Sunday, February 21, 2016

About Fidelity's Health Care Cost Estimate for Retirees

When I recently posted about a highly-circulated report from Fidelity Investments estimating the expected lifetime cost of health care for a 65-year old couple today at $245,000, some readers were skeptical. Fair enough. We should question the motives of the authors of any study, and one assumes Fidelity generally has a profit motive. There were also complaints that Fidelity published only the expected value of $245,000, so we don’t know the distribution of those expected costs.

Fidelity's estimated $245,000 includes the cost of deductibles and co-pays, premiums for optional coverage for doctor visits and prescription drugs, and out-of-pocket expenses for prescription drugs. It does not include long-term care or most dental care.

I queried Fidelity regarding the distribution of those expected costs, but they informed me that the information is considered proprietary. That’s OK. There are multiple sources for this kind of data, so I pulled a few of them together for a comparison.

One of my favorite sources, the Center for Retirement Research at Boston College, had this to say in 2009 about expected health care costs in retirement (download PDF):
". . . the mean and 95th percentile of remaining lifetime health care costs, including the cost of nursing home care including . . . Medicare, Medigap, and retiree health insurance premiums. . . are $260,000 and $570,000, respectively."

". . . the results of the same simulation, but excluding the cost of
nursing home care. . . including insurance premiums. . . the age 65 mean and 95th percentile amount to $197,000 and $311,000 ."
(The four studies mentioned in this post were conducted at different times. For a fair comparison, I adjust the expected expenses to 2014 dollars. Hover over the expenses above to see the 2014 dollar value assuming medical cost inflation from 2009 through 2014 of 3.8, 3.8, 3.6, 3.7, 2.0 and 3.6%, respectively. Values in the table and graph below are shown in 2014 dollars. For example, the CRR reported a cost of $260,000 in 2009. Hovering over that figure above will show the 2014 dollar value of $318,029, which will also appear in the table and graph below.)

A 2013 study sponsored by the Society of Actuaries (download PDF) found the following:
“The future health care needs for a retiree vary by the retiree’s current age and their expected lifetime, but are estimated to be about $146,400 for someone currently age 65 with an average expected lifetime of 20 years ($292,800 for a couple of the same age). That amount includes health care costs not paid for by the federal government through the Medicare program (including Medicare Parts B and C premiums). If they think they will live until age 90 (25 years instead of 20 years) they will need $220,600 (or $441,200 for a couple). These amounts are for the “average” retiree and do not include long term care costs that some retirees may incur.”
Another analysis is provided by HealthView Services (download PDF):
“The average lifetime retirement health care premium costs for a 65-year-old healthy couple retiring this year and covered by Medicare Parts B, D, and a supplemental insurance policy will be $266,589. (It is assumed in this report that Medicare subscribers paid Medicare taxes while employed, and therefore, will not be responsible for Medicare Part A premiums.) If we were to include the couple’s total health care (dental, vision, co-pays, and all out-of-pockets), their costs would rise to $394,954.
Lastly, the Employee Benefit Research Institute (download PDF) provides expected health care costs for 65-year old couples broken down by the need for prescription medicines. Their estimate ranges from $150,000 for median prescription drug usage to $220,000 for high usage. Their 90th percentile estimate (not 95th!) is $255,000 to $360,000.

Here is the more-precise data in tabular format.

Fidelity Investments Boston College CRR Society of Actuaries HealthView EBRI Average
Publication Date 2014 2009 2010 2014 2013
Mean Lifetime Health Care Costs for a 65-year Old Couple
Excluding LTC Costs $245,000 $240,968 $309,408 $394,954 $155,400 to $227,920 $261,442
Including LTC Costs

90th/95th Percentile Lifetime Health Care Costs for a 65-year Old Couple
Excluding LTC Costs

$269,464 to $372,960 $328,824
Including LTC Costs


Although Fidelity Investments took it on the chin from some readers for an expected cost appearing too low and for not publishing a standard deviation or 95th percentile estimate, their expected value is almost identical to that from the Center for Retirement Research and only 6% below the average of all studies. EBRI's expected cost was even lower.  Furthermore, among the five studies listed, only two provided a 95th percentile expected value.

