Extra Info from Moshe Milevsky about ER..........

[FinanceDude]

I pressed Dr. Milevsky about why he thinks that ER's face a larger chance of failure due to their long planning horizon.

Since I didn't ask his permission to post his reply on here, I will paraphrase..........

His reponse was that there are 3 reasons ER folks have sustainable income issues for longer retirements:

1) You have to finance the consumption stream for a longer period of time

2) The sequencing of returns will have a greater impact.

3) Inflation will erode purchasing power over a longer period of time.

He referred me to an article he wrote in April of 2007 regarding the "Sustainability and Ruin"...........

I just thought I would pass this info along, as Nords and others were interested........while there is nothing earth-shattering here, maybe it can help somebody.............

 

[wompo]

Interesting

I think this is it: http://www.qwema.ca/pdf_research/2007APR_RUIN.pdf

If I retired today I would have a ruin probability of 19%

 

[FinanceDude]

I think this is it: http://www.qwema.ca/pdf_research/2007APR_RUIN.pdf

Thanks, that is it.........

 

[Keopele]

I'm curious if the retirement ruin logic is close to the inverse of Firecalcs retirement success logic. I think 2 of the three Ruin inputs are in Firecalc. If so, I would much rather go with the glass is half full logic rather than the glass is half empty logic. I would try to run some numbers now, but it's 10pm here in Zwolle and my friends hops and barley say no math now please.

 

[DblDoc]

I'm curious if the retirement ruin logic is close to the inverse of Firecalcs retirement success logic. I think 2 of the three Ruin inputs are in Firecalc. If so, I would much rather go with the glass is half full logic rather than the glass is half empty logic. I would try to run some numbers now, but it's 10pm here in Zwolle and my friends hops and barley say no math now please.

The last paragraph in the article would imply that it is the inverse of "popular" retirement calculators.

DD

 

[Nords]

Thanks, FD, Wompo, that's a good read.

I'm surprised at Milevsky's age-- he seems to write as if he's in his bearded 60s, or at least has the experience of that perspective. For some reason I had him slotted alongside Fama, French, & Sharpe. But I still doubt that he'll ever retire, not that he'd have any incentive to.

I also like the idea of tweaking the factors that seem to affect the failure rate-- a nice counterpoint to FinancialEngines and FIRECalc. I see some GAMMADIST spreadsheet fun in my future.

 

[hogwild]

Very interesting article. Using 20% volitility, 5% return, 5% spending and 30 year life, I get 45% chance of ruin.

 

[Meadbh]

Very interesting article. Using 20% volitility, 5% return, 5% spending and 30 year life, I get 45% chance of ruin.

I decided to set up an Excel spreadsheet to do sensitivity analysis using the Gammadist function as he describes in the article. But I must be making a mistake somewhere, because (a) I am not getting 45% ruin for your numbers, but 57% eek, and (b) the results are not responding to changes in the input variables in a predictable manner. I don't think the Excel function is using the same formulas.

 

[Meadbh]

I decided to set up an Excel spreadsheet to do sensitivity analysis using the Gammadist function as he describes in the article. But I must be making a mistake somewhere, because (a) I am not getting 45% ruin for your numbers, but 57% eek, and (b) the results are not responding to changes in the input variables in a predictable manner. I don't think the Excel function is using the same formulas.

I'm not making a mistake. The Gammadist formula is different. I have set up my new Milevsky Ruin Forecaster spreadsheet to just calculate Alpha and Beta. Then you consult the table. Unfortunately Excel files cannot be uploaded here, so if anyone would like a copy, please PM me with an email address.

 

[hogwild]

I'm not making a mistake. The Gammadist formula is different. I have set up my new Milevsky Ruin Forecaster spreadsheet to just calculate Alpha and Beta. Then you consult the table. Unfortunately Excel files cannot be uploaded here, so if anyone would like a copy, please PM me with an email address.

I have Excel 2003 and the function works fine. I get the same results, when rounded to whole numbers, as the table in the article. I used separate formulas to compute the alpha and beta in two cells. Then used the gammadist function and pointed to the alpha and beta cells.

 

[LOL!]

So where would you get return and volatility numbers from? Perhaps from the table here: http://www.fundadvice.com/articles/buy-hold/fine-tuning-your-asset-allocation.html

 

[Delawaredave5]

The article reads well. I don't understand the math yet. But when I got to the below investment return assumption for 65 year old, the credibility of the author/article "took a hit" with me....

"...Also, assume your million-dollar nest egg is allocated to a mutual fund that is expected to earn 7 percent after inflation and all investment management fees..."

 

[FinanceDude]

The article reads well. I don't understand the math yet. But when I got to the below investment return assumption for 65 year old, the credibility of the author/article "took a hit" with me....

"...Also, assume your million-dollar nest egg is allocated to a mutual fund that is expected to earn 7 percent after inflation and all investment management fees..."

He's got a LOT more credibility than MANY financial "gurus" we suffer with.............

