Weekend Links - 6/29/2017

QUOTE OF THE WEEK

No matter how you build your portfolio, hindsight will show it to be the objectively sub-optimal decision if your goal is only to maximize returns. Corey Hoffstein 

MAP OF THE DAY

RETIREMENT FINANCE AND PLANNING

Chapter 19: Individual Biases in Retirement Planning and Wealth Management, independent.  This chapter … describes giving nudges to help individuals close the savings, investing, and behavior gaps that will improve their total wealth and wealth-transfer picture. 

The Most Important Factor in Determining Your Retirement Withdrawal Rate, retirementreseacher.com.  Blanchett found the level of guaranteed income to be by far the most important factor in explaining optimal spending rates from investments. Withdrawal rates were up to four percentage points higher across the range of guaranteed income levels he examined. …Optimal success rates vary based on individual circumstances, but as a general rule of thumb, Blanchett finds a 75 percent success rate is generally a more acceptable target than one of 90 or 95 percent…A simple focus on a retirement income strategy that applies a low failure rate for the investment portfolio is woefully incomplete….An over reliance on only spending at a “safe” withdrawal rate may unduly sacrifice lifestyle in early retirement. 

SS Claiming

Because I am 58 and because I am not part of a married couple and because I think SS is going to either break or be means-tested in the future I have not thought much or counted much on SS as part of my plan (I heavily discount a PV calc). But I know it's there and will have some impact. Dirk Cotton had a good article on SS claiming recently, a topic over which much ink has been spilt. In that piece, without getting too analytical, he comes up with several reasons why someone might claim early such as:

• you have a bunch of money so SS is more or less irrelevant
• you think SS is going to go bankrupt 
• you are a lower earning spouse 
• your longevity expectations are lower because of poor health
• you need the $ right away 

Most articles I have seen make a strong case for delaying SS benefits and in the end Dirk's article is no different: "All things considered, I still believe that most retirees should delay claiming Social Security benefits for as long as they are comfortable doing so. Delaying claiming is simply transferring some income from early in retirement until late in retirement for the benefit of those of us who do enjoy a very long life. It is the cheapest longevity insurance you can buy."

Some Differences Between Open-ended MC Simulation and Historical "Closed" Sims

One of the smartest early retirement blogs around these days is earlyretirementnow.com.  This is a guy with skin in the game because he wants to retire early.  He has also put some of his prodigious PhD skills to use in doing the homework necessary to get ready.  He does stuff that I can't touch or sometimes even understand.  I tried to play around with (abuse might be a better word) some of his math here because I liked the elegance of the approach although it took me a while to figure it out.

Because he likes to share what he has learned in his ER journey, ERN now has a spreadsheet that takes some of his math that I was playing with (link above) and that he had originally worked into some GNU Octave code (which is like matlab according to ERN; I have to imagine it is not too different than R). The spreadsheet does what I want to call a type of historical rolling simulation (not exactly, I think, like what others mean when they use that term but very close) starting with data from 1871.  The tool also allows one to look at subset "runs" such as "since 1950" or CAPE <=20 or CAPE >30, etc.

RH40 in "multiplier" terms

I started my journey into questions on retirement finance a little late. So late, in fact that it was well after my career which is why I have not spent much time thinking about "multipliers." These are rules of thumb for how many multiples of your spend rate one needs to have in order to retire. I've seen numbers like 25 or higher tossed around. 25 happens to be the 4% rule (1/.04) where the other, higher, multiples are more conservative reflecting our current environment or maybe younger ages. I have also seen high multiples excoriated for being too conservative and a buzz-kill on retirement planning and consumption. I disagree with the latter comment but let's ignore that debate.

Instead let's say that multiples are merely inverses of spend rates (true) and that they should probably be age and/or risk-aversion tweaked as well. Let's also aver that a conservative result is good if for no other reason that it might be a good starting point to which other considerations can then moderate it later. Let's also assume that my RH40 formula (spendrate = Age/(40-(age/3))) is useful for at least one person in the world (prev posts). Then, if all that is accepted it is easy enough to invert the RH40 rule into an age and risk-aversion adjusted "multiple."

