The Chain of Longevity Risk

I've spent the last several weeks working on some interesting portfolio survival research with my son and daughter, so my posts have been a bit few and far between. My apologies. Cary and I realized one day this summer, over a local craft beer after a round of sporting clays, that retirement portfolio survival and the medical research he does are largely the same research problem. I hope to have something here on my blog about our findings in a few weeks. In the meantime, here are some thoughts about portfolio survival in general.

Longevity risk is the risk that a retiree will outlive his or her retirement savings. It develops in four stages as we make decisions about funding retirement.

Let’s consider those risks by imagining a retiree who splits his retirement savings portfolio in half on the day he retires. The first "legacy" portfolio is intended for his heirs and the second “funding” portfolio is intended to fund his retirement expenses.

To simplify the example, let’s assume he invests both identically in the same 40%-equity index fund on the same day. The only difference between the funding portfolio and the legacy portfolio is that he will spend annually from the funding portfolio and then re-balance it to 40% equities. The legacy portfolio will remain untouched to be left to his estate.

A retiree can pretty much avoid longevity risk altogether by purchasing life annuities or TIPS bonds. There are plenty of good reasons to invest at least some of our savings in stocks and bonds, though, and that decision leads to the first risk, known as market risk. Market risk refers to the volatility of stock prices over time. Once we invest in risky assets like stocks, outliving our savings becomes a possibility.

We can mitigate market risk by reducing our equity exposure or we can completely eliminate it, by purchasing life annuities or TIPS bonds. Our imaginary retiree has decided to mitigate market risk in both portfolios by investing only 40% in equities, but he has not avoided market risk altogether.

If this retiree never spends from or saves to either portfolio, those portfolios will have equal values at the end of retirement. We don't know what that value will be, however, because both are exposed to unpredictable market risk. We only know that they will be exposed to identical market risk and that their "terminal value", or value at the end of life, will be the same.

When a retiree begins to spend from her funding portfolio, the outcomes of those two portfolios go their separate ways. No matter how little our retiree spends each year, so long as there is net spending, there is no future in which the terminal value of the legacy portfolio will not be larger than the terminal value of the funding portfolio at the end of retirement for two reasons.

The first cause is obvious – her funding portfolio will be smaller  because she is spending some of it – but the second cause, path-dependent risk, can make her legacy portfolio's terminal value larger or smaller. The funding portfolio will always, however, have less value than her legacy portfolio, again because she is spending some wealth and never saving, but path-dependent risk can leave the funding portfolio fatter or thinner than it would have been with no path-dependent risk.

Path dependence refers to the fact that, once we begin spending from a volatile portfolio, the order of market returns can change the portfolio’s value. A buy-and-hold portfolio has no path dependence (“Path dependence” means the outcome depends on the path we take to get there, which in this discussion refers to the order of annual portfolio returns.)

Let me provide a quick example to explain path dependence. Assume that over the next five years, the stock market will provide the following returns in the following order: 5%, -7%, 9%, 3% and 4%. If we invest $1,000 in this market at the beginning and neither buy nor sell additional shares, we will end up with $1,140 five years later, no matter which order those returns occur.

If we spend $30 at the beginning of each of the five years, however, the order of returns does matter. There are 120 different ways (5 factorial) those five returns can be ordered and each will provide a different outcome. The outcomes will range from $966 to $988, but always less than $1,140. Once we spend from or save to a volatile portfolio, the outcome is path-dependent.

Note that in none of these 120 permutations is our account balance depleted. Path dependence isn't the same as risk of ruin and if we are only spending 3% annually ($30), it is very unlikely that we will exhaust our savings.

Some refer to path dependence as “sequence of returns risk” but the term isn’t always used in that way, so I prefer to avoid it whenever possible. If returns are experienced with the highest gains early in retirement and the lowest gains toward the end, this path dependence helps our portfolios over time and if returns are experienced with the worst returns early in retirement, path dependence hurts our portfolio.

