Congratulations. You made it through 2021!
In our ongoing effort to turn you all into actuaries, this post will recommend that you perform an “actuarial valuation” based on your personal and financial data as of January 1, 2022. An annual actuarial valuation is part of our 7-step Recommended Financial Planning Process. As part of this process, we will also encourage you to prepare a brief “actuarial report” to document your thought-process and any planning decisions you make for this year.
If you are using one of the new Actuarial Financial Planner (AFP) workbooks for retirees this year, you may wish to rerun your January 1, 2021 actuarial valuation utilizing the new AFP workbook and last year’s information to make comparisons between the two years easier.
The purposes of this annual valuation exercise are to:
- Review how well you did in 2021
- Develop your 2022 spending budget reflecting experience to date
- Review your current asset allocation
- Perform “what if” scenario testing, if you haven’t done so recently
- Document the assumptions, data and adjustments used to determine your 2022 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, 2022 and the actuarial report you prepared for last year.
We encourage you to involve your spouse, if you have one, in this process.
Measuring How You Did in 2021
We hope that you saved your data as of January 1, 2021 and documentation of your 2021 spending budget calculations. With this data you should be able to determine how you did in 2021, by approximating the items in the following equation:
BOY 2022 Accumulated Savings | = | BOY 2021 Accumulated Savings | + | 2021 Investment Income | + | 2021 Income from Other Sources | – | 2021 Amount Spent |
Solving for these amounts and comparing them with amounts expected, based on your 2021 calculations, will enable you to determine your total actuarial gain/(loss), by subtracting Expected 2022 BOY Accumulated Savings from Actual BOY 2022 Accumulated Savings. If your actual 2022 BOY Accumulated Savings is greater than your Expected BOY 2022 Accumulated Savings, you experienced an “actuarial gain” for 2021.
In our post of December 15, 2021, we asked you to pull together spending data for 2021 for purposes of seeing how your actual spending compared with your budget and for developing spending estimates to use in the January 1, 2022 valuation.
The S&P index finished 2021 about 26.9% above the beginning of year index. As a result of Covid-19 restrictions, many retirees spent less during 2021 than they budgeted. For those significantly invested in equities, these investment and spending gains will generally translate into actuarial gains for 2021 and a higher Rainy-Day fund (balancing item between your total assets and spending liabilities) as of January 1, 2022 than as of January 1, 2021, all things being equal.
Developing 2022 Recurring Spending Budget “Data Points”
As discussed in our post of April 20, 2017, the process of deciding on your recurring 2022 spending budget involves considering a number of “data points.” These data points may include, but are certainly not limited to, the following:
- Your 2021 actual recurring spending increased with inflation or some other percentage increase
- Your 2022 recurring Spending Budget recommended by your financial advisor or someone else
- 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)
- Your non-recurring spending anticipated for 2022, etc.
For the first item above, we recommend using the same increase announced for Social Security cost of living increases (in the U.S.) for 2022 benefits of 5.9%.
As discussed above, if you invested significantly in equities in 2020 and underspent your 2020 spending budget, it is likely that you experienced some experience gains last year. In order to avoid undesirable fluctuations in recurring spending, you may wish to consider some or all of the following actions:
- Adding to your Rainy-Day Fund
- Increasing 2022 non-essential non-recurring expenses (for example by doubling up your 2022 vacation expenses as discussed in our post of August 24, 2020), or
- Using a budget smoothing approach (illustrated in our post of November 6, 2018).
Based on the data points discussed above (and possibly others), you can finalize your 2022 total spending budget. Your total spending budget for 2022 is equal to the sum of the amount you plan to spend during 2022 on non-recurring expenses plus your 2022 recurring spending budget. And while we use the terms “final” and “finalize,” you can always revise your final 2022 spending budget during the year by performing a mid-year actuarial valuation if economic conditions or your personal situation change significantly during the year. This might make sense, for example, if you experience negative investment returns during 2022 or you experience significant unplanned non-recurring expenses during the year.
Reviewing Your Current Asset Allocation
As discussed in many of our posts, we encourage retirees to consider how much of their assets they may want to allocate to relatively low-risk investments in the Floor Portfolio anticipated to fund their Essential Expenses. We encourage retirees and near retirees to use the Actuarial Financial Planner workbooks for this purpose.
“What if” Scenario Testing
As discussed in our post of November 26, 2017, we believe it is important to periodically model potential deviations from assumed future experience. For example, we believe it is important for married couples to model what would happen if one of partners were to die during 2022.
Documenting Your 2022 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 2022 spending budget. This process can be as simple as printing out the “Input and Results” tab and other relevant tabs of the workbook you used and writing notes on the printed tabs. Or you may save the workbook with your notes in a file on your computer.
Conclusion
We recommend that you take some time in the near future to think about your personal financial situation and do a little planning. If you invested in equities during 2021 and/or you underspent your 2021 spending budget, you may have experienced an actuarial gain during 2021. What actions should you take in 2022 in response? Should you increase your spending budget or should you use the gains experienced in 2021 to increase your Rainy-Day Fund?
We recommend that you document your budget calculation thought process in an actuarial report that you can revisit at this time next year. 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. It just makes good sense for both of you to be on the same page when it comes to your household spending.
If you haven’t done so already, now may also be a good time to make sure your estate planning is up to date.
We hope that 2022 is a happier year for you, and that you find some truly enjoyable things on which to spend (while at the same time staying healthy).
Happy New Year from Ken and Bobbie
