Aug 31, 2018

My 2 cents on buybacks

Talk of buybacks has been in the the air lately on twitter, blogs, papers, etc.  I get the basics, Modigliani and all. Dividends, buyback, investment (projects) are what the company does with surplus.  I have no problem with this and I certainly agree with the recent pushback by the fin-twit crowd on the intellectual vacuousness, if not intellectual adolescence, of the anti-buyback crowd.

I have no real comment on dividends or buybacks as such, though I do happen to enjoy receiving dividends for my own reasons.  But let's call all three methods more or less equivalent and worthy and defensible propositions that have some variation on taxation and efficiency.  Except, I guess, sometimes for the third...

I point out investment (projects) in particular because supposedly that is what is being "starved" according to the critics with ill effects due to the starvation, I suppose they'd say, on employment and income inequality. I also point it out because I have seen no small number of "projects" with my own eyes.  As a former management consultant with a global consulting firm, I have been in or near many "projects" over the years.  And here's the deal.  On all but a few, all of the people should have been fired and the project shut down given the foolishness of the plan, the incoherence, the waste, the inefficiency, the errors, the weak management... I get it. It's a portfolio concept and some have to fail. But there was a lot of fail.

Maybe this makes "their" point about employment and certainly I never wanted to get fired for being on one of these crappy projects.  But now, as an investor, the idea that a corporation, on which I have some small claim, would -- instead of paying out my surplus in a dividend or buy back some or all of my shares or put it into the very very best of growth opportunities...for me -- pour it into one of these ill advised and poorly managed projects? It's a form of thievery. Or at least it's a form of burning money in a greasy pit. I'd take a buyback any day. There are plenty of productive things I could do with the cash.

Aug 30, 2018

Endowments, Retirement and Spending

I was recently following a twitter thread on a question about endowment targets.  The proximal question at the top of the thread was "Is 4% real a reasonable target for an endowment?" I didn't jump in on that because (a) I am a fin-twit coward and newbie, and (b) at first I was confused about whether they were talking about returns or spend rates, but it did get me thinking.  My first thought was that it doesn't matter whether it was spending or returns because those issues are necessarily and importantly intertwined (a point often forgotten or ignored) and the second thought was that they were asking the same question about endowments that retirees do when they talk about sustainability of their retirement portfolios over time.

Of course there are differences.  Taxation is different, endowments are generally perpetual, there is often a dedicated and experienced staff, and, importantly, they have contribution inflows (that's what I need! gofundme...). In addition I guess there are some other soft issues like politics to consider. No one (yet) is asking me to divest from energy or tobacco.


Aug 29, 2018

Retirement as Jazz

From the Flaw of Averages by Sam Savage:
"The form of reasoning based on "subjective degrees of believe about the uncertain future" is like improvised jazz, in which the musicians commit to their own notes in advance of knowing with certainty what the others are going to play. If there were a field of statistics to deal with black swans, it would be this improvisational form."

"...but let's not forget that many jazz musicians have had classical training..." 

Aug 27, 2018

A 2nd attempt at viewing retirement choice as a type of real option - preliminary

Summary

This is an exploration with untested and un-reality-checked ideas on "retirement as a real option." This is just for fun and self-learning and the conclusions are going to be thin. Skepticism is warranted.

What feedback I do have from this effort looks a little similar to other work I've seen that tells me that, up to a point, holding a risky portfolio has some option value that is accretive to undefined bequest plans and maybe to an undefined and unscheduled decision on when (what age) to eliminate risk in favor of something else...like lifetime income. But that is a pretty indirect inference. And also well known already.

The Point of this Post

In a past post I tried to look at retirement as a "real option" by using an annuity boundary as a strike price. This was in order to do (via simulation, not Black Scholes) an amateur reproduction of some work by smarter ret-fin guys than me so that I could learn something new, especially about the benefits of not annuitizing "just yet."  In this post I wanted to look at the idea again but now without the annuity boundary and this time with some variation in spend rates and return assumptions. In addition I wanted to also try to discount the intrinsic-value results at expiration with a conditional survival probability.  The goal here, by the way, is "self-learning" and just to "see what it looks like."  At this point all of this is pure play and I'm not sure if my assumptions and approach are on solid enough ground yet to make any conclusions if they are even meaningfully interpretable in the first place. More on that later.