Why would studies exclude long-term care costs? Medical expenses excluding long-term care are significantly easier to predict than long-term care expenses, so it makes sense to think of them separately. You may have retirement-threatening long-term care expenses or none, at all, but you will undoubtedly have substantial "other" medical care expenses.

The two are insured differently, as well. Medicare covers medical expenses (though, not all) but not most long-term care costs. Long-term care is covered by LTC insurance or Medicaid. So, there's another reason to think of them separately. They are different and distinct risks.

It’s important to note that, according to this AARP Bulletin, health care costs will consume most of the future Social Security benefits for some households. And as HealthView puts it,
With health care cost inflation rate likely tripling COLAs for the foreseeable future, retirees will eventually use more of their Social Security income to pay for health care. Over time, the compounding effect of this differential will place incredible stress on the average retirement budget.

According to AARP, health care costs will consume most of the future Social Security benefits for some households.
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According to Fidelity Investments, their 2015 Couples Retirement Study showed that "nearly three-fourths of couples surveyed said being able to afford unexpected health care costs in retirement was their top concern. However, only 22 percent of couples had factored it into their financial planning." It should be near the top of every retiree's list of concerns and factored into everyone's retirement plan.

Nearly three-fourths surveyed by Fidelity said affording health care costs in retirement was top concern, but only 22% planned for it.
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The range of potential lifetime health care expenses for retirees is huge and there is no way to predict where an individual household will fall within the spectrum, so how does a retiree best use this data for planning purposes? Consider the following:

  • Even the best-case predictions for lifetime health care costs in retirement will threaten the budgets and sustainability of many households. Health care costs should play an important role in retirement budget planning. 
  • Estimate them as accurately as you can for your individual circumstances. Consider the averages a starting point and Google costs for health care and long-term care in your geographic area, and consider your own health.
  • Assume a higher rate of inflation for medical expenses than for other costs. The cited HealthView paper reports medical cost inflation of around 3.7% for the past few years, but that is historically low. (The Economist provides a chart of historical rates of health care cost inflation here.)
  • Because this key budget item is so unpredictable, especially the long-term care component, consider reducing your overall spending a bit to provide some safety margin.
  • Plan for expected (mean) annual health care costs excluding long-term care, but be aware that your own costs may be a lot lower or several times higher than you "expect." (Don't plan on expected lifetime costs as these assume median life expectancy. Your retirement plan should anticipate a long life.)
  • Look at long-term care costs separately. They can break the bank.
  • When we combine elder bankruptcies caused by medical expenses with those caused by credit card debt spawned by medical expenses, health care costs are the greatest bankruptcy threat to retirees. Protect your retirement assets from creditors as best you can.

Friday, February 5, 2016

Retirement Plan or Investment Plan?

My last few posts have explained that outliving retirement savings as a result of sequence of returns risk isn’t the worst thing that can happen to a retiree. Becoming insolvent as the result of unexpected and uncontrollable expenses is significantly worse, though less likely – less than half a percent of Americans over age 65 declare bankruptcy.

I also recommended that a comprehensive retirement plan address all known financial risks and not simply the risk of outliving our savings due to market volatility and overspending. In this post, I want to suggest what those other risks might be (by reviewing reasons that people over age 65 typically file for bankruptcy and adding a couple of risks of my own), and some potential ways in which planning might mitigate (lessen the severity) or even insure against them.

Becoming insolvent (unable to pay your debts) and declaring bankruptcy are not the same thing. Declaring bankruptcy is a legal action that might help deal with insolvency, depending on the specifics of your situation. Whether or not it is the best alternative is something you would want to discuss with a bankruptcy attorney, should you ever need to consider it.

(In this post, I am discussing the risk of insolvency. In previous posts, I used bankruptcy statistics from the U.S. Court system. It's important to distinguish between the two.)

Far too many retirement planning discussions focus primarily on market risk.
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Given that I described spending crises as chaotic, synergistic (in a bad way – they combine to have a greater negative impact that the sum of their parts), unpredictable, and difficult to stop once they begin to spiral downward, it might seem that there would be little to be gained from planning, but that isn't the case.