The best possible outcome is achieved when our market returns are ordered from best to worst. The worst possible outcome is the reverse. With 30 years of annual market returns over a long retirement, the odds of experiencing the best or worst outcome are literally astronomical (1 in 30 factorial, each – there are fewer than 30 factorial stars in the visible universe).

The source of path-dependent risk is selling in the spending phase of retirement finance and buying in the accumulation phase. We have no idea what price we will receive for the securities we will sell (or buy) in the future and that price risk is path-dependent. TIPS bond ladders held to maturity and life annuities have no path dependence risk because we know their future values relatively accurately.

(As an aside, savings portfolios during the accumulation phase also have path-dependence risk because we don’t know the future price at which we will buy equities. A lot less attention is paid to path-dependence in the saving phase because it doesn't lead to portfolio ruin. It does, however, greatly impact wealth accumulation.)

So far, our retiree’s legacy and funding portfolios are both exposed to market risk, and the funding portfolio is exposed to additional risk (path-dependent risk) once she starts spending from it. Note that this risk is introduced by the retiree’s decision to sell shares. Path dependent risk is not market risk, cannot be diversified away like market risk, and therefore we can’t be compensated for it. In general, more risk means a greater expected return, but the market doesn’t compensate us for taking path-dependence risk.

Our retiree will make another decision that affects path-dependence risk, how much to spend annually. The more she spends each year, the more she exposes her portfolio to that selling-price risk each year and the more path dependence risk and risk of ruin she accepts. Simply said, a 4% “sustainable withdrawal rate” is riskier than a 3% rate.

The term “sequence of returns risk” is also sometimes used to refer to the probability that a retiree will outlive his savings, which I refer to as "risk of ruin." Path dependence doesn’t cause a retiree’s portfolio to fail, at least it is not the proximate cause. Refusing to reduce spending when our portfolio declines in value causes portfolios to fail is the proximate cause of portfolio failure. This is not a market risk or path-dependence risk, but a poor decision on the part of the retiree. If your portfolio declines significantly in value and you don't start spending less, you risk ruin.

Most spending strategies, like ARVA, constant-percentage spending and "RMD" rarely or never deplete a portfolio because they reduce spending as a portfolio declines in value, lowering the risk of ruin. Constant-dollar spending is the exception.

I wrote a post some time ago entitled, "When You Have Less Money, You Probably Ought to Spend Less", showing that portfolio failure occurs under the (absurd) assumption that a retiree will continue to spend the same amount from his portfolio every year, even when it becomes obvious that the portfolio will soon be depleted. This is an interesting technique to use in research, but it is not a realistic retirement spending strategy. We sometimes refer to this as “constant dollar spending.”

That post also shows that retirees who spend a reasonable constant percentage of remaining portfolio balance each year will not deplete their savings. Their portfolio will eventually recover and spending can increase.

The  “RMD” spending strategy avoids ruin, as well, by dividing the remaining portfolio balance by your remaining life expectancy to calculate a safe withdrawal amount, similar to the manner in which the IRS calculates required minimum distributions for IRA's. Waring and Siegel's ARVA strategy (download PDF) does something similar. Both strategies reduce spending when a portfolio is faltering. In fact, constant-dollar spending is the only widely acknowledged spending strategy that results in portfolio ruin under reasonable spending assumptions.

The third layer of risk in the chain of longevity risk is that of portfolio ruin. It is introduced when a retiree decides to keep spending the same amount after significant portfolio losses. Rational, knowledgeable retirees will reduce spending when their portfolio wealth dwindles dangerously low, but they expose themselves to the risk of a permanent reduction of spending if they wait too long to adjust. (This is a key reason I recommend dynamic spending and annual adjustments. Small, annual adjustments are easier to tolerate and help avoid larger, permanent adjustments by limiting damage.)

To summarize, our decisions can lead us down a chain of retirement wealth risk. It begins when we decide to invest some of our savings in equities. We increase risk by allocating more of our portfolio to equities and decrease it by allocating less.

