My Personal Planning Components
Contrary to what one might come to believe based on a quick scan of the content on this blog, I do not personally do very complex financial planning. The bulk of my work revolves around keeping family financial statements like an income statement and a "flow-based" or actuarial balance sheet. I then manage an infrequent monitoring operation that focuses primarily on:
- periodic feasibility (net monitizable assets > than the PV of consumption) tests
- periodic, simple, and very skeptical review of "sustainability" via lifetime ruin risk, and
- watching for trends or acceleration in effective spend rates within very broad, moving control boundaries
- plus maybe a couple other things
That means I do not personally perseverate on things like stochastic present value analysis. In the development of the balance sheet, however I do have to have a proxy for the SPV of spending. Typically I recommend following a program like that recommended by Ken Steiner at howmuchcaniaffordtospendinretirement.blogspot.com. For my purposes, though, I often do just a "reality check" that both simplifies this PV and adds a complicator which I'll describe.
My reality-check thumbnail-estimate calc
Since my estimate of future spending is fluid over time and includes some age-based step downs that change every time I think about it, most of the time I bother to look at this kind of thing I just do a thumbnail check of what the estimated spend PV value is then while also assuming, probably incorrectly, that it could be defeased efficiently at any time I want with some type of an SPIA. So, basically I do an annuity-type calc on a cash flow projection. But I simplify this by allowing the inflator and the discount to offset each other so all I have is a probability-weighted simple cash flow:
cf * tPx
or 100k (not really my number, btw) to infinity weighted by a survival probability. The question then, one might ask, is where does that rough estimate fall compared to:
A. a non-weighted cash flow over a fixed horizon, and/or
B. the four SPV scenarios in the last post
Reality Check vs. "A"
When I take 100k and weight it using the SOA IAM table data and make that conditional on a 60 year old using G2 projections to 2018 I get an answer of about ~2.6M. Comparing that to "A" is easy because if we do the inflate/discount-cancel, then 100k times, say, 30 years is $3M. In that case the weighting gives a more optimistic spend estimate due to the more pessimistic longevity expectations over the next 60 years. I could, of course, get more sophisticated with my inflation and discounting. Any interpretation here I'll leave to you.
Reality Check vs. "B"
Recall that we generated four SPV distributions in the last post. Now, if we overlay the "reality check" simple version of spending on those distributions we can see where the reality check lies with respect to more uncertain spending. Charted out it looks like this
Then the question becomes: where in the various distributions does this simple estimate fall? Integrating the distributions to the "estimate" gives the following percentiles, by scenario:
| A | 0.87 |
| B | 0.72 |
| C | 0.59 |
| D | 0.43 |
So is the estimate close enough? No idea. It's a policy choice. It seems a little weak in the longest lived scenario, though. One extremely simple option is to do it like a contractor and throw a 20% contingency at spending. In this case I'd just make the spend rate 20% higher to 120k and see where that falls. It plays out like this where the spend estimate is now ~3.1M which, by the way, is not too distant from the 100k x 30 years "dumb" heuristic:
| A | 0.94 |
| B | 0.85 |
| C | 0.74 |
| D | 0.59 |
Close enough? Sure, why not. All I really need to remember is that either way the estimate is just an estimate around which there will be a lot of variance and residual uncertainty. Also, even the SPV distributions themselves are "fake" and will look nothing like what really plays out over time ...remembering that the spending process will likely behaviorally self-correct over time if it goes too far out of bounds either way. So in sum, my thumbnail estimate is probably ok for now if tempered with a little self-awareness.
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