Certainly, there are some spending crises that would completely overwhelm nearly anyone's personal finances (a spinal cord injury, for example, could cost millions), but there are many crises that can be mitigated with the right planning. Let's start by recalling the 10 most common causes of elder bankruptcies:
  • Credit Card Interest and Fees (67%)
  • Illness and Injury (65%)
  • Income Problems (41%)
  • Aggressive Debt Collection (35%)
  • Housing Problems (27%)
  • Divorce (15.1%)
  • Birth or adoption of child (9.7%)
  • Death of family member (7.5%)
  • Retirement (6.7%)
  • Identity Theft (1.9%)
Recall that the major causes were self-reported and that most respondents to the survey reported multiple causes, so the percentages total more than 100%.

In Retirement and Chaos Theory, I suggested that insolvency behaves like a fixed point attractor. Our finances can develop a positive feedback loop and spiral downward to that point if they enter into insolvency's “gravitational field.” Sometimes, it's nearly impossible to avoid ruin once that process begins.

One way to mitigate that risk would be to stay as far away from insolvency's region of influence as possible, avoiding the risk of going broke like avoiding the gravitational field of a black hole. Consumer credit, inadequate insurance, and financial dependence on a spouse, for example, move you closer to insolvency's gravitational pull.

Let's look at those risks, chaotic though they may be, and show that there are ways we can plan for them.

Credit card interest can be deadly and research shows that typical credit balances continue to increase throughout retirement. Retirees can plan to pay off all consumer (non-mortgage) debt before they stop working and to control credit use after retiring by sticking to a solid retirement spending plan.

Most retirees will be eligible for Medicare when they turn 65, but Medicare doesn’t pay all of our medical costs. Fidelity Investments has been tracking retiree health care costs since 2005 and estimates that a 65-year-old couple retiring in 2015 will need $245,000 to cover future medical costs, not including the cost of long-term care.

That's more than most households save for retirement. It will devour a large portion of Social Security benefits for many. Retirement plans shouldn't ignore this risk.

We might consider planning to retire to a state with low health insurance costs, lower long-term care costs, and lower medical costs, but we should also consider the quality of care available.

Income problems cited in the studies were primarily the result of either age discrimination leading to unplanned early retirement or medical problems leading to unplanned early retirement. In some cases, unplanned early retirement was necessary to take care of a family member with a medical problem.

A retirement plan can assess the risk of unplanned retirement in our profession. Optometrists can work longer than oil field roughnecks. We can also assess our own health risks and the health risks of others who might need our care. These observations might lead us to the conclusion that we need to plan to find a job where we are more likely to be able to work to an older age, even if it pays less, or that we need to increase our savings, or lower our retirement income expectations.

Foreclosures soared in 2007 and they are particularly damaging to seniors. Foreclosure risk can be reduced by relocating to an area with less expensive housing, for example, or by planning to pay off (or pay down) a mortgage before retirement.

Believe it or not, one can purchase divorce insurance, though that doesn’t seem like a great way to deal with the devastating risk of elder divorce. A comprehensive retirement plan will model our financial risk of a divorce at various ages and can show the impact that a break-up would have on each spouse. E$Planner software can provide such contingency plans, for example. This analysis may provide insight into ways our retirement plan might be adjusted to improve outcomes for both spouses.

As with elder divorce, the impact of the death of a spouse at various ages can be modeled in a retirement plan. Life insurance, however, works much better than divorce insurance and software like E$Planner can calculate the amount of life insurance that will be needed at various ages. It can also model the impact of that death on Social Security benefits.

The final cause for bankruptcy cited by the Institute for Financial Literacy is identity theft (1.9%). I have previously recommended placing a freeze on your credit report.

Although lawsuits don’t appear to be major contributors to elder bankruptcy, I’m still fond of umbrella liability insurance.

Do you have a child or parent with health issues? Legal or medical costs could break your retirement plan and need to be considered.

Lastly, if you can’t avoid bankruptcy, there are steps you can take to protect assets. Holding assets in a retirement account will usually protect them from creditors. Future Social Security benefits are also protected. Even Social Security benefits that you have already received can be protected in bankruptcy if you hold them in a separate account that is only funded by those benefits. Commingling them with other funds can expose them to creditors.

