Sunday, March 12, 2017

The Actuarial Approach—Much More Than Just a Measure of Where You Stand Financially

In his post of March 10, Bob French touts the benefits of comparing one’s assets to one’s liabilities to determine where an individual or couple stands financially.  Bob calls this calculation “the funded ratio.”  This is the second recent discussion advocating what is essentially the Actuarial Approach to develop a funded ratio.  See our post of March 5, “Actuarial Approach with a Different Name” for discussion of the “personal funded ratio” proposed by Messrs. Hill and Pittman.

The concept of comparing one’s assets to one’s liabilities is the foundation of the Actuarial Approach advocated in this website.  Readers of this website are quite familiar with the following equation, which we employ frequently:

where items on the left-hand side of the equation equal the individual’s assets and the items on the right-hand side equal the individual’s spending liabilities.

The funded ratio proposed by Messrs. French, Hill and Pittman divide assets by aspirational liabilities (the individual’s spending goals) to help the individual determine where he or she stands in meeting retirement goals and how much the individual’s assets would need to be to meet these goals.  And while this aspirational funded status measurement is easily accomplished under the Actuarial Approach with the assistance of our Actuarial Budget Calculator (ABC) workbooks (by backing into how much assets are required to produce the aspirational spending budget), individuals can also use this basic actuarial equation to develop an actuarially calculated spending budget for the current year, by manipulating the above equation, to get:

The denominator of the item on the right-hand side of this equation is the present value of future years of retirement, with desired increases in future recurring spending budgets of x% per year (similar to the cost of retirement developed in the Blackrock CORI index, as discussed in our post of January 29, 2017).

So, if you like how the Actuarial Approach helps you determine how much assets you will need to fund your aspirational spending liabilities, you will really like how it helps you develop a spending budget, based on the assets you actually have.