The next step is our decision to spend from our savings portfolio. Spending more raises the risk and spending less lowers it.

The final step in the chain of risk depends on the decisions we make when our portfolio dwindles in value.  Path-dependence can lead to portfolio ruin, but it probably won't if we lower spending when our portfolio is stressed.

Each step we take, we add more risk. Except for the final, "overspending" step, these can all be reasonable risks to assume. Understanding them can help retirees understand how much of each risk they should accept.

Have You Already Been Hacked?

I recently wrote a post entitled, “Assume Your Social Security Number is Already Out There”, which was inspired by an article I read suggesting that the personal information of about a quarter of Americans has already been hacked. My experience in the computer networking industry makes me think that number is likely quite conservative.

I have been notified four times in the past year that my personal information might have been compromised. When large companies like Target are hacked, they often offer their customers a year of free credit monitoring service and I currently have two such subscriptions going simultaneously.

There is only so much these services can do, however. Neither noticed when someone filed a tax return in my name, for instance.

Long before business school and my interest in retirement finance, I was a systems analyst with a degree in computer science. My specialty was data communications networks. Truth be known, computers are my first love and much of my financial research is done at my computer with code I write in Mathematica or R.

I had an email account 35 years ago. (As geeks go, I’m ancient.)

Today, I read an article in the New York Times Personal Tech section under the headline, “How Many Times Has Your Personal Information Been Exposed to Hackers?”. The authors began with this statement:

“Half of American adults had their personal information exposed to hackers last year alone.”

That sounds more like it, but since most companies don’t know they’ve been hacked until they find their data for sale somewhere on the Internet, it might be an optimistic guess. Many companies will never know they were hacked.

The quiz at the NYT article will give you an idea of your vulnerability, but look at the names. Who hasn’t subscribed to AOL, or used a charge card at Target or K-Mart, applied for a government job, joined E-bay or Twitter, or downloaded Adobe something-or-other?

The article reinforces my own feeling that nothing is currently safe on the Internet: “Security experts say there is no way to keep hackers out of systems with traditional defenses like firewalls and antivirus software.” The skills and tools available to hackers today have a huge advantage over the tools available to protect us. Passwords don’t work. Firewalls and anti-virus software are speed bumps.

I’m not suggesting you avoid these tools. It’s a little like making sure yours isn’t the easiest house on the block to break into. But if a burglar wants your house badly enough, he can probably find a weakness.

I have long suggested two-step authentication wherever it is available. A list of websites that support two-step authentication can be found at TwoFactorAuth.org. For many of these websites, a hacker would need your password and your phone. I use two-step authentication at Fidelity, Vanguard and Charles Schwab and on several other sites, including FaceBook.

(Some two-step authentication processes use a special key fob device to provide an ever-changing PIN (Charles Schwab, for instance) and others use an authenticator app on your smart phone (several companies use Google Authenticator). But many use text messaging to send a one-time password to your phone. Be aware that hackers may be able to access your phone at say, VerizonWireless.com, and forward these text messages to themselves. If your carrier's website is not also protected by two-step authentication, this leaves a hole for hackers to get through. A fob or an authenticator app are safer.)

Password managers like LastPass can help you create and “remember” complicated passwords. (They say the best password is the one you can’t remember.)

If you don’t have virus protection, don’t let the cost hold you back. I like Avast and it’s free, but there are plenty to choose from.

Another important step that I think makes a lot of sense, especially for retirees, is a credit freeze. I wrote about those in Assume Your Social Security Number is Already Out There. They can be a bit of a pain if you open credit accounts frequently, but most retirees don’t. Even if you do, it’s less painful than finding out someone has opened a credit account in your name and run up a huge bill. You won’t be responsible for much of that bill, if any, but cleaning up the mess will be formidable.

Personally, I’m not sold on credit monitoring services, though I do use them when the companies I trust with my personal information get hacked and offer those services free. They can’t hurt, but they monitor your credit report, not your accounts.