The following list of insolvency risks is not comprehensive (though all but the last two risks were identified in a study as the top causes cited for elder bankruptcy). Nor is my list of possible strategies to mitigate them by any means complete. The key point is that it is important to identify the major financial risks in your retirement plan, to quantify them, and to identify ways to mitigate them, if possible. If mitigation is not possible, it is important to understand the risks if for no other reason than to avoid overconfidence in your plan. Far too many retirement discussions focus primarily on market risk.

Risk Potential Mitigation or Insurance
Credit Card Interest and Fees Pay off consumer debt before retiring
Illness and Injury Relocate for lower medical costs, Medicare, Health Insurance
Income Problems Change to a more sustainable job, evaluate your household's health risks
Aggressive Debt Collection Understand your rights
Housing Problems Pay off mortgage before retiring, relocate
Divorce Develop retirement financial contingency plans for divorce
Birth or adoption of child
Death of family member Develop financial contingency plans, life insurance
Retirement Evaluate your prospects for continued employment
Identity Theft Educate yourself, keep current on identity theft scams and freeze your credit report
Fraud Educate yourself and keep current on elder fraud
Financial needs of parents and children
Legal liability Umbrella liability insurance

A good place to start would be to list the risks to which you have significant exposure from the table above, add any other risks that might apply specifically to you, and then check to see if they are considered in your current retirement plan. If not, then you (or your advisor) have more work to do.

A plan that only addresses asset allocation and withdrawals isn't a retirement plan – it's an investment plan.
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Does your retirement plan consider these common causes of insolvency and plan for them? If it mostly tells you how to invest your savings and how much of your portfolio you can safely spend each year then you don’t really have a retirement plan.

You have an investment plan.

Thursday, February 4, 2016

A Dozen Ways to Get More from the Retirement Cafe´

Thanks for reading The Retirement Cafe´. There are a number of ways you might get more value from the blog. Here are a few suggestions.
1.) Images can be small and difficult to read in the blog. Click on an image to increase its size in a new window. Or, to zoom in on text or images, type “CTRL +” or “CMD +”. Change the + to a - to make the font smaller, or change it to a 0 (zero) to change the zoom back to normal. Whether to use the Control button or the Command button varies by browser and operating system, so just try both to see what works.

2.) Text that appears in yellow will provide an explanation of the highlighted text if you hover the cursor over it and wait a few seconds (this is sometimes called a “mouse-over”). Hover your cursor over the yellow text and try it out. If that isn’t enough information, clicking on the link will often open another browser window with even more information. Closing the new window will take you right back to the one you were reading.

3.) Clicking orange text opens another website in a new window without closing the one you've been reading. Again, closing the new window will take you right back to the one you were reading.

4.) I tweet as @Retirement_Cafe. You can follow me on Twitter by clicking on the little bluebird on the right side of the page here:

I tweet a lot of links to posts you may not have noticed from great retirement writers like Wade Pfau, Michael Kitces and Moshe Milevsky. If you don’t use Twitter, you can see the tweets here on my blog.

5.) I try to keep a recent retirement news story at the bottom of the right column that I think might interest you. It won’t always be about finance, but it will almost always be about retirement.

6.) Want to find my post about chaos theory? You can use Google to search my blog. Use the window at the top left of the blog with the little magnifying glass (or maybe it's a capital “Q”). It looks like this:

There is another “Search this Blog” box at the bottom of the post.
7.) Click the G+1 button to recommend the post on Google Plus.

8.) I place key points in a “Tweet This” box like the following. If you are a Twitter user, you can click on the orange [Tweet This] link and retweet the information in the box with a link back to my post.

Spending a sustainable amount of your portfolio is retirement savings insurance, not bankruptcy insurance.
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9.) I try to point out the key take-aways of each post in the summary paragraphs at the end.

10.) Links to my other recent posts appear in the right column just below my bio.

11.) I post roughly once a week, but not always on the same day. The best way to be notified that I have published a new post is to enter your email address in the Follow by Email box, also in the right column and just below Recent Posts. The entire post will appear in your inbox. Clicking the title of the post within the email will take you to the post on my website, where it might be easier to read, and you will have access to the other features mentioned above, but you can also just read the post in your email.

12.) Often, the best part of a post will be readers' comments at the bottom. They have great ideas, great opinions and they give me an opportunity to explain parts of the post that perhaps were less than totally clear. I encourage you to read them, but also to post your own comments and questions.
A permanent copy of this information is available at the page link in the right column of the blog. You will find the link under "Resources" and "Reading Tips".

