Our primary mission here at How Much Can I Afford to Spend in Retirement is to help people make better financial decisions (usually in or near retirement). To try to accomplish our mission, we promote use of the same basic actuarial principles we applied during our careers as pension actuaries. Our primary audience includes intelligent DIYers and Financial Advisors. As noted in our website, we receive zero compensation from visits to our blog or from any activity associated with the blog. We have, on several occasions, however, received nominal prize awards for essay submissions.
We are certainly not the only bloggers, writers or organizations trying to help people make better retirement-related decisions. Nor are we the only actuaries. With the aging of our population and the decline in employer sponsored defined benefit plans, helping retirees manage their finances has become a big business that has attracted economists, policy wonks, academics, researchers, financial advisors, insurance companies, actuaries, etc., and has created a rapidly increasing body of literature on retirement financial planning. Unlike many other retirement “educators”, however, we have no products or services to push and no potential conflicts of interest to disclose.
In this post, we will discuss two very sophisticated mathematical approaches for retirement planning and a general non-mathematical approach that we see frequently. We will then compare these approaches with the relatively simple actuarial approach recommended in this blog.
RISMAT by William F. Sharpe, Nobel Laureate
In 2019, William F. Sharpe, a Nobel Laureate, wrote Retirement Income Analysis with Scenario Matrices (RISMAT). His preface indicated that his purpose in writing this book was to “help retirees make better choices among the many possible alternative approaches for the provision of future income.” He also said,
“So – for whom have I written this book? The most honest answer is: myself. In an act of self-indulgence, I have focused on a set of issues that I believe are of major social importance and a set of techniques that I believe might help society deal with them. The methods are not simple. The reader will need to focus on procedures for dealing efficiently with uncertainty by employing large sets of information about potential future outcomes. There will be mathematics and computer algorithms.”
We agree with Dr. Sharpe’s understatement that his methods are “not simple.” For example, he suggests that readers of his book would be wise to familiarize themselves with MATLAB Matrix Algebra. MATLAB is a “proprietary multi-paradigm programming language and numeric computing environment” developed by MathWorks.
In Chapter 21, he notes:
“If there is any conclusion to be reached after reading the prior twenty chapters it is this: comprehending the range of possible future scenarios from any retirement income strategy is very difficult indeed, and choosing one or more such strategies, along with the associated inputs, seems an almost impossible task. At the very least, retirees will need some help.”
Retirement Income Recipes in R by Moshe Milesky
In our post of May 27, 2021, we referred readers to a new book by retirement expert and academic, Dr. Moshe Milesky, entitled “Retirement Income Recipes in R.” The blurb in Amazon describes the book as follows:
“This book provides computational tools that readers can use to flourish in the retirement income industry. Each chapter describes recipe-like algorithms and explains how to implement them via simple scripts in the freely available R coding language. Students can use those skills to generate quantitative answers to the most common questions in retirement income planning, as well as to develop a deeper understanding of the finance and economics underlying the field itself. “
Suffice to say that the sophisticated math required by Drs. Sharpe and Milesky’s suggested approaches are beyond the comprehension of most retirees and their advisors.
General Non-Mathematical Educational Material
At the other end of the education spectrum, we see a fair number of articles that dispense retirement advice by assiduously avoiding discussion of numbers, financial concepts or assumptions. It is the hope of the authors of these articles that advice presented in “everyday language” with few numbers or discussions of assumptions will appeal to non-number crunchers and do a better job of educating individuals to help them make better financial decisions. General non-mathematical advice frequently relies on opinions of “experts”, general rules of thumb or research results that may not adequately reflect individual circumstances. Frequently such educational material presents potential advantages and disadvantages (trade-offs) of alternative decisions, and often contain warnings to be sure to remember certain types of expenses when retirement planning. As actuaries, we generally don’t find these non-quantitative articles particularly useful, but that just may be us.
Actuarial Approach
The actuarial approach recommended in this website uses time-proven actuarial principles to develop a robust spending strategy. In addition, we encourage the use of a liability driven investing approach to fund Essential Expenses with investments in non-risky assets. The math involved in our workbooks is not as sophisticated as that proposed by Drs. Sharpe and Milesky, but in our opinion, it is sophisticated enough to provide robust decision-making data.
The motto of the Society of Actuaries is “The work of science is to substitute facts for appearances and demonstrations for impressions” (John Ruskin). Consistent with this motto, we believe it is important to employ basic actuarial principles, including assumptions and present values, in addition to incorporating individual data, spending goals and risk tolerances, in retirement financial planning calculations performed for individuals or couples.
The mission of the Society of Actuaries is “Through education and research, the SOA advances actuaries as leaders in measuring and managing risk to improve financial outcomes for individuals, organizations, and the public.” Consistent with this mission statement, we believe it is important for the Actuarial Approach we recommend to enable individuals and their financial advisors to measure and manage retirement risk. With respect to measuring risk, we note that without employing assumptions in the financial planning process, it would be impossible to assess (measure) risks, as risks are defined (in Actuarial Standard of Practice No. 51) as “The potential of actual future measurements deviating from expected future measurements resulting from actual future experience deviating from actuarially assumed experience.” In addition, separating expenses into Essential and Discretionary categories enables households to manage risk and directly reflect their tolerance for risk in their plans.
So how complicated is the approach we recommend? Actually, it isn’t very complicated at all. Data points to facilitate many retirement-related financial decisions can be obtained by answering the following two questions with the results obtained from our Actuarial Budget Calculator (ABC) Workbooks.
Two Key Questions to Facilitate Financial Planning in or Near Retirement
Question #1--Does the household have sufficient non-risky assets to fund the present value of their future Essential Expenses (their self-selected “needs”) using assumptions consistent with purchase of these liabilities from an insurance company?
Question #2—Does the household have sufficient risky assets to fund the present value of their future Discretionary Expenses (their “wants”) using reasonable assumptions?
If the answer to either of these questions is no, the household may wish to consider modifying their spending or investment strategies or the timing of their retirement.
To assess and manage the risks of future measurements differing from assumptions, the household or financial advisor can stress-test the longevity, investment return or inflation assumptions used in our workbooks or other assumptions made in the planning process.
That’s it! Yes, it does involve inputting data into an Excel workbook on an annual basis, but it is nowhere near as complicated as learning MATLAB or R coding language.
Summary
We support all forms of education that will enable individuals to make better financial decisions. We acknowledge that not all forms of education are going to be helpful for everyone. For obvious reasons, we believe the actuarial approach we advocate can be quite helpful for at least some individuals and financial advisors. And, while we believe it is important to crunch numbers to develop a reasonable retirement plan and make better retirement-related decisions, we don’t believe the actuarial approach is anywhere near the “almost impossible task” to perform or understand as anticipated by Dr. Sharpe, and we certainly don’t think you need to be as smart as a Noble Laureate to use our workbooks. Finally, did we mention that our workbooks are available for free?
