Now, That’s What I’m Talking About

We recently came across a great Think Advisor column written in 2011 by Dr. Moshe Milevsky that we would like to share with you in this post and encourage you to read.  The column is titled, What Does Retirement Really Cost?  Dr. Milevsky is a Professor of Finance at the Schulich School of Business at York University, Toronto, Canada, and we have discussed his writings in several prior posts.

The obvious reason that we like this particular column so much is because in it Dr. Milevsky advocates using the same basic financial economics principles (annuity based pricing of spending liabilities) that we advocate in our website to develop your Actuarial Budget Benchmark (ABB).  He says:

“As such, the annuity price is effectively the cost of your retirement income plans and the only answer to the question posed in the title of this column. Any other answer involves extra risk, possibly invisible to the naked eye. It is often obscured from view thanks to heroic assumptions hardwired into financial calculators.”

In this column, Dr. Milevsky cautions us to be suspicious about retirement plan strategies (such as those that may be developed using Monte Carlo modeling or safe withdrawal approaches) that appear to offer higher levels of spending at little or no perceived additional risk.

Note that Dr. Milevsky is (and we also are) not recommending that retirees actually go out and purchase annuities, only that they be used to price the cost of retirement.  Combining this pricing concept with basic actuarial principles yields your Actuarial Budget Benchmark (ABB), which provides an indication of potentially how aggressive or how conservative your current proposed spending plan may be.

As discussed in our post of June 27, you can use your ABB to help you develop an investment and spending strategy with which you are comfortable, based on:

• Your tolerance for future spending cuts 
• The proportion of your retirement spending covered by sources outside of your investment portfolio, and 
• The availability of reserves (such as Rainy Day funds, LTC reserves or flexible bequest motives, for example)
  

For someone with relatively high essential expenses and therefore a lower tolerance for future spending cuts, or who doesn’t have much other income from outside the portfolio or who doesn’t have much in the way of reserves, this may imply more conservative investment and/or spending strategies (i.e., lower ratios of proposed spending for the year to your ABB).  On the other hand, someone with relatively low essential expenses and a higher tolerance for future spending cuts, or someone who has significant amounts of income from outside the portfolio or has significant reserves may be comfortable with more aggressive investment and spending strategies (i.e., a higher ratio of proposed spending for the year to your ABB).