The basic concept in its super reductive form is this:

1. A well known academic researcher in the area of personal and retirement finance systematically simulates a whole bunch of retirement scenarios that cover a broad spectrum of assumptions,

2. The guy in #1 reduces the effort put into #1 into a regression formula that explains a very high percentage of #1's results,

3. A pension expert and comes up with a rule of thumb that is easy to remember, is age adjusted, and that has at least two modes: conservative and risky. He writes an article in a Society of Actuaries newsletter that explains the economic rationale,

4. An amateur hack (me) converts #3 into an alternative single age-and-risk-adjusted rule of thumb formula by going from pretty darn conservative when youngish (say 55-60) to risk accepting when older (say 95) and then sees that the simple formula fits the curve implied by #2 for at least one conservative "success rate" assumption between the ages of 60 and 95,

5. Now invert #4 into a "multiple" rule of thumb. Assume it is pretty conservative so maybe only represents a starting point for discussion. A lot of factors might influence one's judgement on this, the availability of Social Security or other permanent income not the least of them.

The inverted rule of thumb might look like this where A is age:

RHMultiple = (40/A - 1/3) x 100

or, more accurately, it might look like this:

Multiple = Min[50, RHMultiple]

Behold: an age and risk-aversion-adjusted multiplier rule of thumb.



Postscript 7/6/17:

Reflecting on this further, I realize that this is all a little silly.  If the goal is to come up with an age-based rule of thumb that is easy to remember, by creating another formula as a "multiple" version is kinda stupid.  Instead of that, just remember the RH40 formula [ A / (40 - A/) ] and if you need a multiple, just invert it [ 1 / RH40 ]. Much much easier to remember.  

Comments on Ritholtz's review of William Sharpe's RISMAT

I tried the other day to read and comprehend William F.Sharpe's Retirement Income Scenario Matrices (RISMAT.  Tipped off to this by David Cantor at PwC). I tried…and failed.  It was a little heavy on things that were opaque to me.  But I also happened to read Barry Ritholtz's ThinkAdvisor piece on Sharpe's RISMAT method Tackling 'Nastiest, Hardest Problem in Finance' that gave me a fresh angle.  

Here is a digest of the Ritholtz article (in single quotes, between the dashed lines):  

Weekend Links - 6/8/17

QUOTE OF THE DAY

If we were indifferent to risk, much of finance would collapse. Mihir Desai 

CHART OF THE DAY

Pension fund funded ratios for single 

employer, multi-employer and large 

city public plans 

RETIREMENT FINANCE AND PLANNING

Monte Carlo Investment Assumptions In Your Retirement Planning Projections, Kitces.com if you don’t recognize how high the correlations really are, you end up grossly overstating how much diversification is actually helping you, and understating the risk. Which ironically means, if the reason you don’t like doing things like Monte Carlo analysis in the first place is you don’t think it takes into account the risks of the marketplace when you try to add in more investments, then adding more investments without accounting for correlations, actually makes it worse. 

Kitces on Simulation, RiversHedge.  Well…maybe not in his software… 

Society of Actuaries Confirms Impact of Continuing to Work on Spending Budget, Ken Steiner.  

Managing Retirement Decisions, Society of Actuaries.  

The Difference Between ‘Safe’ and ‘Optimal’ Withdrawal Rates for Retirement Spending , Pfau.  Also, instead of focusing on the traditional objective of worrying only about using a low failure rate, we sought a better balance between two competing tradeoffs: (1) wanting to spend and enjoy more while you are still alive and healthy, and (2) not wanting to deplete the investment portfolio and rely only on non-portfolio income sources in later retirement… In practical terms, retirees who are more longevity-risk averse and less flexible with spending would like to smooth spending over retirement… someone with greater spending flexibility and more outside sources of income may be willing to accept rather high failure rates as a part of balancing these competing tradeoffs… we found that with those capital market expectations, the 4 percent retirement withdrawal rate strategy may only be appropriate for more risk-averse retirees with moderate guaranteed income sources… there is an important point to re-emphasize here. In one case in the article we identify a 7 percent withdrawal rate as “optimal.” That is not a “safe” withdrawal rate [comment: no sh*t…unless you are about 85 or older]. With the market assumptions in the article, the 7 percent withdrawal rate has a 57 percent chance of failure over a thirty-year retirement. 

