Monday, December 31, 2018

2018 Year-End Review and 2019 Budget Development - Part II

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, 2019, 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 2018 
  • Develop 2019 spending budget “data points” 
  • “Finalize” your 2019 calendar year spending budget (or spending/savings budget for pre-retirees) 
  • Document the assumptions, data and adjustments used to determine your 2019 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, 2019.

Measuring How You Did in 2018

We hope that you saved your data as of January 1, 2018 and documentation of your 2018 spending budget calculations.  With this data you should be able to determine how you did in 2018, by approximating the items in the following equation:

Solving for these amounts and comparing them with amounts expected, based on your 2018 calculations, will enable you to determine your total actuarial gain/(loss), by subtracting Expected 2019 BOY Accumulated Savings from Actual BOY 2019 Accumulated Savings.  If your actual 2019 BOY Accumulated Savings is less than your Expected BOY 2019 Accumulated Savings, you experienced an “actuarial loss” for 2018.

Similarly, you can determine your gain/(loss) by source by comparing actual amounts experienced in 2018 with expected values (based on the 2018 actuarial valuation) for the following items:

  • investment income 
  • income from other sources 
  • spending
Since it looks like U.S. equities lost about 6.2% during 2018 (based on the S&P 500 index), those of you who invested a significant portion of your Accumulated Savings in equities probably experienced an actuarial loss on investment income (for the first time in many years) during 2018.  For retirees, these investment losses will generally translate into a lower Actuarial Budget Benchmark (ABB) for recurring expenses for 2019 than your 2018 ABB increased by inflation (or desired increase used in your calculation last year, if different from inflation).  These losses will probably make development of your 2019 spending budget a little less enjoyable for you than in more recent years, but if you invest in risky assets, it is important for your financial plan to be able to address both gains and losses as they occur.  We will discuss below steps you might want to consider to “smooth” the effect of these investment losses on your 2019 spending budget.

For pre-retirees, an investment loss will generally translate into a lower projected first year of retirement recurring spending budget than last year.  

Developing 2019 Recurring Spending Budget “Data Points”

As discussed in our post of April 20, 2017, the process of deciding on your recurring 2019 spending budget involves considering a number of “data points.”  The data points may include, but are certainly not limited to, the following:
•    Your 2018 recurring Spending Budget increased with inflation or some other percentage increase
•    Your 2019 recurring Spending Budget recommended by your financial advisor or someone else,
•    Your 2019 Actuarial Budget Benchmark (ABB) for recurring expenses
•    Your desire to avoid significant fluctuations in spending
•    Your desire to be conservative or aggressive
•    Your scenario testing (discussed in our post of November 26, 2017)
•    Non-recurring spending anticipated for 2019, etc.

For the first item above, we recommend using the same increase announced for Social Security cost of living increases for 2019: 2.8%.  If you develop your recurring spending budget based on desired future increases of inflation minus 1%, however, your preliminary 2019 recurring Spending Budget “data point” would be your 2018 recurring spending budget increased by 1.8% (2.8% ‒ 1%).

As discussed in many of our previous posts, we encourage you to develop your Actuarial Budget Benchmark (ABB) as another data point in your budget setting process.  The ABB is a recurring spending 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 inflation-indexed insurance annuity contracts to cover your future spending).  This calculation is accomplished in our Actuarial Budget Calculator (ABC) spreadsheets by using the default assumptions.  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 recurring spending with which you are comfortable and, just as important, you can monitor how aggressive your recurring spending is each year by annually comparing it with your annually revised ABB.  Default assumptions used to develop your 2019 ABB are summarized in the overview tab of our ABC workbooks and are unchanged from last year. 

As discussed above, if you invested significantly in equities in 2018, it is likely that you experienced some investment losses last year.  In order to avoid undesirable fluctuations in recurring spending, you may wish to consider some or all of the following actions:

  • Dipping into the Rainy-Day Fund that you previously established with investment gains enjoyed in previous years 
  • Reducing 2019 non-essential non-recurring expenses, or 
  • Using the Smoothed Actuarial Budget Benchmark (illustrated in our post of November 6, 2018).
Finalizing Your 2019 Spending Budget

Based on the data points discussed above (and possibly others), you can finalize your 2019 total spending budget.  Your total spending budget for 2019 is equal to the sum of the amount you plan to spend during 2019 on non-recurring expenses plus your 2019 recurring spending budget. And while we use the terms “final” and “finalize,” you can always revise your final 2019 spending budget during the year by performing a mid-year actuarial valuation if economic conditions or your personal situation changes significantly during the year.  This might make sense, for example, if the negative investment returns experienced on equities in December of 2018 continue into 2019 or you experience significant unplanned non-recurring expenses during the year.  

Documenting Your 2019 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 2019 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 2019 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 provide a sample spreadsheet for this purpose that resides in our “spreadsheets” section.  This spreadsheet has been slightly revised this year.  We encourage you to complete the its items in the spreadsheet through the beginning of the 2019 year. 

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.  Also feel free to customize this spreadsheet to make it better fit your personal situation.  We 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.

As discussed in our post of November 27, 2018, you may wish to calculate how much of your total retirement assets are invested in equities or other risky assets to measure how much investment risk you are assuming in your investment strategy.  We have included this ratio in this year’s version of the historical spreadsheet.  


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.  For the first time in quite a while, you may have experienced an actuarial loss on your investments during 2018.  What actions should you take in response? 

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 so that you can use it to make better spending decisions and better assumptions in future actuarial valuations.  

As noted in our post of December 20, 2018, we encourage you to involve your spouse (if you have one) in your year-end review and planning process.   We also suggest that you take this end-of-year planning opportunity to perform some “what if” scenario testing to assess your risks in the event that your budgeting assumptions turn out to be inaccurate.   

While this year’s review and budgeting setting process may not be quite as fun as it was in recent years, we are still pretty sure that you will feel better about yourself and more prepared for 2019 after you have completed it.

Happy New Year and Happy Budgeting from Ken and Bobbie.