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Author: trader2012 Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 35392  
Subject: Re: Funding Retirement Date: 10/6/2012 11:17 AM
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RH,

Thanks for responding.

For sure, there are many ways to estimate one’s life-span. E.g., one can use the ‘interview approach’. What were the ages of your parents/grandparents when they died? and causes? Do you smoke? Exercise? Have a heart condition? Etc. But the questionnaires are too easy to game. You know what answers you should give, and it’s too easy to obtain an unrealistic result.

At the other end of the spectrum, one can simply guess a number, which isn’t as bad an idea as it sounds. On average, those who think they will live a long life, do so by an average of seven years longer than those they think they are short-lived.

A third approach is to pull a number from an actuarial life table, such as is found at the SS website. But the number can be pulled from the table in several ways, one which is your method of taking the 'half-life' of the remaining cohort, given one’s present age. But that doesn’t tell me anything about the distribution of the right-hand tail, i.e., the likelihood of losing the bet that one won’t live longer than that projected average, nor by how much. That’s why I prefer the “last man standing approach”. If I don’t fund my retirement until I’m the last man standing, and I do live to be that last man standing, then I could end up in the breadlines. (OTOH, if I die earlier, my heirs receive a chunk of unexpected money.)

What is the hope of most people? That they don’t run out of money before they run out of life. But my bet is that they are going to lose that bet, because they under-estimate their lifespan, under-estimate inflation, and over-estimate their investing gains. (See Easterling's work on this topic. http://www.crestmontresearch.com/docs/Stock-Retirement-SWR.p...) When I run my numbers, I’m out of money at age 132 or something equally ridiculous. So what I was trying to do was to stress-test my approach. If retirement is only funded to 1StdDev of one's life-expectancy (however that life-expectancy is estimated), then approximately one in three times the person ends up in the bread-lines. Funding to 2 StdDevs cuts the failure-rate to about one in twenty cases. Funding to 3 StdDevs cuts the failure-rate to about one in two hundred cases, or something close to an acceptable risk.

Financial planners glibly do 20-40-year projections for their clients that have a 100% chance of having a chance of failing, nor can they quantify what that chance is, because, as Taleb has proven in his technical papers, one can't use the known sample of rare events to estimate their distribution. I prefer a “Safety First” approach for my retirement income-streams, the easiest of which is to have 4x-6x coverage, most of which is disconnected from market-pricing. Yes, for sure, “One nuclear bomb could ruin your whole day.” So, no financial plan is truly bomb-proof, and I do accept the possibility that I might fail for systemic causes (e.g., the US defaults on its debts and/or WWIII).

But I don’t intend to fail because I’ve made the avoidable mistake of under-estimating how long I might live. And I’ve got bad odds. My grandmom died at 96, her brother at 103, her two sisters at 105 and 109. If I’ve inherited those genes, then there’s no question that I need to fund myself to at least 3 StdDevs of my life-expectancy, if not four, which, fortunately, is already in place. So my problem isn’t to amass more capital than I already have, but to keep it moving forward against the time when it might be needed. But that isn't most people's problem. Their problem is far more basic. They have no idea how long they will live, nor how much money they will need in retirement, nor where it will come from. Their hope, of course, is for a return of the bull market of the '90s, or when that doesn't happen, that the government will bail them out of their failure to do basic financial planning.

Charlie
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