I use alarms on all my financial accounts that send a text message to my phone if there is an overseas charge on a card, an ATM withdrawal, or a charge above some maximum amount.

To summarize, here are a few things you can do to protect yourself:

• Consider a credit freeze at all three credit agencies
• Use two-step authentication whenever it is available
• Use your free annual credit report from one of the three agencies every four months to review your credit
• Use a password manager to help create and use strong passwords online
• Use a firewall and a virus checker at home. Excellent versions of both can be downloaded free.
• Set up text message alarms to notify you of unusual activity on your bank or credit card accounts

These won't fully protect you, but as my grandfather used to say, they're better than a poke in the eye with a sharp stick. It's more efficient for a hacker to steal your personal information in  bulk from Home Depot than to attack your home computer, but the latter still happens.

As I said in the previous post, I think it’s safest to assume that identity thieves already have your personal information, even if they haven’t gotten around to using it, yet. They probably do. The credit freeze may keep them from opening a new account in your name.

In general, the bad guys currently have all the artillery. If you don’t believe that, take the quiz at the Times article. It will open your eyes.

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My post on Social Security benefits and early retirement generated several comments. (Posts on Social Security always do.) If you're looking for a basic booklet that explains your benefits in a very readable way, I recommend The Social Security Claiming Guide from Boston College Center for Retirement Research. There is a small charge for hard-copies, but downloadable versions are free.

Early Retirement and Social Security Benefits

In my first post on this topic, The Risk of Retiring (or Being Retired) Early, I noted that retiring early means a longer and more expensive retirement. In my second installment, Retiring Early: Lost Savings, I reviewed the risk of saving less. And in the third, Early Retirement: Spending Sooner, I considered the combined consequences of simultaneously stopping savings and starting spending. Another major financial risk of retiring early is not optimizing Social Security benefits.

I recommend that most retirees delay Social Security benefit claims as long as possible, but there are some people I just cannot convince. They're afraid that fiscal conservatives who have tried to dismantle the program since its inception in the 1930's will soon have more success than they have had in the past 80 years, or that they will not live long enough after retiring to "break even." But, I suspect a lot of it is addressed by a recent Forbes piece entitled, Most Americans Can't Pass This Basic Social Security Quiz, and they just don't understand how Social Security works.

The basic problem we try to solve by delaying Social Security benefits is the mitigation of longevity risk (growing very old and outliving all our savings) and delaying benefits is the single most cost-effective way to achieve that.

Here's the problem we hope to mitigate by waiting. John can retire at age 70 and receive benefits of $36,000 a year, he can retire at full retirement age of 66 and collect $27,600 a year, or he can retire at age 62 and receive $21,000 a year.  John's wife, Martha, will be entitled to spousal benefits of $13,800 a year, assuming she claims at her full retirement age. Her spousal benefit, like his retirement benefit, is reduced if she claims early, but her spousal benefit, unlike her survivors benefit, isn't dependent on when John claims.

If John claims at 70 and dies first, which is more often than not the case, Martha's spousal benefit will be replaced by a survivors benefit equal to John's retirement benefit. If John claims at age 70, Martha's survivors benefit will equal (his) $36,000 a year but if he claims at 62, her survivors benefit will only be $21,000 a year for the rest of her life.

If John claims at 62 and dies at 71 but Martha lives to 96, Martha is stuck with a $21,000 benefit for two and a half decades when she might have enjoyed $36,000 a year.  (Whether your Martha begrudges the extra $375,000 after you're gone is between you and your spouse.) It really all boils down to whether you view Social Security retirement benefits as insurance against a very poor financial outcome or you view it as a game you are trying to win against the Federal government. But, be forewarned that the government doesn't care who wins and that you generally "win" when you claim early by not living long.

Here's the problem the "claim early" crowd hopes to mitigate. John, or John and Martha, plan to delay claiming, but both die in their late 60's and never receive a penny of their benefits. From a purely financial perspective, this isn't as severe an outcome as living to 100 with inadequate funds for the last decade or so. While we would all probably hope to live longer, a short retirement means we are far less likely to outlive our wealth.