I hope these tips make Retirement Cafe´ even more valuable for you. Thanks for reading!

Monday, February 1, 2016

Expense Risk in Retirement

I have recently posted about bankruptcy risk, positive feedback loops, chaos theory and Kaplan-Meier estimators and now I'll try to tie all of those posts together. They're mostly about the unpredictability of spending in retirement compared to sequence of returns risk, the probability of outliving your retirement savings due to market volatility. A retiree can enjoy a favorable sequence of market returns, limit spending to a sustainable amount, and still suffer insolvency as a result of huge medical bills, divorce or identity fraud.

Much of retirement writing focuses on the unpredictability of market returns, but unpredictable spending is a greater risk. The most you can lose of your savings is 100% of your portfolio, but you can have unexpected expenses far greater than your savings – a medical catastrophe, for example. Retirees typically plan for a 5% to 10% probability of outliving their retirement savings, but about a half-percent of Americans 65 and older file for bankruptcy, and that number appears to be growing.

First, the big picture. Your retirement finances will likely include some combination of Social Security benefits (in the U.S., or a similar program where you live), private pensions, personal retirement savings, and more and more, working longer. Sadly, private pensions, known as defined-benefit (DB) plans, are disappearing and a sizable majority of Americans don’t have a significant amount of retirement savings to invest. The GAO recently found that older households typically have retirement savings only “equivalent to an inflation-protected annuity of $310 [to] $649 per month.”

Your retirement finances will also include expenses and that spending side of the equation is significantly less predictable than market returns. Most retirement research assumes that you will only spend a "sustainable" amount of your savings portfolio ( a "spherical cow") but in reality, you will spend whatever life costs. Spending a sustainable amount of your portfolio is "retirement savings insurance", not bankruptcy insurance.

Spending a sustainable amount of your portfolio is retirement savings insurance, not bankruptcy insurance.
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David Blanchett and Sudipto Banerjee showed that retirement spending typically declines about 2% annually for retirees spending appropriately for their wealth and that even when there are large end-of-life expenses these are usually less in real dollars than spending was at the beginning of retirement. Spending crises, however, are not typical. They develop from unpredictable and uncontrollable expenses like large medical bills, housing problems, debt problems, and fraud.

Much retirement research focuses on how to make your personal retirement savings last your entire lifetime, by spending only 3% or 4% annually, for example. This does not, however, consider what happens when life costs more than your sustainable withdrawal plus your Social Security benefits. If it costs a lot more, you could end up insolvent.

You can manage your savings portfolio's longevity risk by reducing spending, but elder bankruptcies are most often the result of spending crises. By definition, you can’t reduce spending in a spending crisis. Controlling spending is the problem, not the solution.

When a household’s finances crash and lead to bankruptcy, it is most often the result of a positive feedback loop of two or three problems. Not only is the household subjected to multiple problems, but these problems feed off one another and act in synergy, “the interaction of two or more agents to produce a combined effect greater than the sum of their separate effects.”

The key point of the Positive Feedback Loops: The Other Roads to Ruin post is that a financial crisis in retirement is often the result of a spending problem that causes another problem that causes a third problem, the problems become synergistic, and then the downward spiral is nearly impossible to stop. These failures can begin without warning and can bankrupt a family in a year or less.

Your retirement plan should consider all risks to your financial well-being, not just sequence of returns risk, and you should not be overconfident even if you have a low annual withdrawal rate. The four households I discussed in that post were all flying high a year before insolvency.

Positive feedback loops in retirement finance suggest the presence of chaos. In Retirement Income and Chaos Theory, I investigated that possibility and found that there are good reasons to believe that retirement finances are chaotic. If they are, then we will never have enough empirical data to understand the underlying mechanisms. Predicting your financial future using probabilities based on past data will always be suspect and can also lead to overconfidence.

The key point of that post is not that our financial future is totally unpredictable and planning is useless, or to measure how much more random market returns are than we believe. The take-away is that, while simulations and forecasts are useful when our finances are in equilibrium (which is most of the time), there will be times when our finances can behave wildly outside expectations. We need to plan for that.