Kitces on Simulation

In a recent post on Monte Carlo simulation on Michael Kitces site (Monte Carlo Investment Assumptions In Your Retirement Planning Projections) he describes some of the counter-intuitive effects of adding more and more asset classes to simulation (from a planning perspective one can inadvertently understate risk too much) and the importance of understanding asset class correlation. That was fine and interesting and important and useful and maybe even a little obvious if one has worked with simulators.  That was not what caught my eye, though. It was a comment later in the article on another topic:

But unfortunately, there’s no Monte Carlo software that can actually show that, what I like to call regime-based retirement projections. Where we’re in a low return regime for a decade and then we normalize. It’s possible mathematically to do it, the software just doesn’t do it now. Which means, the only alternative is to haircut long-term returns, which is what we actually do in practice. We reduce long-term returns by about 1% or 100 basis points, recognizing some of the risk of the low return environment.

Well...maybe not in his software.

Weekend Links - 6/1/2017

QUOTE OF THE DAY

I have a different perspective. I fear it’s now so easy to avoid doing any real work on our financial planning that many of us have lost – or never gained – a real understanding of how and why all the numbers fit together. -Monevator 

CHART OF THE DAY

RETIREMENT FINANCE AND PLANNING

Importance of Individual Account Retirement Plans and Home Equity in Family Total Wealth, ERBI. …when measuring families’ financial asset holdings at retirement, it is overwhelmingly the case that just IA assets plus home equity represent almost all of what families have for retirement outside of Social Security and defined benefit pension plans. 

A Proven Way to Budget Clients’ Spending, Ken Steiner at advisorperspectives.com.   Using Monte Carlo modeling to develop client spending budgets is an effective approach but not a perfect solution. In addition to using historical data to forecast future investment performance, many clients don’t fully understand the probability-of-success output. Some advisors use even less effective approaches to develop spending budgets for their clients, such as adding “safe” withdrawals from an investment portfolio to income from other sources. Rather than requiring clients to have faith that these approaches will produce results consistent with their financial objectives, advisors should supplement their current approach by calculating and communicating an ABB to enable their clients to make better budgeting and investment decisions. Adding this additional data point to advisor-client discussions will reduce your fiduciary risk and will result in better informed and more satisfied clients.      [comment: Ken Steiner is on solid ground.  In a future post I'll try to explain why Ken's actuarial method is one of at least three main legs of a retirement "table"]

3 Ways to Manage Retirement Planning Stress, ERBI.  

Taking Portfolio Spending into the Real World For Retirees, Pfau.  The authors [Milevsky and Huang] summarize the rational investor’s decision-making process as, “Wealth managers should advocate dynamic spending in proportion to survival probabilities, adjusted up for exogenous pension income and down for longevity risk aversion.”  … both of these factors will be tempered somewhat to the extent that a retiree is particularly fearful of outliving their financial portfolio. Greater longevity risk aversion requires spending less in order to maintain the portfolio over a longer time horizon.  

Weekend Links - 5/26/2017

QUOTE OF THE DAY

I’m convinced that having a long-term mindset and being more patient than other investors is one of the last true edges remaining in the markets. This is one of the few things that can never be arbitraged away by faster computing power or more intelligent hedge funds looking to make a quick buck. Ben Carlson 

CHART OF THE DAY

RETIREMENT FINANCE AND PLANNING

Why Retirees Cut Back on Spending: A Growing Pessimism, ItSeems, WSJ.  

The Mental Mistakes We Make With Retirement Spending. WSJ.  

The Relationship Between Guaranteed Income and SafeWithdrawal Rates, Mike Piper. In other words, holding all of the other variables constant, it’s reasonable for a person with a very high level of guaranteed income to spend from their portfolio at roughly three-times the rate of a person with a very low level of guaranteed income. 

The Impact of Guaranteed Income and Dynamic Withdrawals onSafe Initial Withdrawal Rates, David Blanchett.  Modeling dynamic withdrawals also affected safe initial withdrawal rates, although its impact was significantly less than that of guaranteed income, slightly less than return assumptions, but greater than the assumed portfolio asset allocation.

Active Retail Investors Are Useless, Right?

How many articles have I read in the last year that tell me that retail investors suck (and active managers, too, for that matter...except that they are not ding-ed as hard for behavioral bias as retail)?  A lot.  Personally, I think a set of systematic rules and a focus on something other than the S&P500 might make a lot of difference to a certain type of investor. Here for example is me put up against a pair of  trend following managed futures funds (12 billion and 500 million AUM; one is a mutual fund and the other is a private placement. I blocked the private name in case I have some clause in the placement that I could get hung up on by "publishing" results. The third line is a private placement I killed in 2016 so that doesn't count) looking only at time series and skipping over things like ratios, efficient frontiers, etc.  I think I might have posted something like this before but a combination of ego and irk-ed-ness at the articles I read motivated me to throw it out there yet again.  That ego reason must mean I am due for a drawdown.