The other reason I'm here on this is that so many of my posts seem to focus on the negative: sequence risk, ruin, wealth depletion, disutility, mortality, etc. Dark stuff.  It's easy (for me) to forget that one of the many reasons to hold a risky portfolio -- and not 100% bonds or life income annuities or TIPS ladders with a side portfolio -- is that it represents a big upside option above and beyond providing what it is supposed to provide: reasonable probabilities of funding consumption. It is an option to get access to additional lifestyle growth, bequest motives, etc. that might otherwise be foregone.  That means the option has value, up to a point, in the context of finite, random life.  This is a second attempt to try to see and understand the process and "the point." My guess is that it'll take a while and more than this preliminary and flawed post for me to get there.

Aug 21, 2018

Spend Rates by Age, Wealth Level, and Risk Aversion in a Lifecycle Utility Model

Summary 
  • Wealth looks like it matters in determining the spend rate optima in the analysis but as far as I can tell only indirectly in the sense that lower levels of wealth support lower absolute dollar spend rates and those spend rates present less of a "cliff" over available income when wealth is depleted.  There is a lower height to fall from when consumption depletes wealth and then drops to available income. That means higher spend rates in a low wealth situation are not penalized as severely (in the utility math) as they would be for larger wealth and bigger falls.  
  • Optimal spend rates tend to go up with age, though this is already known.  But in this model, it appears as if the impact of the previous point is accelerated or accentuated at later ages as longevity probabilities come in a bit.   
  • Risk aversion, in this model, has a significant impact on optimal spend rates as well as the rate at which spend-rates change for changes in wealth and age in the presence of pensionized income like social security or annuities. The means and methods of measuring risk aversion in real life are beyond me. Contemplating the idea of the stability of risk aversion over time makes me woozy.  

The Point of the Post

The goal of this post is to use a lifecycle utility model [1] -- one that anticipates a "wealth depletion time" i.e., a time interval in the late lifecycle when non-pensionized wealth runs out and consumption snaps to available income -- to evaluate "optimal spend rates" by optimizing a value function (expected discounted utility of lifetime consumption) that is calculated across different spend rates, wealth levels, a range of ages, and different coefficients of risk aversion.

This exploration is neither sufficiently rigorous nor exhaustive enough to make hard conclusions or recommendations about spend rates. There are too many dials to turn...and one has to accept the model as meaningful in the first place. The exploration, rather, is intended to help me see the general shape of lifetime consumption utility in terms of spend rates and in graphic form.  It also helps me shake out the software one more time. 

Aug 20, 2018

Wealth and spend rates in a lifecycle utility model - preliminary

This is a quick, preliminary look at how the lifecycle utility model I've been working with lately might handle changes in wealth for difference spend rates. This post uses the WDT model mentioned in the past (link explains how the value function works) and a set of generic quick-look assumptions[1].  As a quick, informal pass, there are limits to what I can conclude but let's try this:

Aug 15, 2018

A quick peek at consumption utility with a deferred annuity

SUMMARY 
  • [note -- this is a casual and mostly non-rigorous post]  
  • It's been well known before I ever came along, that risk pooling can enhance consumption utility by hedging out longevity risk and shifting it to the pool or insurer.  This post is doing a quick drive-by to see how much spending might be nudged under some narrow, artificial and simplified assumptions using my lifecycle model with a deferred annuity (DIA).  
  • Last year I estimated, in another casual post, that if one were to try to keep risk the same (i.e., holding ruin risk constant in a ruin-risk-based simulator at that time) when hedging out a minimal level of age 85+ consumption with a DIA, one could increase spending ~14% (the way I did it then). This time, using the lifecycle utility model I recently built, and hedging out some of age 80+ consumption with a nominal DIA representing a "consumption floor," one can, under some generic, arbitrary, and very simplified assumptions, perhaps increase spending between 10-20% (or more) while keeping "discounted lifetime consumption utility" the same or higher. This is apples to oranges, of course, and probably optimistic, but the general magnitude still makes sense and is consistent with the results from last year.  

THE POINT OF THE POST

This is a drive-by look-see to see what happens in a lifecycle utility model when some portion of wealth is allocated up front to a DIA intended to support very late age (if any) consumption.  I had done something similar last year with a standard Monte Carlos sim and this question, reposed to myself this year, was a chance for me to add some code to my WDT-utility model to be used for working with nominal streams of income in addition to what I already had. In this case I was thinking about DIAs or pensions.  In this post, I'm taking one tiny set of shoot-from-the-hip parameters and taking a quick shot to see what happens.  I realize that this kind of DIA analysis has been done before quite often. I just wanted to shake out part of my model for some new features and to do a superficial validation of the spend increase benefits of hedging longevity that I had tried to do last year.

