It’s Time to Retire Ruin (Probabilities)

Abstract

Concerned about the growing use of ruin probabilities as the guiding risk metric for retirement income planning, the author introduces the idea of portfolio longevity being parallel to the biological longevity of human life and discusses how to educate clients regarding the most important factors influencing their money’s longevity. He suggests that advisers start by providing clients with an estimate of the number of years their portfolio will last—assuming they continue on the current path—using a framework that can be easily understood and communicated.

Editor’s note: The author may have a commercial interest in the topics discussed in this article.

Editor’s note: This article was reviewed and accepted by Executive Editor Stephen J. Brown.

I thank Stephen Brown, Branislav Nikolic, François Gadenne, David Laster, Faisal Habib, and Nabil Tahani for comments on earlier drafts.

Notes

¹ That was the same year William Bengen published his 4% tour de force in the Journal of Financial Planning. Our piece was published in the fall 1994 issue of a relatively obscure Canadian journal. I am still proud of that paper, my first publication: K. Ho, M.A. Milevsky, and C. Robinson, “How to Avoid Outliving Your Money,” Canadian Investment Review, vol. 7, no. 3 (Fall 1994): 35­–38.

² Before you rush off to a casino to capitalize on this factoid, note that today’s gambling dice are crafted with greater care (and symmetry), partly because of this fact.

³ Full disclosure: CFA Institute published a monograph of mine in 2013 called Life Annuities: An Optimal Product for Retirement, and I have worked as a consultant for a number of insurance companies.

⁴ Note that when g itself is randomized, the expected value of portfolio longevity might not be defined by or even equal to the deterministic EL. In a stochastic environment, the median would be more suitable.

⁵ Personally, I would have compliance departments place firm-wide restrictions on the highest risk-adjusted g that can be used in illustrations, but that is another matter.