What’s in a Name? That Which We Call the Actuarial Approach…

We get questions from readers and “push-back” from retirement experts and others about the name we have chosen for the approach we advocate in this website for helping people make financial decisions.  Some don’t know what “the Actuarial Approach” is and are looking for a definition and some point out that there are many approaches that involve actuarial concepts to varying degrees, and it is presumptuous of us to lay claim to “the” actuarial approach.  This post will discuss:

• what the approach is, 
• common misperceptions about it, and 
• why we call it the Actuarial Approach.
  

What is the Actuarial Approach?

The Actuarial Approach is the use of basic actuarial principles to accomplish one’s personal financial goals.  For many years, actuaries have been helping sponsors of financial systems accomplish financial goals using basic (or fundamental) actuarial principles (or concepts).  The Actuarial Approach advocated in this website applies many of these same principles to personal financial goals.  These fundamental actuarial concepts include:

• Making assumptions about the future 
• Time value of money 
• Concept of probabilities 
• Mortality 
• Use of actuarial present values 
• Use of a generalized individual model that compares assets with liabilities 
• Periodic gain/loss adjustment to reflect experience different from assumptions (annual valuations), and 
• Conservatism
  

These principles (and others that may not be applicable to a personal financial situation) are conveniently summarized in the 1989 monograph by Charles Trowbridge entitled, Fundamental Concepts of Actuarial Science.  We have included a copy of this monograph in our Other Calculators and Tools section, for those who may be interested in actuarial science.

We believe these tried and tested principles are mathematically superior to the strategic withdrawal plans advocated my many retirement experts and academics.

For additional discussion of the Actuarial Approach, you can read our brief description of the Actuarial Approach.

Common Misperceptions About the Actuarial Approach

We find that there are several misperceptions about the Actuarial Approach and, for the most part, they all stem from the same source: individuals believe the Excel workbooks we provide in our website and our recommended assumptions comprise the Actuarial Approach.  It is important to note that we provide the workbooks and recommended assumptions simply to make it easier for users to apply the following basic actuarial formula, which compares one’s assets with one’s spending liabilities:

This one misunderstanding apparently creates a lot of confusion and misperceptions.  For example, we have been told:

• Because the Actuarial Approach uses deterministic assumptions, it is not as robust as approaches that use Monte Carlo modeling and stochastic assumptions 
• Because the assumptions used in the Actuarial Approach are conservative, the results are too conservative 
• Because the Actuarial Approach uses a fixed lifetime planning period rather than probabilities of death, it is not sophisticated enough 
• Because it determines spending budgets on a pre-tax basis, it is not useful, etc.
  

These comments all reflect the same basic misunderstanding about the Actuarial Approach: Just because we make simplifying assumptions (like the ones discussed above) to make the calculations easier in our workbooks, doesn’t mean that these issues necessarily apply to the general Actuarial Approach model.  If you want to make the Actuarial Approach more complicated and theoretically more sophisticated, you can do it and still follow basic actuarial principles.

Why do we call it the Actuarial Approach?

We call it the Actuarial Approach for several reasons:

• The name is sexier and more concise than “the approach that uses basic actuarial principles to accomplish personal financial goals” 
• It is consistent with the approach used by actuaries to help sponsors of financial systems accomplish financial goals 
• We are two pension actuaries who used a similar process for guiding pension plan sponsors 
• It utilizes more of the basic actuarial principles than almost all the other approaches currently in use.
  

Summary

Actuaries use basic actuarial principles to help keep many financial security systems sound and sustainable.  These same principles can be used to help individuals achieve financial goals.  We encourage individuals and their financial advisors to consider using these time-tested and proven basic actuarial principles in their financial planning, at a minimum as a supplement to what they are currently using.  To paraphrase Juliet, “That which we call the Actuarial Approach by any other name just makes good financial sense.”