Wednesday, December 27, 2017

It’s Time to Perform Your Annual Actuarial Valuation

As part of our ongoing effort to encourage you to think more like an actuary when it comes to your personal finances, this post will recommend that you to perform an Actuarial Valuation based on your personal data as of January 1, 2018, and prepare an “Actuarial Report” to document your thought process and your planning decisions.  The purposes of this exercise are to:
  • Review how well you did in 2017 
  • Develop 2018 spending budget “data points” 
  • Finalize your 2018 calendar year spending budget (or spending/savings budget for pre-retirees) 
  • Document the assumptions, data and adjustments used to determine your final 2018 spending budget, and 
  • Collect and save information that may be useful for your future actuarial valuations
The first step in the actuarial valuation process is to gather all your relevant personal financial data as of January 1, 2018.

Measuring How You Did in 2017

We hope that you saved your data as of January 1, 2017 and documentation of your 2017 spending budget calculations.  With this data you should be able to determine how you did in 2017, by approximating the items in the following equation:

2018 Accumulated Savings
2017 Accumulated Savings
2017 Investment Income
2017 Income from Other Sources
2017 Amount Spent

Solving for these amounts and comparing them with amounts expected, based on your 2017 calculations, will enable you to determine your total actuarial gain/(loss), by subtracting Expected 2018 Accumulated Savings from Actual 2018 Accumulated Savings.  If your actual 2018 BOY Accumulated Savings exceeds your Expected 2018 Accumulated Savings, you experienced an “actuarial gain.”

Similarly, you can determine your gain/(loss) by source by comparing actual amounts experienced in 2017 with expected values (based on the 2017 actuarial valuation) for the following items:
  • investment income 
  • income from other sources 
  • spending
Since it looks like equities will have earned about 20% during 2017 (based on the S&P 500 index at the time of writing), those of you who invested a significant portion of your Accumulated Savings in equities probably experienced actuarial gains on investment income during 2017.  All things being equal, these investment gains will translate into a larger Actuarial Budget Benchmark (ABB) for 2018.  We will discuss below, however, whether you might want to save some of these gains in a Rainy-Day Fund rather to use them to increase your 2018 spending budget.

Developing 2018 Spending Budget “Data Points”

As discussed in our post of April 20, 2017, the process of deciding on your 2018 spending budget involves considering a number of “data points.”  The data points may include, but are certainly not limited to, the following:
  • Your 2017 Spending Budget or actual 2017 spending increased with inflation or some other percentage increase 
  • Your 2018 Spending Budget recommended by your financial advisor or someone else, 
  • Your 2018 Actuarial Budget Benchmark (ABB) 
  • Your desire to avoid significant fluctuations in spending 
  • Your desire to be conservative 
  • Your scenario testing (discussed in our post of November 26, 2017) 
  • Recurring and non-recurring spending plans for 2018, etc.
For the first item above, we recommend using the same increase announced for Social Security cost of living increases for 2018: 2%.  If you develop your spending budget based on desired future increases of inflation minus 1%, however, your preliminary 2018 Spending Budget “data point” would be your 2017 spending budget increased by 1% (2% ‒ 1%).

As previously discussed in many of our previous posts (most recently in our post of November 6, 2017), we encourage you to develop your ABB as another data point in your budget setting process.  The ABB is a budget developed using basic financial economic principles by comparing the market value of your assets with the approximate market value of your spending liabilities (i.e., the theoretical cost of purchasing currently available insurance annuity contracts to cover your future spending).  The purpose of the ABB is to gauge how conservative or aggressive your current spending strategy is.  Armed with this benchmark, you can choose the level of spending with which you are comfortable and, just as important, you can monitor how aggressive your spending is each year by annually comparing it with your annually revised ABB. Recommended assumptions to develop your ABB as of January 1, 2018 are summarized in the overview tab of our Actuarial Budget Calculator (ABC) workbooks and, with the possible exception of using different Lifetime Planning Periods (LPPs) for couples, are unchanged from last year.  

As noted above, if you invested significantly in equities in 2017, it is likely that you enjoyed some investment gains.  In order to avoid significant fluctuations in spending and to be more conservative, you may wish to put some or all of your unexpected 2017 investment gains in a Rainy-Day Fund.  One way you can do this is to increase the amount entered in our Actuarial Budget Calculators (ABCs) for the present value of unexpected expenses and non-recurring expenses.  We have no idea when the equity market will see its next “correction,” but it does seem prudent to us to plan on one.  You may wish to use our 5-year forecast tabs (in the ABCs for single retirees and pre-retirees) to see how a significant correction in 2018 could affect your 2019 ABB.

Finalizing Your 2018 Spending Budget

Based on the data points discussed above (and possibly others), you can finalize your 2018 Spending Budget.  And while we use the terms “final” and “finalize,” you can always revise your final 2018 spending budget during the year if economic conditions or your personal situation changes.

Documenting Your 2018 Actuarial Valuation

Actuaries generally document their work in what is called an “Actuarial Report.”  We encourage you to document your work in sufficient detail that you can figure out next year what you did to develop your final 2017 Spending Budget.  This process can be as simple as printing out the “Input and Results” tab of the ABC workbook you used and writing notes on it.  Or you may save the workbook with your notes in a file on your computer.

Maintaining an Historical Record

In addition to documenting your work in developing your 2018 Spending Budget, we encourage you to maintain an historical record of your spending budget calculations.  This historical information will provide you with additional “data points” that you can use to refine future spending budget determinations.  We have provided a sample spreadsheet for this purpose that will reside in our “spreadsheets” section.  We aren’t trying to make you do a bunch of unnecessary busywork, so feel free ignore items in this spreadsheet you don’t feel like maintaining.  This is just a spreadsheet that we use ourselves to maintain historical information.  We have started the spreadsheet with 2017 information, but if you have information for earlier years, feel free to add that earlier information to your personal spreadsheet. 
(click to enlarge)


Instead of watching some of those college football games this year, we recommend that you take some time to think about your personal financial situation and do some planning.  We recommend that you perform an actuarial valuation of your assets and spending liabilities, and document your thought process in an Actuarial Report that you can revisit next year during college bowl season.  We also recommend that you maintain this information each year so that you can use the historical information to make better assumptions and spending decisions.

Happy New Year and Happy Budgeting from Ken and Bobbie.