2016 (untested by a downturn, fwiw). I blocked the names out because I don't remember if I signed something in the placements preventing me from showing their results.  The purple line is a private placement that is relatively well known and that I have some respect for.  The red line I dropped this year because, well because look at it.  The blue line is an off-the-shelf and well known managed futures mutual fund from a large provider of systematic alternative-risk funds.  I like those guys too but I'm still paying them 120 bp which I guess isn't all that crazy all things considered. Better than 2 and 20 is the best I can say.

Conclusion?

Given what I do, it's probably a good and fair comparison to use managed futures funds as a benchmark which I will continue to do in addition to using an asset-allocation-based index for a baseline. Fwiw, I think the purple line has a lot of potential to either sink me or sail past my strategy so we'll see over time whether I can keep up.  For now, I guess I'll conclude that I'm still in the game, if not ahead[1], when looking at it like this and I'm kinda gratified that I can hold my own (and not pay 2 and 20!) over more than 4 1/2 years against guys that get paid way, way more than zero.  Me? I get paid zero.  

Weekend Links

QUOTE OF THE DAY

“We didn’t give ourselves the participation trophies, just saying!”  -A millennial 

CHART OF THE DAY

RETIREMENT FINANCE AND PLANNING

The 3 Stages of Retirement Income, Darrow Kirkpatrick.  Based on my experience living in retirement, I’m seeing three irreversible stages of retirement income. Once you leave each one behind, you’ll be fully dependent on only what’s left….  

Floor And Ceiling Retirement Spending, With A Twist, W Pfau.   

The Implied Longevity Curve: How Long Does the Market ThinkYou Are Going to Live? Milevskey et. al. Journal of Investment Consulting Vol 17 2016.  In other words, over the past decade markets implied an improvement in longevity of between six and seven weeks per year for males and between one and three weeks for females. Although these values are implied from quotes, they are consistent with forward-looking demographic projections… This research is relevant to practitioners interested in the optimal timing and allocation to life annuities as our results indicate that annuitization procrastinators are swimming against an uncertain but rather strong longevity trend.  

One More Update on an Amateur Alt Risk System

I realize that this is a little repetitive with some past posts I've done but I wanted to throw this out there again because I think that the Fed and interest rates changes are going to kill me later this year and I just wanted to again claim a brief moment in the sun before that happens.  This chart is my core strategy put up on a mean variance map against portfolios of random combinations of either 2 or 5 different asset class ETFs: Bonds, US Large Cap, International developed, Real Estate, and Gold. That is my imperfect representation of stuff that could be plausibly stitched together into a retail allocation.  That and the data is easy to get. I know that posting this chart (especially given the short amount of time covered) can be a type of soft boasting which, if the literary canon of the last 3000 years (and market experience over the last 100) means anything, means that I will likely get my face rubbed in that boast sometime soon but here it is anyway.  

     as of 10/26/2016    2014-Oct2016. 

The strategy itself is more or less this: fixed income momentum using mostly etfs + macro exposure (mostly forex, interest rates and commodities) + short volatility (mostly short futures options) + other (a messy collection of stuff I perhaps shouldn't be doing).  All of this sits on top of what I can only call an assertive, if not dangerous, interpretation of a collateral-yield program.  

Another reason for putting this kind of thing out here again without the details is to convince myself, if not others, that a retail/amateur investor can in fact create an edge in the capital markets and deploy his or her own capital in an efficient manner without high minimums, long lockups or out-flow-gates, and onerous and unpleasant and often unearned fees…at least for a short time. I mean really, look at hedge fund results this year.  90% of these guys are overpriced under-performing bozos (keep in mind I have awestruck respect for the ones that are at the very top of the industry but they are few and far between and not accessible to me). I realize that the kind of active investing/trading implied in the above is not everyone's cup of tea and requires a little bit of time and effort but it is at least doable.  For me, this is not a full time job...at this point, anyway. 

Yield Curve Range Since 2011

from here

Watch the World Get Better

Press play on the embedded image and watch the world get better for a change.

Fail Rate Estimates vs. Number of Simulation Runs

The Votes Are In

My reader poll is done.  The question was whether I should keep doing this or move on.  Ignore the fact that I've found this "what I've been reading lately" linkfest to be totally ruinous to my eyes, the weight of the poll is upon me especially since I got a 100% "keep going" vote.  We'll also ignore that it was one vote. I think the mandate is clear.

Weekend Links

QUOTE OF THE WEEK

If you drove drunk but got home unscathed, you wouldn’t wake up the next morning and think, “I guess it’s okay to get behind the wheel after 13 beers.” Yet, when handling our finances, we do that all the time.  Jonathan Clements

CHART OF THE WEEK

RETIREMENT FINANCE AND PLANNING

Reverse Mortgages: When the Last Resort is the Best Resort, Dirk Cotton.  If you expect to remain in your home throughout retirement, my advice is to consider opening a HECM line of credit today, while interest rates are low and the maximum HECM loan value is high, but to hold off on spending much of it until you see what life has in store. Often when spending home equity, the last resort will prove the best. 