This chart is after fund fees (and my expenses for my own strategy) but before adviser fees which are zero only for my alt-risk strategy which leans on but is not exclusively trend-following (but maybe it's close enough for the comparison...which it is since I often use MF to benchmark myself). Green is me:

This, of course, proves very little and what little it proves might be summed up by saying something like "you don't have to be paid an ungodly amount of money and manage billions in Connecticut to have a reasonable edge; don't let the pundits cow you out of actively (with rules, though) managing your own capital." Is five years long enough? Sure, why not?  At the pace of the modern world that seems like an eternity, certainly long enough for me to trust my suck-y retail methods.


See Not So Dumb at humbledollar.com.  I read this right after I posted the above.

Mortality Table Differences

I was curious about the difference between the 2013 SS life table and the 2012 SOA Individual Annuity Mortality Table (Basic Rates) for a 58 year old.  Just for the heck of it this is my best guess at mortality probabilities for someone my age using the two different tables.  The differences, I gather, reflect the different population of people that seek annuities vs. a more general population.   I'm not sure that this changes my planning because my planning conservatism already reflects the longevity risk implied in either table but if I were to use a longevity formula like a Gompertz equation I might move the mode out a bit further than I have been.  

LinkedIn Version of RH40

Here is the LinkedIn version of my write-up on the RH40 rule of thumb.  Same content as other posts done here but maybe presented a little better.

One Measure of the Cost of Self-Insuring Longevity

In the absence of annuitization, they say, one needs to plan for a "max lifetime" rather than an "average lifetime."  I've seen some papers on this, of course, but I was curious to see for myself what I could come up with for the following proposition:

IF:

- An average lifetime expectation is 85 (base case; but maybe closer to 82 for me)
- Max lifetime is, say, 95 (arbitrary, had to pick something)
- Endowment is 1,000,000 for the base case
- Start age is 60
- Spending is 3% (not 4%!) constant, inflation adjusted for the base case
- 50/50 two asset portfolio with some fee and tax assumptions thrown in
- No SS assumption
- No return suppression
- No spend trends, non-inflation spend variance, or spend shocks
- No stochastic longevity, and
- The base case risk turns out to be .05 fail rate risk

THEN:

1. What is the incremental difference in the endowment required to maintain same risk when the terminal age moves from 85 to 95, or alternatively

2. What is the incremental difference, for same endowment, in the spending required to maintain same risk for the same age shift?  i.e., what is the (maybe not "the" but what I want to call "a") "cost" of self-insuring under the assumptions above?


The answer based on a couple quick thumbnail sim runs where fail rates were rounded to whole number percents is:

1. I would need ~35% more (1350000) in the initial endowment to keep the fail risk constant[1]

2. I would need to have an initial spend rate (constant, infl adj) that is ~25% lower.


-----------------

[1] I have not read Waring and Seigel (2007) but according to Sexauer, Peski and Cassidy(2015 - Making Retirement Income Last a lifetime): W&S "estimated that the loss from not pooling is 34.5 percent of total capital saved." While it sounds like a slightly different question is being asked, it also seems of a piece with my post.

A Practical Application of Geometric Return Analysis: Retiring My Alt Risk Strategy [updated]

I recently updated my LinkedIn profile to "retired." [1] I did this mostly -- tongue in cheek -- to satisfy my girlfriend's need for me to say I'm retired rather than working as an active private investor (she's still working so me saying "I'm working" is a trigger).  But if I am going to retire I should really retire and hang up the active investing thing which is mostly me running my systematic alt risk strategy.  While it has been incredibly efficient over the last three or four years[2] it is a little like riding a bike in first gear: a lot of energy and motion for minor forward progress.  No reason not to at least consider hanging it up.

Since it is accretive, though, I need to either keep doing it or I need to replace it with something that is at least no worse.  And by worse I mean in the retirement finance sense.  I define that as: my cumulative return after a series of N "games" (really years; I was trying to get fancy there) net of consumption has to be about the same in the replacement strategy as it is in the baseline strategy.  N is a retirement milestone in the future I'll define later, returns are cumulative geometric, and consumption is spending of course. One could argue that at the margin there is no consumption if I am more than fully funded but where would the fun be in that since the consumption constraint makes it way harder.  