Some of those arguments made by the "claim early" crowd are valid. Maybe you and your spouse won't live a long time, who knows? Maybe benefits will be reduced in the future. But living long enough to regret claiming early is a far more common event than reductions in Social Security benefits have been. Don't protect yourself from sharks and ignore heart disease.

Nearly all academics in the field and economists, some Nobel laureates, recommend delaying benefits as long as possible. If they can't convince you, I certainly can't. If you do, however, agree that delaying claims for Social Security benefits is a good idea, then it becomes a consideration for early retirement.

Retiring early often means that you will need to live completely off retirement savings until Social Security benefits kick in, unless you are lucky enough to have a pension. That may put pressure on your retirement plan, unless you are quite wealthy, to claim benefits sooner than you otherwise would and to forgo the most effective longevity insurance available.

Next time, I'll talk about my own decision to retire early in Early Retirement: Would I Do It Again?

Before I do, let me say that I really appreciate your questions and comments and I hope you won't feel constrained to the topic of the post you are reading. Feel free to ask any retirement finance question anytime. If I don't know the answer, I'll find it. Sometimes your questions spawn an entirely new post. If you have a question, there is a good chance that several others have the same one. I prefer that you log in any leave your name, but do so anonymously if it makes you more comfortable.

I hope you're enjoying your summer as much as I am mine!

Early Retirement: Would I Do It Again?

After my first post on this topic, The Risk of Retiring (or Being Retired) Early, several readers wrote comments about the rewards of retiring early, despite the financial risk. You don't have to sell me. I retired quite early and I am having the time of my life. But, none of these posts were meant to suggest whether you should retire early or not. My intent is simply to make you aware of the financial risks you ought to consider before you make that decision.

And then there is the darker side of this issue. First, the majority of American workers will not be able to accumulate enough savings to retire comfortably at 70, let alone years earlier. And as surveys I mentioned in that first post show, more recent retirees are reporting that they weren't able to retire when they planned than those who report they were. Unfortunately, that number is growing. Retirement isn't always a choice. It usually isn't.

The major factors that can make early retirement financially riskier are:

• a longer (and consequently more expensive) retirement, 
• fewer years to save, 
• lost returns on those forgone savings, 
• lost returns on savings that we spend at an earlier age,
• difficulty un-retiring the longer you are out of the workforce,
• a lower sustainable withdrawal rate (or life annuity payout) due to the longer expected lifetime in retirement, and
• the potential pressure to claim Social Security benefits sooner.

There are several others, of course. Health insurance cost should probably still be considered risky, though the Affordable Care Act has removed some of the risk of obtaining insurance until Medicare kicks in at 65. It is still costly. ACA was intended to make insurance more widely obtainable, not to make it cheaper. Consider this in your decision, particularly if you're used to company-provided health insurance.

There is also the loss of the safety net of returning to work. Wages typically peak around age 55 and decline afterward, anyway, but the longer you leave the workforce, the harder it is to return with anywhere near your previous income.

The converse of those risks provide a list of things you can do to make retirement financially less risky by delaying it:

• a shorter (and consequently less expensive) retirement, 
• more years to save when you're typically able to save more, 
• investment returns on those additional savings, 
• more years for our portfolio to grow without spending,
• a higher sustainable withdrawal rate (or life annuity payout) due to the shorter expected lifetime in retirement, and
• less pressure to claim Social Security benefits sooner.

In fact, this series of posts is not only about the financial risks of retiring earlier, but about the benefits of retiring later.

I suspect than many workers contemplating early retirement underestimate the risks I have pointed out in these past few posts. (I did.) Just a few years either side of a planned retirement age can make a difference; several years make a big difference.

You may be wondering how I feel about retiring early a decade after I made that decision. I'll share a bit of the experience.