 

[Nords]

The article reads well. I don't understand the math yet. But when I got to the below investment return assumption for 65 year old, the credibility of the author/article "took a hit" with me....

It's not wildly out of line-- 10.xx% over the last 70-something years, minus about 3.xx% inflation. Conventional wisdom with a lot of assumptions about large-cap weighting, survivor bias, "stable" inflation, and future performance. But I agree with you that I wouldn't use the same projections with MY portfolio.

Presumably the guy does put these articles through some sort of peer-review process.

I think Milevsky's point is that even with cautiously-optimistic returns the risk of failure may be more than most are willing to accept. And when you shave the numbers back to Dimson & Marsh's 5% for an all-stock portfolio after inflation... and then throw in the volatility... well...

 

[haha]

I think Milevsky's point is that even with cautiously-optimistic returns the risk of failure may be more than most are willing to accept. And when you shave the numbers back to Dimson & Marsh's 5% for an all-stock portfolio after inflation... and then throw in the volatility... well...

Well, best to have a COLA pension!

Ha

 

[clifp]

Anybody have a good longevity calculator. The table is good starting point but my portfolio is much less than 50% international closer to 20%...

 

[chinaco]

Interesting article. Its nice to have another set of calculations and chart to reflect upon.

I think the wisdom it provides is for people to not be overly optimistic.

I am a pessimist... therefore my plan is structured a certain way.

Of course we should all do little contingency planning so we know how we should react depending on certain expected scenarios.

 

[walkinwood]

Where do you get your "volatility" values from? I can use the Morningstar Asset allocator tool to give me my expected portfolio return, but can't find a source to calculate the Volatility. It is defined in this doc by Milevsky
http://www.qwema.ca/pdf_research/2007SEPT_SustSpending.pdf
but its way beyond my ability to figure it out.

 

[ats5g]

Where do you get your "volatility" values from? I can use the Morningstar Asset allocator tool to give me my expected portfolio return, but can't find a source to calculate the Volatility. It is defined in this doc by Milevsky
http://www.qwema.ca/pdf_research/2007SEPT_SustSpending.pdf
but its way beyond my ability to figure it out.

I can't tell either, but he's probably just ballparking the 100% stocks as having 20% standard deviation, 50/50 stocks/bonds having 12% standard deviation, etc. I think historically, they've been closer to 17% and 10% respectively, but as he says in the article,

Thus, having a longer life span is interchangeable with decreasing the portfolio return or increasing portfolio variance.

So, he's probably erring on the side of caution.

 

[ats5g]

Here's another article on a similar subject by the same author:

A Gentle Introduction to the Calculus of Sustainable Income: What Is Your Retirement RisQuotient?

I created a little spreadsheet for people to try out different scenarios.

- Alec

 

[FinanceDude]

I'm just happy I brought some value to this discussion........

 

[bongo2]

Milevsky has a useful formula, but there is a very important caveat that I don't see in the short write-up linked above (the longer write-up does mention it). This is that Milevsky uses a constant force of mortality - that is, he assumes that the retiree is x% likely to die each year no matter how old. In fact, of course, people are very unlikely to die in their 40's and become much more likely to die as they age. For a standard retiree this won't be as big a problem, but for the early retiree in their 40's or even 50's this dramatically overstates the probability of dying early, and will overstate the "success" (success in this case is dying before running out of money) of the plan.

 

[FinanceDude]

Milevsky has a useful formula, but there is a very important caveat that I don't see in the short write-up linked above (the longer write-up does mention it). This is that Milevsky uses a constant force of mortality - that is, he assumes that the retiree is x% likely to die each year no matter how old. In fact, of course, people are very unlikely to die in their 40's and become much more likely to die as they age. For a standard retiree this won't be as big a problem, but for the early retiree in their 40's or even 50's this dramatically overstates the probability of dying early, and will overstate the "success" (success in this case is dying before running out of money) of the plan.

Moshe uses actuarial data he gets from insurance companies for his longevity risk info.................

 

[Independent]

Milevsky has a useful formula, but there is a very important caveat that I don't see in the short write-up linked above (the longer write-up does mention it). This is that Milevsky uses a constant force of mortality - that is, he assumes that the retiree is x% likely to die each year no matter how old. In fact, of course, people are very unlikely to die in their 40's and become much more likely to die as they age. For a standard retiree this won't be as big a problem, but for the early retiree in their 40's or even 50's this dramatically overstates the probability of dying early, and will overstate the "success" (success in this case is dying before running out of money) of the plan.

I agree with your observation - if Milevsky is using a constant force of mortality, then he is going to get bad numbers.

Looking at page 53 in the paper linked above, it certainly looks like the only thing he cares about is "average" mortality.

However, it you go to lengthier stuff that he's written, he really is doing this pretty well. He assumes that the force of mortality is an increasing function (my recollection is exponential, but I know he discussed a couple other possibilities). The lambda in the article is a parameter in the mortality function, not the result of the function.

 

[haha]

He assumes that the force of mortality is an increasing function (my recollection is exponential...

Is that ever a depressing thought!

Ha