How Variable Withdrawals Improve Retirement Outcomes, Joe Tomlinson.  Once a retiree secures funding for essential spending needs, the remaining assets are “liberated” and can be invested more aggressively. [comment: I can't recall a single article by Joe that I have not found useful and insightful] 

I'm Not Immune to the Charms of a Possible Silver Trade

I was looking at silver futures today and I'm thinking it's possible there are some opportunities on the short side of future's options.  My point of view on fundamentals is that I don't think it's going to run a lot either way...but I can't support that here in a post very well since I don't have a lot of research at my finger tips.  Technically, the signals aren't stacking up strongly either way as far as I can tell so selling premium might not hurt.  The premiums seem to be ok -- not perfect, just ok -- and far enough out in a lower risk zone that it might be worth a look.  I'll be keeping an eye on this over the next week and doing a little research to see what I can gin up.  So far, as of today, this is what it looks like to me, with strike prices on the x axes.  Getting 2-300 for deltas under 10 for a couple months of time decay isn't too bad but I might be wrong. No doubt I'm missing something so I'll take my time.

A Dirty Little Piece of Braggadocio

I run, as a sideline, a hobby perhaps, though with a just-slightly-less-than-trivial grubstake, a systematic alt risk strategy that is more or less this: (fixed income momentum)+(macro)+(short vol)+(other).  Let's call it an incoherent hodgepodge of non-correlation strategies I thought I could manage based on all sorts of things I've picked up here and there over the years working in areas like consulting, trading, hedge funds, etc.  I have posted a bit on this elsewhere.  Mostly, if not entirely, rule based, I've been running this thing from somewhere around Q2 2011 [red flag: I am not tested by '07-'09!] thru today with minor twists and turns in strategy here and there over the years.  I have to say that during most days, weeks, months and years over that entire slice of time I have had serious and entrenched and ongoing doubts about whether what I am doing is accretive, on the margin, to my family's financial world, a financial world where the mistakes could be fatal to me and my kids if I get it wrong (that means I test everything, all the time, to make sure).  That also means that I have had a total commitment, every step of the way, to the proposition that the absolute millisecond I am convinced that it, this thing I do, is not adding to my overall efficiency, I will walk away...with no regrets...ever.    On the other hand, for a brief shining moment, I think I can say that I am doing ok. Tomorrow is another story but today is ok.  This is what I see YTD 2016:


+04.70%   S&P total returns
+04.29%   Barclays Hedge Fund Index
+00.15%   Barclays CTA index
- 01.56%   Credit Suisse Hedge Fund index
- 01.08%   Credit Suisse Global Macro index
- 03.24%   AQR Managed Futures returns
+04.30%   AOM asset allocation ETF*

+08.90%  RiversHedge "junk" strategy


Ah, but what about volatility you say?  I have no idea right now but every time I've checked on this over the last 5 years, the RiversHedge "junk" strategy has had substantially lower vol than all of that other stuff. Every time I put this on a mean variance map I seem to do ok (there are posts on the site that have the goods on this). I was too lazy to look at this issue for this particular post but I am confident that my Sharpe Ratio is on pretty solid ground here.  This is not a public accounting kinda thing so I guess you'll have to trust me for now.  Like I said in the title, I'm just doing a dirty little bit of bragging before everything goes south.  You know, a pride-and-fall kind of thing.





* Last time I checked this was 40-60 to 50-50 stocks/bonds.  Depends on when one looks.  I also need to dbl chk returns of AOM and S&P since the allocation index returns are a little too close to the S&P.  That confuses me but I will retreat to the hedge I've used before: no one reads this stuff so the stakes are low...

Weekend Links

QOTD

It’s hard to know the difference between “Be patient” and “Change your mind when the facts change.”  Morgan Housel

CHART OF THE DAY

      Withdrawal rates in retirement vs retirement duration in terms of fail rate estimates. 

       If I remember correctly this was from retirementresearcher.com.

      

RETIREMENT FINANCE AND PLANNING

Seeking A Fixed Percentage Approach To Retirement Spending, Pfau. 

Pension Section News – Sep. 2016, Society of Actuaries. Selected Articles:

• Thinking About Spending in Retirement: Findings From SOA and EBRI Research By Anna M. Rappaport
• Decumulation Strategy for Retirees: Which Assets to Liquidate  By Charles S. Yanikoski
• Decumulation for a New Generation  By Elizabeth Bauer
• Multiple Objective Asset Allocation for Retirees Using Simulation By Kailan Shang and Lingyan Jiang
• Decisions Misaligned With Priorities: The Non- Annuitization of Retirement Savings By Paul J. Yakoboski

Trading Time for Money

I keep bumping up against various option selling pros both online and in books that are pretty convincing about the idea of "trading time for money" -- by which they mean: get away from the common wisdom of option sellers that are focused on less-than-30-day time decay range "standard" -- in order to collect more premium for less risk. This is taking liberties with paraphrasing, of course, but their main case, which I think in general is more correct than not, is that by going further out in tenure (2-6 months tenure rather than 30 days or less) there is a sweet spot in time decay that provides some benefits like:

Another Case for Selling Options

This post is a pass thru post but I thought, since I often write options, that EconomPic.com had some good points on short-option strategies in an expensive market that were worth pulling out of the usual linkfest I do on Fridays.

     The Case for Put Writing in an Expensive Market

Hurricane in my hood

Weekend Links

QUOTE OF THE DAY

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

CHART OF THE DAY

RETIREMENT FINANCE AND PLANNING

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

Child Labor

From OurWorldInData.com

Highway 12

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

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

Recalling 1987

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

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

On the Virtue of Risk Management Rules

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

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