I retired in 2005, just before the market crash (housing and stock) in early retirement that we financial analysts say you should fear more than just about anything except perhaps living to 110. Fortunately, my finances were positioned well enough to absorb it. My finances are in better shape now than the day I retired.

I struggled with health insurance before ACA because I had a pre-existing condition. I was able to find health insurance, but the cost was tremendous, much higher than I had planned, and in ten years my high-deductible insurance never paid a claim.

Would I do things differently? I retired early primarily for non-financial reasons. Given my same circumstances as 2005, I would make the same decision. But as much as I had studied retirement before deciding to retire early, I didn't fully understand the financial risk I was taking. After a decade, and knowing what I do now, I might have considered working a while longer to reduce some of that risk – but probably not.

I'm pretty sure that retiring early is far, far riskier than most people assume. Then again, I'm the happiest person I know. My day is packed and virtually everything on my calendar is something I really, really want to do.

On the other hand, the second happiest person I know loves his job so much that he barely slows down for weekends. He may never retire.

The decision isn't purely financial, but I would advise you not to ignore that part of it.

Early Retirement: Spending Sooner

In my first post on this topic, The Risk of Retiring (or Being Retired) Early, I provided some thoughts about the risk of retiring early and perhaps extending what might already have been a long and expensive retirement. In my second installment, Retiring Early: Lost Savings, I reviewed the risk of retiring early and consequently saving less. As I mentioned in that second post, limiting savings at the end of retirement has a significant impact, but when we stop saving early, we typically also start spending from savings. The cost of early spending is greater than the cost of forgone savings and the two combined are substantial.

(As always, click on a chart or table to see a larger version. Hover your mouse over any yellow text.)

Here's the chart from that second post showing the cost of forgone savings without the simultaneous cost of early spending, in other words, imagine a retiree who could stop saving, retire, and avoid spending savings until age 70. (Note a minor change to the chart from my last post: this one graphs balances at the beginning of each year whereas the last post assumed the worker retires at the end of the year.)

Chart 1

As you can see, were this imaginary retiree able to retire at age 55 and not touch retirement savings until age 70, her portfolio value at age 70 would be about $265,000 less than it would be if she had kept saving until age 70. She would save $156,000 less over those 15 years and lose $109,000 in interest on those forgone savings.

Typically, however, when a worker retires and stops saving for retirement, he also begins spending from savings. Chart 2 below shows the resulting portfolio balances when a retiree simultaneously stops savings and starts spending at a given retirement age. It also shows the amount of spending supported assuming a constant-dollar annual withdrawal of the portfolio balance at the retirement age.

The amount of the sustainable withdrawal percentage is calculated using Milevsky's formula for sustainable spending (download PDF) using the life expectancy from the "male" columns of the following table. Note that females have slightly lower SWR's because they have longer life expectancies. My first post on this topic noted that the longer you postpone retirement, the greater your expected savings will be and the larger the percentage you can safely spend annually.

Table 1.

For example, if our sample retiree stops saving at age 65 (the inflection point in the purple line on Chart 2), he would have accumulated $1,181,178 by age 65 and Milevsky tells us we can assume he could spend 4% of that amount, or $47,247 annually beginning at age 65. If he saves until age 70, he accumulates $1,712,935 and Milevsky tells us he can spend 4.6% of that amount annually because he has a shorter life expectancy.

These probably seem like hugely different outcomes, and they are, so let me walk through one example of retiring at age 65 (purple curve on Chart 2 above) versus waiting until age 70 (teal curve on Chart 2 above) in Table 2 below.

Table 2.

Retiring at 70 allows the retiree to contribute $56,000 more to savings in this example. Five more years of 7% annual returns with no withdrawals provides over $530,000 more in portfolio savings. Together these amounts create a portfolio at retirement five years later that is $531,756 larger. Because the 70-year old has a 4-year shorter remaining life expectancy, he can spend 4.6% of this portfolio, according to Milevsky, which is 15% more than the 4% he could spend at age 65. The increase in spending from 4% of $1.18M to 4.6% of 1.71M is more than $30,000 a year.

