We have never been big fans of Monte Carlo models for determining how
much one can afford to spend in retirement from year to year. As
actuaries, we believe that following the simple “3M” process described
below is much more import than the model used in the process.
Actuarial Approach–Three Key Planning Steps
- Measure your Funded Status (assets/liabilities) at the beginning of each year
- Monitor your Funded Status from year to year, and
- Manage your spending, assets and risks in retirement as necessary
Yes,
we included this process description in several of our prior posts, but
we feel it is sufficiently important to justify its repetition.
Apparently,
several retirement planning experts are also not big fans of Monte
Carlo models typically used by financial advisors today.
In his recent Advisor Perspective article, Dr. William Bernstein said,
“If
you think that a souped-up piece of Monte Carlo software in any way
subsumes the gross macroeconomic and personal uncertainties of both
retirement saving and spending, then you must also devoutly believe in
the Easter Bunny.”
In his LinkedIn review
of Dr. Bernstein’s article, Dr. David Blanchett indicated that while
Monte Carlo models have their issues, they could be improved by
- decomposing the retirement income goal [making goals more granular],
- incorporating dynamic adjustments, and
- using better outcomes metrics (especially moving away from the probability of success!),
We
would like to point out that the Actuarial Approach advocated in this
website, with its Funded Status metric, is entirely consistent with both
Dr. Bernstein’s suggested simple “non-Monte Carlo” approach and Dr.
Blanchett’s suggested planning improvements.
If you are a financial planner or you are just responsible for your household finances, you may want to give the Actuarial Approach and the Actuarial Financial Planner workbooks a try.