We should plan for the most likely outcomes but try to create backup plans for “worst-case” scenarios. Like a floor, for instance, made up of assets that are not exposed to the equity markets and are protected from creditors.

In the post entitled, “Why Retirees Go Broke”, I combined the findings of an outstanding paper from Dr. Deborah Thorne with a paper my son and I recently co-authored analyzing the timing of portfolio ruin to show that, while sequence of returns risk might eventually deplete your savings, it is unlikely to be a major contributor to bankruptcy.

Outliving your savings and going bankrupt are two different risks. You can outlive your savings without going bankrupt. You may not spend all of your savings if you declare bankruptcy because Social Security benefits are protected from creditors and so are some retirement account assets, especially in bankruptcy. But, poor market returns aren’t the only way to deplete your savings. A spending crisis can deplete savings even faster than market losses and can lead to bankruptcy.

(ERISA-qualified retirement accounts – 401(k)s, are a typical example – are typically protected from judgments even when bankruptcy is not declared, but protection of non-ERISA-qualified retirement accounts like IRAs is complicated. You should discuss both with an estate attorney, but you can find good explanations at and at the Strictly Business Law Blog.)

You can become insolvent even if you invest all of your savings in Treasuries and annuities because expenses will still be uncertain – owning stocks isn’t a prerequisite for financial disaster. The culprit is unpredictable expenses.

The point of the bankruptcy post is that you should not confuse mitigating portfolio ruin with mitigating insolvency. Most elder bankruptcies result from spending crises, not poor market returns. Plan for both.

Most retirement research calculates a lifetime probability of portfolio ruin, the probability that you will deplete your retirement savings sometime during your life. Spend 3% of your portfolio annually, for example, and you have only a 5% probability of outliving your savings. In reality, that probability of portfolio survival ranges from near zero in the first decade of retirement to 5% after three decades or so. Kaplan-Meier curves, as I described in Death and Ruin, show how your probability of portfolio survival changes with age.

That post also explains that unless you live past your median life expectancy, you probably won’t outlive your savings with a reasonable withdrawal rate. The biggest risk of portfolio ruin, assuming you select a reasonable annual spending rate, is longevity, not market risk.

Retirement finance may be quite different than what you’ve read. Losing your savings due to market volatility is only one risk of retirement and it isn’t the worst outcome. You aren’t likely to go broke because you spend 4% of your savings annually instead of 3%, or even to completely deplete your savings. You’re more likely to see your savings decline, then to reduce spending to avoid going broke, and finally to suffer a decline in your standard of living as a result. About half of us won’t live long enough to be exposed to sequence of returns risk, at all.

In the unlikely event that you do spend all your savings, that doesn’t mean you’ll be bankrupt. Bankruptcy is far worse. It means you have more debt than you can repay and your debts need to be reorganized. You may lose all your assets that are not protected from creditors, but you will still receive Social Security benefits and you will keep assets in retirement accounts, although traditional and Roth IRA's are only protected to an inflation-adjusted $1,000,000 (currently about $1,200,000) and this applies to all your plans combined. You won't have credit and you will probably have trouble using banks for a long time.

Sequence of returns risk will rarely be a big contributor to bankruptcy and it takes decades to erode savings. Bankruptcy will strike like a bolt out of the blue as a result of spending shocks and may cost much more than just your savings. (All four of the families I wrote about in Positive Feedback Loops lost their homes, too.) The crisis will be difficult to stop once it starts.

Some shocks are impossible to avoid, but we should plan for the ones we can. We should be aware of the ones we can’t, if for no other reason than to avoid overconfidence in our retirement planning.

Retirees should focus on a bigger picture than just spending sustainable amounts of savings and the right asset allocation.
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The expense side of the retirement finance equation is at least as important as the income side and it's probably riskier. Retirees should focus on a bigger picture than just spending sustainable amounts of their savings and getting their asset allocations right.

Retirement research should, too.

In my next post, I'll review the major expense risks of retirement and suggest a few ways to deal with them.

Moshe Milevsky just published a piece entitled, "It’s Time to Retire Ruin (Probabilities)". Regular readers of this blog will recall a similar post, "Time to Retire the Probability of Ruin?", from last April, though Dr. Milevsky makes a much better argument.