May 12, 2023

Into the Spend Zone...Again

The important role of uncertainty around expected lifetime in making plans for retirement consumption has been around for a while and has seemed, based on my n=1 read of the literature, to be something found more often in economics papers than in finance though I think that is changing. The pivotal role of this complicator became most manifest in Yaari (Uncertain Lifetime, Life Insurance and the Theory of the Consumer, 1965) which focused on optimal consumption and annuitization given random life among other things. 

"Wealth / Life Expectancy" as it Relates to Consumption Choice 

Subsequent papers over the years (e.g., Merton 1969, Samuelson 1969, Milevsky & Huang 2010, Irlam & Tomlinson 2014 among others) have made various heuristic conclusions that, due to the role of longevity uncertainty, a proxy for optimal consumption can sometimes devolve to "wealth divided by a measure of remaining life expectancy."

"Their [Merton and Samuelson] work also addressed consumption over the life cycle, and they were able to show that, under one particular set of reasonable assumptions[note 1 ... pay attention to the particularity], optimal spending each year could be approximately determined as current wealth divided by remaining life expectancy. Milevsky and Huang [2010] later demonstrated a similar result." [Irlam and Tomlinson, italics added]