
Subject: Funding Retirement Date: 10/5/2012 4:41 PM
Recommendations: 4
What are the odds that you will live to age 80? 90? 100? Alternatively, what are the odds that you will need to fund your retirement at least until then? There are many ways to estimate one’s lifespan. But one way to obtain an impartial estimate is to convert a period-life chart (such as is found at the Social Security website) into a betting table, as has been done below. http://www.ssa.gov/oact/STATS/table4c6.html#fn2

Male Female
Age Odds Odds

79 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 0.75% 2.41%
101 0.48% 1.66%
102 0.30% 1.11%
103 0.18% 0.72%
104 0.10% 0.45%
105 0.06% 0.28%
106 0.03% 0.16%
107 0.02% 0.09%
108 0.01% 0.05%

Yes, females are going to live, on average, 3-4 years longer than males. But the important question either needs to answer is this. “How much risk am I willing to accept?” If you fund your retirement to a confidence level of one standard deviation, or 68%, you’re making a 2:3 bet that you won’t live past age 85 (male) or age 89 (female). If you lose that bet and do live longer, but meanwhile have run out of money for failing to having created the income-streams you need, you’re in the bread-lines. So that’s the tradeoffs you’re making. It’s easy to fund retirement to 1 StdDev, but the risk of failure is quite large. Funding retirement to 2 StdDevs is tougher, but doing so hugely reduces the risk of financial failure. Funding retirement to 3 StdDevs might be overkill. But such a person should sleep well at night. Reformatting the previous table gives us the following one.
Odds of Failing If Fund Retirement Only Until Various Ages

Odds Male Female
~32% 85 89
~5% 95 98
~0.5% 101 104

If food stamps are taken as a proxy for ‘bread-lines', 1 in 7 people in this country of any age are already in them. And due to the failure of most retirees to adequately fund their retirement, more will be joining them soon. So, what might be a solution? First, they shouldn’t have quit their day job. Second, they need to stop over-estimating their investments-gains and to stop under-estimating their lifespan and the impact of inflation. At an unrealistically-low inflation-rate of 4%, their expenses will double in 18 years and quadruple in 36. At a probably realistic rate of 5%, their expenses will double in 14.4 years and quadruple in 28.8. At a more conservative estimate of an inflation rate of 6%, their expenses will double in 12 years and quadruple in 24.

Now run this thought-experiment. Create a retiree, have him or her embark on their journey at age 65, and then estimate how soon they will have gotten themselves into a squeeze where their expenses are rising faster than they can find income from their investing to meet them. Now comes the tough part. In an investing environment that is projected to offer only modest returns going forward, how does a current retiree maintain his/her present income, much less increase it? For bond-investors, two courses of action are traditionally proposed. Extend maturities, or accept greater credit-risk. But there is actually a third path, and it’s the one I embarked on with this morning’s purchase. Instead of requiring that each new investment's return remain at prior levels (which isn’t going to happen), one can simply increase the amount of money one puts to work. (I.e., $5k at 10% is the same at the grocery store as $10k at 5%.)

To see how this might play out, let’s create a fictitious retiree. Let’s make the retiree male, age 65, willing to project a 6% inflation-rate, is current managing a mid-sized portfolio that offers a 10% return, and is carrying $50k-$100k in cash that offers nothing. Furthermore, his incomes and expenses look like this:

SSI $20,000 COLA indexed to CPI
Pension $30,000 no COLA
Investing-Income $50,000 no COLA

Present-Expenses $25,000
Current-Ratio 4.0

Inflation-rate 6%
Future-Expenses $100,000
(in 24 years)
Future-Ratio 1.0

As his bonds come due, he’s going to find it all but impossible (until genuine economic recovery does occur) to put the money back to work at the same rate of return. But if every maturing dollar is matched from his stash of cash and then put back to work at half the rate of return, then his income-stream remains unimpaired, the credit-risk profile of his portfolio doesn't rise, and he gets himself to age 89 with only a 1 in 5 risk of outliving his cash-flows, at which time he can begin to spend down his $1 Million plus balance-sheet to get him the next seven years to age 95, at which time his odds of living have dropped to 1 in 20, or a bet he’s willing to make for not being likely losing it.

In short, I don’t like buying bonds that don’t offer a real-rate of return after taxes and inflation. But I held my nose and went shopping this morning, because I refuse to buy stocks at current prices, and I refuse to sit in cash while waiting for the correction we all know is coming but might take much longer than any one expects. In short, rather than suffer the negative returns of “mattress cash” while waiting (probably futilely for yields to rise to more normal levels), I’m now buying decent-quality bonds of short to mid-term maturity, regardless of the fact that they fail to offer a real-rate of return after taxes and inflation. In other words, rather than lose an known (-6%) on mattress-cash, I'd rather cut that loss to (-1.5%) or so for the next 5-10 years. There’s not a lot of issuers to choose from. But there’s enough to need my needs, at least until I spend down my cash to more tolerable levels.

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