B-Day Post and also the Cost of Retirement Safety

1. The B-day post part

Since I've passed through to the other side of another age (again, dammit) I thought I'd take a look at what that means in ret-fin terms. Let's see what has changed over the last year:

Age
Longevity expectations
Last year's returns have been realized
New return (and discount) assumptions have emerged
Last year's inflation has been realized
New inflation assumptions are in hand
Risk aversion has probably changed
Health, mental, and financial capabilities have probably changed
Another year's realized spending has gone out the door
Future spending expectations have changed
Insurability has shifted
Employability has shifted
One year closer to penalty free IRA distributions!
No doubt there are infinite other things that have changed

Frankly I do not know how people can do a set-and-forget static plan in retirement.  Me I think about this stuff not in static terms and not really even in annual terms. I won't go as far as to admit the insanity of a continuous view of things but I am willing to think in continuously adaptive terms as "big enough" change arrives...as it will now and then.

2. The Cost of Safety part

I was looking at aacalc.com again and I still marvel at how a youngish non-retired guy knows so much pretty darn advanced retirement finance math and knows it so well.  Most of his stuff I can't touch (but do appreciate).  One of his web pages talks about the cost of safety.  This is the idea that the last dollar of savings has relatively less impact on the risk of failure than the first, or as his first paragraph puts it "When building a retirement portfolio for fixed withdrawals, the first dollars of the portfolio will have the biggest impact on your retirement success, and the last dollars the least. This is because the last dollars get spent only if the first dollars are inadequate due to either poor portfolio performance or a long life span. This much is obvious, what is less obvious is the speed, extent, and location of the transition from "first dollar" to "last dollar".

While I trust his math more than my own and he typically uses more complex and theoretically correct methods than do I, I wanted to see if could more or less replicate his chart and analysis and his claim that "This means it is difficult for those seeking absolute portfolio success according to the historical data; they must save twice as much as someone who is willing to accept a 4% chance of portfolio failure."  The only way I could do this quickly was to use simulation and look at the fail rate for changing levels of endowment (500k to 4M in 100k increments [1]).  You can look at the aacalc article for his stuff but my chart looked like Figure 1. This result is not too different from his though maybe the curve is a little different in delta-slope terms and choppier too in that I was doing relatively few sim runs to speed up the analysis.  I used the same scale on x and y as the aacalc chart:

 Figure 1. The Cost of Safety

According to my rudimentary sim runs, and taking $4M as "absolutely" safe given my input assumptions (though nothing is absolute) then the cost of being absolutely safe vs. a 4% chance of failure is roughly three times as much savings required.  Using a .12% threshold for fail rate, which seems to be pointless but probably fine since that is effectively zero as well, the cost of being perfectly safe is about 2 times a 4% risk of failure.  And, just to round it out, in this set of sim runs the cost of going from 20% to 5% failure was, without getting too rigorous on interpolation, a little over 2 x the cost of going from 35-20%. [2] 

So, I gather now that I've done this: it really is expensive to be more rather than less sure about one's retirement risk.  I actually found this more useful than I expected, psychologically speaking.  I guess aacalc's claim stands. But then again I am not surprised.  

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[1] some standard assumptions in the sim: Endowment in increments, 35k constant spend, 50/50 allocation (static; his is dynamic), to fixed age 95, no SS, historical returns, return suppression of 1% for 10 years, no spend shocks or trends or variability, etc.

[2] This is not very scientifically fit but over the 1M to 2M range 1E+28W^-4.186 just about describes the relationship where W is the endowment.