Aug 14, 2018

Hindsight 12 - No Math Will Save Me or The Most Important Equation

When I first saw my retirement[1] risk a few years back I was a little shocked. I thought, shortly thereafter, that trying to understand retirement finance would help. Which it did...quite a bit.  But the real conclusion, over more than a few years, is that it is not really about the math. And this should not have been shocking.  It is about everything else, too.  Since this blog leans on retirement finance so often, let's set up "the most important equation" like this:

RS = f(W, A, Ce, U, B, H, Z, MPIF, O)

RS: Retirement success

is a function of...

RH Links - 8/14/18

QUOTE OF THE DAY

Think, when reading the following, of a constant inflation-adjusted spend rate, set at the beginning of retirement, and then never revisited...

“Life is a process of becoming, a combination of states we have to go through. Where people fail is that they wish to elect a state and remain in it. This is a kind of death.” Anais Nin 

RETIREMENT FINANCE AND PLANNING

How screwed are you when it’s time to retire? Allison Schrager @ quartz.com
Saving enough, managing investment risk, and knowing how much you can spend in retirement is hard. https://qz.com/1335391/how-screwed-are-you-when-its-time-to-retire/

Divorce Very Bad for Retirement Finances, Boston College
When a marriage ends in divorce, there are no fewer than seven ways that it could damage a person’s finances…for most people who divorce, their retirement finances will take a hit. The good news is that divorce rates, having peaked with the baby boom generation, are now in decline. http://squaredawayblog.bc.edu/squared-away/divorce-very-bad-for-retirement-finances/

New research on loss aversion is causing me to think deeper - Worth a closer look, Mark Rzepczynski
Now we have research that calls into question loss aversion as the core reason for these effects both from a theoretical and empirical point of view. There is clear evidence that contradicts loss aversion, but it has either been dismissed or ignored. Loss aversion is a description of behavior and not an explanation of behavior. This research is not offering an alternative to loss aversion but rather a commentary on its usefulness and explanatory power. https://mrzepczynski.blogspot.com/2018/08/new-research-on-loss-aversion-is.html

Why the Most Important Idea in Behavioral Decision-Making Is a Fallacy, Scientific American
as documented in a recent critical review of loss aversion by Derek Rucker of Northwestern University and myself, published in the Journal of Consumer Psychology, loss aversion is essentially a fallacy. That is, there is no general cognitive bias that leads people to avoid losses more vigorously than to pursue gains. Contrary to claims based on loss aversion, price increases (ie, losses for consumers) do not impact consumer behavior more than price decreases (ie, gains for consumers).  [wait til they retire…] https://blogs.scientificamerican.com/observations/why-the-most-important-idea-in-behavioral-decision-making-is-a-fallacy/ 

Aug 11, 2018

Asset Allocation and Spend Rates in a Lifecycle (WDT) Utility Model

SUMMARY

  • Over some pretty broad, middle of the road asset-allocation ranges and moderate spend rates, spending control looks like it trumps asset allocation as a lever for lifetime consumption utility. This is more evident as the concept of risk aversion rises. My take-away from this is that once a consumption plan has been rationalized, asset allocation -- over a broad range from 30-40% to 80-100% to a risk asset -- is of less importance than spending control. 
  • Risk aversion, if it is considered a valid analytical tool, has a significant effect on the results and suggests that spending control is an important tool in the presence of high risk aversion.  High aversion seems to command lower spend rates.
  • Random lifetime, when it is modeled as "literally random life" as opposed to just a vector of conditional survival probabilities for a given age, makes the simulation unstable except at very high iterations within the sim. My naive take-away from this is that in real life, the individual path one is dealt in terms of longevity matters a lot and may trump both spending and asset allocation as a significant factor for consumption utility over the life-cycle.  In the absence of "pensionized wealth" this might be considered a vote for conservatism in spend rates given the first and second bullets. ...or maybe a vote for pensionized wealth.
  • Volatility reduction, all else equal, appears to have positive effects on consumption utility and would imply support for higher (constant) spend rates.  Alternatively, looking at it from another perspective, parameter estimation uncertainty in constructing efficient portfolios (e.g., estimation of parameters such as returns, vol, covariance, etc) would imply some need to think carefully about conservatism in planned spend rates.  It is not shown here but it has been shown elsewhere (e.g., Claire 2017, Hoffstein 2018) that allocations to alternative risk premia and anomalies like trend following, given the effects on the volatility of portfolio returns, is accretive to retirement portfolios that are seeking higher consumption rates.  
  • The very lowest allocations to portfolio risk, counter-intuitively to some retirees, appear to be the least productive of lifetime consumption utility and might reasonably be avoided by those with moderate to low risk aversion. The exception, of course, might be for those in the most fearful "retirement crouch" but I have not looked at extreme risk aversion yet. When the policy for how the model deals with cases of depletion before income starts is made more assertive, high spend rates with high allocations to risk are much more heavily penalized (not shown) and would be avoided as well.  That policy change may be explored in a follow-up post. 


