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Subject:  Estimating Retirement Incomes, Pt. 1 Date:  9/19/2011  12:13 AM
Author:  charliebonds Number:  69618 of 80405

This will be a multi-threaded project, rather than a multi-posted thread, because estimating retirement incomes depends on making decisions about several factors, each of which requires its own treatment. But let’s begin at the beginning, which is Estimating how long you will live?

There seem to be five ways of making that estimate: genetic testing (aka, the work being done with telomeres); asking someone like your personal physician and trusting them; consulting a life-expectancy table; filling out a detailed “life-style and family history” quiz and then using their guestimate; and, lastly, doing it “by guess-and-by-golly”. Don’t laugh. The last method isn’t as silly as it sounds. Several studies (which you can track down) have shown that those who estimate a long life for themselves tend to live as much seven years longer than a pessimistic control group (who thought they would live shorter lives). So attitude matters hugely.

The second method isn’t as silly as it sounds, either, because we humans tend not to be able to be very objective about our own numbers. If you trust your personal physician, then ask her or him to make a guess for you at your next annual physical. If nothing else, if she or he is able to be honest and candid with you, you’ll receive an opinion based on seeing a lot of patients with your comparable age and state of health. The third method, filling out a detail life-style and family history questionnaire, has its merits, too, because its guesstimates are typically based on broad data samples, and because the questions tend to focus on the things that have been proven to matter to longevity (not smoking, proper diet and exercise, regular medical checkups, a family history of longevity, etc.) The problem with filling out such questionnaires is that they are so easy to game, and it is so tempting to fudge one’s answer by the little bit here, and the little bit there, that makes the suggested result worthless. As for genetic testing, the method is still in its infancy and fairly expensive. So, in this post, I’m going to dig into a method that is cheap and easy, because what matters in making your estimate of how long you will live isn’t getting the answer right, but in being aware of the consequences of getting it wrong. In other words, as they say, “you don’t want to run out of money before you run out of life”.

The easiest to use life-expectancy table I’m aware of is the one found at the Social Security website. What I like about the table is that the webpage can be scraped, dumped into a spreadsheet like Excel, and then reformatted as a betting table, a portion of which I’ve reproduced below. My thinking is this. If you begin life as member of a cohort of 100,000 of the same gender, what are the odds that you will live to age 80? 90? 100? Longer? We can know from looking at the table that males have an even odds chance of living to age 79. (For females, the even-odds age is around 84-1/2). Unfortunately, most people confuse “average life expectancy” with their own personal life-expectancy. In other words, generalizations drawn from a broad sample of 100,000 cannot be applied with much assurance to a sample of one. For sure, that is the way to bet. But it’s also a bet you might lose.
Let’s restate the problem. At what age are you willing to begin betting against yourself? When your odds of living another year drop to one in three? One in five? One in ten? One in 20? As long as the known, maximum life-span for a male or a female? (which are ages 115 and 122, respectively). Now think about the financial burden of having to fund your retirement until those maximum ages. The typical financial planner has you checking into the morgue in your late 80’s to mid 90’s, as they proceed to underestimate the forward rate of inflation and to over-estimate your likely rate of investment return, so they can work their magic with a Monte Carlo simulator and confidently tell you that their retirement plan for you will be an assured success. Maybe it will, but probably it won’t, given that not a one of them (I’ve ever talked to) can support themselves on their own investing, nor has any idea of how counter-factual are the assumptions that underlie their models of a supposedly predictable future. If weather men have trouble predicting whether an outside wedding you plan three months hence will be sunny or cloudy, hot or cold, dry of wet, would you trust what amounts to sales personnel making 20 and 30-year predictions for you? Nope, the best that you can do for yourself is some contingency planning.

“If I have an income-stream of X dollars now, expenses of Y that suffer an inflation-rate of Z, and I want to get from my present age of N to a future age of N+20 (or 30 or whatever), do I have sufficient assets to sustain me if my investment gains-rate is such and such?”

A five-part formula is all that any retirement plan is, and it doesn’t even have to be written as a formula. If you’re math-adverse, it is simplicity itself to build a column by column, line by line, spreadsheet that will do the calculations for you, as well as allow you