Weekend Links - 5/19/2017

QUOTE OF THE DAY

There are two kinds of pitches. Those that are clearly bad ideas, and those where it’s not clear at all if it’s a good idea or a bad idea. Michael Mauboussin 


VIDEO OF THE DAY - Animated Map of Unemployment Over Time

RETIREMENT FINANCE AND PLANNING

When Investment Professionals Discover Market Effects onRetirees: Why Drawdowns Matter: A Visual Demonstration, Willowstreet 

How Should Your Asset Allocation Look in Retirement? Pfau.   [how to market time without actually calling it market timing]

A Simple Age-Based Retirement Spending Rule-Of-Thumb ForWhen Your Dog Eats Your Simulator, W Selden. Sometimes you just want a simple, well-informed, easy-to-manage guess.  

One More Thought on RH40 - Dynamic Longevity

I was thinking about one more thing in evaluating my formula [ Age / (40 - Age/3)].  Longevity estimates are dynamic in real life but I have not been comparing RH40 to retirement calcs where Longevity changes with age. In other words, what would happen if I put RH40 up against a really simple model with dynamic longevity. Right now, using Blanchett's simple formula, I hew to a fixed "to-95" assumption.  But median terminal for someone my age is somewhere around 81-83 depending on the life-table used. Joe Tomlinson once told me maybe 88 is better.  Many retirement writers say use 95 just to be conservative.  But it's not just about setting a single assumption that is conservative. The median expectation for longevity extends out for each year survived while the survival probabilities still continue to go down. For example, using the SS 2013 life table the average expectancy at 95 is ~98, not 82 anymore, even though there are fewer and fewer survivors each year.

Playing Around With Some RH40 Math for context...

I tried to come up with a reason that this post might have any real serious functional purpose.  I couldn't do it or couldn't do it very well.  This post is really just me playing around with some math to contextualize my RH40 formula by using Blanchett's simple "dynamic" formula.  There is no advice here; I'm just goofing around.

Why my RH40 formula might actually be ok...

In my last "tongue-in-cheek" post I laid out my super cool formula for retirement spending.  It was a little jokey because I started with the desire for a formula before I had a reason to come up with one so it was kinda flawed from the start. On the other hand it is based on the legitimate retirement risk analysis of people more serious than me.  In the last post I said I'd consider looking at the fail rate risk output of my formula to see if, contra the 4% rule or maybe some others, it could plausibly deliver a more or less constant fail rate. That seems like a reasonable test. Let's see.

RiversHedge Unveils its Very Own New-to-the-World RH40 Retirement Spending Formula

Why, why, why would I add another retirement spending formula to the universe when there is already such a massive proliferation of formulas out there?  Well, first of all it matches ALL of my criteria for a good "pocket formula," unlike anything else I've seen, and second I've always wanted my own signature retirement formula. Don't you? You don't? Really? What's wrong with you?


My Criteria

Let's get right to the criteria.  This is some of what I want in a good retirement formula:

A "Ripcord" Simulation

Since Monte Carlo simulation is so irritatingly passive when it comes to retirement failure and so blasé about the constraint of only having one life to live, I asked myself this random question the other day:

What if, in a simulated context, I wanted to: 1) try to eliminate longevity risk by using annuity risk-pooling, 2) only make a risk-pool purchase at some future date and only if it's necessary, 3) use some minimal two-notches-above-indigent threshold level of lifestyle as a safety-net floor assumption, 4) be able take action while my portfolio is still viable and can still afford to make the purchase, and 5) make the purchase at an age when it is supposedly efficient to do so? Assuming that this engineers a way to mostly eliminate longevity risk (while still retaining a ton of other risk), how much more could I spend today? Or conversely, how much of a margin of error might I have in my current spending?

That's a great question. It's too bad I am not equipped to answer it. Or at least answer it with any serious rigor or credibility. That means, like I've done before, I'll try a back-of-the-napkin amateur hack to see what I can conjure up while also not imagining I am the first to either ask or attempt answer this question. I'm not going to present data or tables or a lot of charts because it's my own private data and also I weary of charting as summer approaches. This, by the way, is a much shorter post than I had planned mostly because the results seemed underwhelming and it saves me a ton of effort on that rigor thing. But, in turn, I guess you'll just have to assume I am being honest with myself…and you.