THE POINT OF THE POST

The goal of this post is to use a lifecycle utility model -- one that anticipates a wealth depletion time i.e., a time interval in the late lifecycle when non-pensionized wealth runs out and consumption snaps to available income -- to evaluate the expected discounted utility of lifetime consumption given various choices in asset allocation and (constant) spend rates.  This exploration is not sufficiently rigorous to make hard conclusions about allocation optima or, for that matter, specific recommendations about spending. The exploration, rather, is intended to help me see the general shape of lifetime consumption utility in visual terms and to get some sense on how it "moves" in response to changes in risk aversion or volatility assumptions. 

Aug 7, 2018

Case for social cooperation among retirees with high vol strategies?

If:

(1) the long-horizon time-averaged geometric return for an individual investor with volatile returns is said to be something like E(g) = µ - σ2/2 (see any finance textbook; long horizon is technically infinity I think but maybe less in practice), and 

(2) the presence of consumption over "multiple periods" in retirement (in the presence of volatile returns) creates the potential for sequence risk above and beyond (or due to?) the drift term and thus the potential for whatever you want to call it: higher ruin risk and/or lower consumption utility due to higher incidence of wealth depletion, etc., and

(3) the mathematics of cooperation for “N cooperators” implies that the “spurious drift term is [- σ2/2N] so that the time-average growth approaches expectation-value growth for large N” [1]

Then: 

Aug 2, 2018

Note on my WDT model

Fwiw, I consolidated my "wealth depletion time" model and links into this page here which is now a tab at the top of the blog:
so that I would:

- not lose track of it
- consolidate multiple posts and links
- give it some extra emphasis since it is integrative of a lot of my learning
- correct some errors of content, grammar and math

I kept losing track of the various posts and related commentary. Now I have one place to go.


RH Links - 8/2/2018

QUOTE OF THE DAY

...beware of incoherence that passes itself off as complexity.  Dani Rodrik

RETIREMENT FINANCE AND PLANNING

Are SUVs Ruining Retirement Savings? Ben Carlson
if you’re one of the many people who are woefully unprepared for retirement or any of your other saving goals, a good place to start would be cutting back on any unnecessary spending on transportation. http://awealthofcommonsense.com/2018/07/are-suvs-ruining-retirement-savings/

Target-Date Funds Aren’t the Retirement Bull’s-Eye, Nir Kaissar
target-date funds are no cure-all. One obvious defect is fees. I counted 227 retirement share class target-date funds with $100 million or more in net assets. Their average expense ratio is 0.67 percent a year, and their asset-weighted average expense ratio — which accounts for the size of the funds — is 0.58 percent…It’s also not clear why retirement savers should own more bonds over time. People are living longer and a bond-heavy portfolio raises the risk of running out of money. And that isn’t the only risk…The combination of those factors — high fees and the potential for unlucky timing and misuse — could easily add up to 1 percent to 2 percent a year in lower returns, costing retirement savers hundreds of thousands of dollars over the course of a career.   https://www.bloomberg.com/view/articles/2018-07-18/target-date-funds-aren-t-the-retirement-bull-s-eye

The Unique Retirement Issues Facing Women, Swedroe
Women face at least 12 unique challenges from financial and life circumstances related to long-term retirement planning. … Specifically, women: 1. Earn less.  2. Live longer.  3. Have fewer years of earned income. 4. Start investing later… https://www.advisorperspectives.com/articles/2018/07/30/the-unique-retirement-issues-facing-women

Why is Retirement Harder than Saving for Retirement? (SWR Series Part 27),  ERN
ust because saving for retirement is relatively simple it doesn’t mean we can just extrapolate that simplicity to the withdrawals during retirement. And that’s what today’s post is about: I like to go through some of the fundamental factors that make withdrawing money more complicated than saving for retirement. Think of this as an introduction to the SWR Series that I would have written back then if I had known what I know now!  https://earlyretirementnow.com/2018/07/25/why-is-retirement-harder-than-saving-for-retirement-swr-series-part-27/