As discussed many times in this website, the Actuarial Approach employs a model and a process that involves systematic comparison of household assets and liabilities and tracking of the resulting household Funded Status over time for the purpose of making better financial decisions in retirement, including decisions relating to spending and investment. This is the same general process used by actuaries to help ensure the financial sustainability of many other financial systems, such as Social Security and defined benefit pension plans.
And while we tend to focus on avoiding over-spending in retirement, there are certain households that could probably afford to spend more if they wanted. In his well-written Kitces.com post of November 8, 2023 Adam Van Deusen outlines several technical framing strategies and behavioral tactics to help spending-hesitant clients increase their spending in order “to have a more enjoyable retirement.” We generally agree with Mr. Van Deusen’s recommendations and encourage you to read his article. In this post, we will focus on his recommended technical framing strategies (summarized below) and discuss how these strategies are easily accomplished using the Actuarial Approach.
Kitces Framing Strategy Recommendations to Boost Retirement Spending
- Avoiding Success Vs. Failure Framing of Monte Carlo Analysis
- Segmenting Spending into “Core” and “Adaptive” Buckets
- Boosting Guaranteed Income Sources
Avoiding Success Vs. Failure Framing of Monte Carlo Analysis
Mr. Van Deusen correctly points out several of the potential deficiencies of Monte Carlo probability-of-success modeling. He says:
“Retired clients who have ample assets to spend but are spending less than they would like because they are afraid of plan failure could be particularly sensitive to their plan's Monte Carlo results. For instance, these clients might want to curb their spending now to maximize the probability of success or to preclude the potential for dramatic reductions to their income in the future, even though the need for such major spending reductions in the future might be highly unlikely.”
By comparison, the Actuarial Approach does not calculate “hard to understand” probabilities of success. Instead, we encourage households to focus on the relatively simple ratio of assets to spending liabilities (Funded Status) and the progress of the household’s Funded Status over time. So, if the household Funded Status is currently significantly in excess of 100% and/or if its Funded Status has increased relatively steadily over time, the household may be encouraged to explore possible spending increases. Also, households can supplement this easy to-understand Funded Status information with additional information obtained from “what-if” testing to further increase spending confidence.
Another reason we believe the Actuarial Approach is superior to Monte Carlo modeling for encouraging spending-hesitant households to increase spending is its ability to:
- distinguish between recurring vs. non-recurring expenses,
- anticipate reductions in expenses after the first death within the couple, and to
- assume lower than inflationary rates of increases in future discretionary spending.
These features are generally not available in Monte Carlo models, but are available in the Actuarial Approach. For example, if a household with a 30-year time horizon has a goal to enjoy traveling only for the next 15 years, it is unnecessary to fund travel expenses each year for the expected remaining lifetime of the couple. It is also more reasonable to assume some drop in anticipated expenses after the first death within the couple. Finally, research has shown that discretionary spending generally decreases in real dollars as we age, so it may be reasonable to assume such future spending will not keep up with assumed rates of inflation.
Segmenting Spending into “Core” and “Adaptive” Buckets
This is another framing suggestion that we don’t normally see in Monte Carlo modeling but we recommend in the Actuarial Approach. As discussed in our previous post, we recommend the use of two separate buckets to fund future essential and discretionary spending expenses with the present value of low-risk guaranteed investments (including the present values of Social Security benefits, pensions, annuities, etc.) comprising the Floor Portfolio used to fund the present value of essential spending and risky investments comprising the Upside Portfolio used to fund future discretionary spending. Since these spending categories are selected by the household in a manner consistent with their spending desires and tolerance for risk, we fail to see any significant benefit in renaming such buckets as “core” and “adaptive” vs. essential and discretionary as suggested by Mr. Van Deusen.
Boosting Guaranteed Income Sources
As noted above, the Actuarial Approach promotes the use of a Floor Portfolio of low-risk guaranteed income sources to fund essential spending. Also, as discussed above, we leave it up to the household to decide which expenses and assets should be classified as essential and which discretionary. We agree with Mr. Van Deusen that matching investment in low-risk guaranteed income with funding of essential expenses can increase household spending confidence if utilized.
Summary
We thank Mr. Van Deusen for pointing out the framing deficiencies in Monte Carlo modeling approaches typically used by financial advisors and for giving us the opportunity to tout the Actuarial Approach as a better alternative for encouraging spending-resistant households to increase their spending if desired and warranted.