A lot of this difference comes from the huge growth in the portfolio the last few years of retirement resulting from compound earnings. These portfolios grow exponentially and each year that you delay spending affects your savings balance more than it did the year before. (This is why most financial planners urge you to be very cautious with your investments the last decade of your working career.)

A substantial amount of the sustainable spending difference also comes from the increased SWR – the retiree gets to spend a larger percentage of a larger portfolio. In this example, the additional spending increases $21,269 a year from a larger portfolio at retirement and another $10,278 from an increased SWR.

This scenario is an example and there is no guarantee that your portfolio will grow at all in the final five years of your career, let alone that it will grow as much as 7% annually. The intent is only to show how changes in retirement age affect retirement spending. How much it affects spending depends on market returns and life expectancy, things we can't predict.

The earlier you retire, the less money you can spend after you retire. A significant portion of the reduction of retirement spending can be attributed to the fact that you stopped saving earlier, and a larger portion of additional cost is attributable to spending savings earlier. Toss in the lower sustainable spending amount at younger ages because we have to plan for a longer retirement and the body blows add up quickly.

So far, those body blows from retiring early include:

• a longer (and consequently more expensive) retirement, 
• fewer years to save, 
• lost returns on those forgone savings, 
• lost returns on savings that we spend at an earlier age, and 
• a lower sustainable withdrawal rate (or life annuity payout) due to the longer expected lifetime in retirement.

Of course, you can turn that frown upside down by looking at the flip side of those bullets as advantages to delaying retirement: a shorter, less expensive retirement, more years to save, etc.

There is still at least one major financial risk to consider when deciding to retire early, or evaluating the impact of forced early retirement, and that is the impact on Social Security benefits. I'll cover that next time in Early Retirement and Social Security Benefits.


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Note: The assumptions for these calculations are the same as in the initial post, The Risk of Retiring (or Being Retired) Early. I assume the worker will earn the "typical" annual incomes shown in the charts in that post and will save 10% of earnings every year. I assume he or she will earn a consistent 7% annual return on all savings (an optimistic assumption in current capital markets). All calculations are in nominal dollars except for expected market returns used for the Milevsky formula, for which I assume a 5.6% real annual return with 11% standard deviation.

Retiring Early: Lost Savings

In my last post, The Risk of Retiring (or Being Retired) Early, I provided some thoughts about the risk of retiring early and perhaps extending what would already have been a long and expensive retirement. A second risk of retiring early is that we will stop saving for retirement sooner.

As the savings, or “accumulation", phase of retirement progresses, the contribution of new savings to our net worth becomes progressively smaller as the contribution from existing portfolio growth increases. Consider the following three graphs. First, our earnings tend to grow from the beginning of our careers, peak in our mid-fifties and then decline a bit each year until we retire.

Assuming a retiree saves 10% of earnings annually until retirement, annual savings contributions would look like the following curve. Note that by retiring early, we stop saving when our annual contributions are near their peak around age 55 to 60. On the plus side, we're robbing our own savings at a time when their potential compounded growth is relatively low because they have fewer years left to grow than did our early-career savings.

Assuming this retiree earned a consistent 7% rate of return on her portfolio, the contribution at each age to her portfolio value from new savings is shown below in red and the contribution from investment returns on previous savings contributions is shown in blue.

The graph above shows that if we retire early and stop saving at age 60, for example, the value of the lost savings is probably a lot smaller than the return we will continue to receive on our portfolio, but the loss can still be substantial.

The following chart shows the results of retiring at ages 55, 60, or 65 instead of age 70, using the same assumptions as above, but assuming that contributions stop at retirement age and that we don't start spending from the portfolio until age 70. (I will discuss the impact of early spending from savings in my next post. For now, let's just look at lost savings.)

