A down-market day like today is a good day to do some financial planning and to worry a bit about “running out of money before one runs out of life”. In part, this thought was prompted by this week’s issue of The Economist and their two articles on the “equity risk premium”. They argue that both investors and pension providers are over-estimating potential equity returns by as much as 100%, which doesn’t differ much from Dalbar’s 20-year studies of how badly the average investor under-performs a common benchmark, such as the SP500. The other half of the question of “How much money can be pulled from markets?” is “For how long will investment gains be needed?” I’ve argued before that most investors are underestimating that number, but I’m in the mood to repeat the exercise. If you take a “period-life table”, such as can be found at the Social Security website, and convert it into a betting chart, you can estimate the odds of living to various ages. More importantly, you can estimate for yourself the sort of odds you would be willing to live with that you will (or won’t) run out of money before you run out of life. E.g., a male has a 1 in 4 chance of living until age 87. Do you really want to bet against yourself by not funding your retirement at least until then? A female has a 1 in 5 chance of living until age 92. Do you really want to bet against yourself by not funding your retirement at least until then? What about a 1 in 10 chance of living? Are you willing to bet against yourself at that point? because that is what you would be doing if you don’t provide funding at least until then.Obviously, as the odds decrease of living another year, the burden of providing funding increases. So, at some point, it does become reasonable to say, “I’m willing to risk that I won’t live any longer, because it really is beyond my means to fund myself to that age.” What that age might be is for each to determine. But what studies such as those of Dalbar and the articles in The Economist do suggest is that the gap between hopes and facts is huge and that corrective action is needed now. Odds of LivingAge Males Females79 51.0% 64.6%80 48.0% 61.9%81 44.9% 59.1%82 41.7% 56.1%83 38.4% 52.9%84 35.1% 49.6%85 31.7% 46.1%86 28.3% 42.5%87 25.0% 38.8%88 21.8% 35.0%89 18.7% 31.1%90 15.7% 27.3%91 13.0% 23.6%92 10.5% 20.0%93 8.3% 16.7%94 6.4% 13.6%95 4.8% 10.8%96 3.5% 8.4%97 2.5% 6.4%98 1.7% 4.7%99 1.1% 3.4%100 0.8% 2.4%101 0.5% 1.7%102 0.3% 1.1%103 0.2% 0.7%104 0.1% 0.5%105 0.1% 0.3%106 0.0% 0.2%107 0.0% 0.1%108 0.0% 0.0%
Odds of LivingAge Males Females79 51.0% 64.6%80 48.0% 61.9%81 44.9% 59.1%82 41.7% 56.1%83 38.4% 52.9%84 35.1% 49.6%85 31.7% 46.1%86 28.3% 42.5%87 25.0% 38.8%88 21.8% 35.0%89 18.7% 31.1%90 15.7% 27.3%91 13.0% 23.6%92 10.5% 20.0%93 8.3% 16.7%94 6.4% 13.6%95 4.8% 10.8%96 3.5% 8.4%97 2.5% 6.4%98 1.7% 4.7%99 1.1% 3.4%100 0.8% 2.4%101 0.5% 1.7%102 0.3% 1.1%103 0.2% 0.7%104 0.1% 0.5%105 0.1% 0.3%106 0.0% 0.2%107 0.0% 0.1%108 0.0% 0.0%
I believe these figures are for a newborn. If you are already 75, the odds of living to be 80 are dramatically greater. All the awful things that could have happened to keep you from reaching 75 didn't happen, and here you are! So a problem with this calculation is that the target keeps moving. So you reach 80 and are running out of money. "Darn! I should have planned for 85!"Therefore, the plan, in order to keep from running out of money, is to assume an infinite lifespan and arrange one's portfolio so you can live off the interest and dividends without touching principal, or better, add enough principal each year so you have corrected for inflation. Best wishes, Chris
I believe these figures are for a newborn. Chris, In one column, the SS website does present "life-span expectations" and shows them to be a decreasing function of age. But I didn't borrow that number from them. Instead, I divided each year's survivors by the original cohort of 100,000 to create a betting table. Therefore, the plan, in order to keep from running out of money, is to assume an infinite lifespan and arrange one's portfolio so you can live off the interest and dividends without touching principal, or better, add enough principal each year so you have corrected for inflation.In theory, that plan could work *provided* investment returns always stayed far enough ahead of taxes and inflation to allow for a draw. But in practice, it's very difficult to pull the needed money out of markets, year after year. So this is the compromise I've settled for. As long as my investable net-worth (aka, working capital, minus real estate equity) can be shown on paper to increase each year beyond my likely maximum life-expectancy, then my retirement plan is considered to have a sufficient margin of safety. In other words, somewhere around age 134, I do run out of money, and there's not much I can do about that other than lie to myself that inflation isn't really running at about 6% per year and/or that I will somehow be able to pull better money out of markets than my track record says I can. Run the numbers. If an investor's income-tax rate is 40% (Fed and State) and if inflation is running at 6%, then it takes a 10% investment return just to break even. There's been years when I pulled three times that out of markets, and my long-term, 27-year average is around 16%. But there's no way I should ever count on being able to do much better than a steady 8%-9% per year going forward from where we are now in the macro-economic cycle, unless I want to go to work full-time as a trader, which I don't. Meeting my ordinary living expenses should never be a problem with my current investing gig, no matter how long I live. But, eventually, taxes and inflation would overcome assets and my ability to stay ahead of expenses. Hopefully, I'll never live long enough to see the day. But that day cannot be ruled out. "All it takes is one nuclear bomb to ruin your whole day (and investment plans)." Charlie
Scientists say that someone is alive today that will live to the age 150.The pessimist says..."that person will probably be my mother in law. If I make it to 85, I'm going to stop using condoms.
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