If this person retired at age 70, he would save $1,832,840. Stopping annual savings at age 65 would reduce the portfolio balance by 3.3%. Stopping savings contributions at age 60 would reduce it by 8.3% and stopping at age 55 would reduce the portfolio balance by 15.5%. Reducing the size of your retirement savings portfolio balance reduces sustainable retirement spending by the same percentage. Reduce your portfolio balance by 3.3% and you reduce your sustainable spending amount from your risky portfolio by 3.3% annually.

Note again that reducing savings by retiring early has a significant impact on a retiree's finances, but that most portfolio growth late in our careers comes from market returns on our accumulated savings and not new savings contributions. On its own, losing a few years of savings contributions is tolerable.

The problem is the two-edged sword created by stopping additional annual savings early and beginning portfolio withdrawals early. I'll look at the latter next time.

In the meantime, Wade Pfau is holding a free retirement planning webinar on Wednesday, July 1st at 5:00 pm ET. You can sign up for it here.

Assume Your Social Security Number Is Already Out There

I’m going to briefly depart from my typical retirement finance post to talk about ID theft and retirees, who are frequent targets of this crime.

A few weeks ago, the IRS informed me that someone had filed a federal tax return for last year in my name and claimed a tax refund. In my case, the fraud have been discovered and IRS had not yet paid the bogus refund, as they apparently have for several hundred thousand or so other fraudulent filings. My real tax refund, tiny though it was, arrived unimpeded a few days later.

The way the scam basically works is that the criminal gathers enough of your personal financial data to electronically file a 1040-EZ and claim a tax return. The IRS is working with the electronic tax return filing industry to put better safeguards in place.

My wife freaked out when she heard. I didn’t. The difference was in our expectations.

“Some criminal has our Social Security number!” she pleaded.

“True,” I replied, “but it’s safe to assume that it’s been out there for quite a while."

News stories appear almost daily about massive security breaches. This one at the IRS. A few weeks ago it was the bank that issued my credit card. Target’s database was compromised by criminals gaining access through their HVAC service company. There’s a really good chance that your financial data has also been compromised and, at any rate, it’s safest to assume that it has been.

If ID thieves had rubbed a magic lamp in the mid-twentieth century and had been offered one wish, it would have been "tie every individual American's sensitive financial information to their Social Security number forever." Unfortunately for the rest of us, they didn't need a lamp.

A website called Information is Beautiful justifies its claim by organizing a history of major breaches in this fabulous display. See any merchants or websites there that you have used?

This brings up an important point. We worry that someone will access our home computers, tablets or smart phones and steal our financial data. While that is possible, it’s a lot easier to get our financial data by stealing millions at a time from Target than it is to sit around a coffee shop waiting for someone to log onto their bank account. The latter is actually a lot easier to protect against, and why pick up crumbs when the entire delicious cake is right there for the taking?

While the IRS works on ways to prevent fraudulent returns, there are some steps that retirees (or anyone, really) can take to secure their credit. I placed a freeze on credit reports at the three credit agencies, Experian, Trans Union and Equifax. Now, no one can use these agencies to approve loans or open new credit accounts in my name or my wife’s without my knowledge. The cost of placing, removing and replacing a credit freeze varies by state law, but there are exceptions for free credit freezes for seniors, minors, documented ID theft victims, etc.

The Federal Trade Commission explains how to place a freeze here.

Be sure to freeze the credit of both spouses!

There are valid considerations for not freezing your credit, as explained in this post by Consumer Reports.  If you take out new car loans or apply for credit cards, you will need to remove the freeze and that can take several days. As the Consumer Reports article mentions, it may be easiest to find out which credit agency your car dealer uses and temporarily lift the freeze at only that agency for only that dealer (or a few).

My household's days of applying for new credit cards is long past and unfreezing my credit a few days before I buy a car every few years isn’t a burden compared to the peace of mind the freeze brings. And if having to unfreeze credit a few days before buying a car stops one of my relatives (you know who you are) from continuing to trade cars on impulse so he or she can later wallow in buyer's remorse, all the better.

Freezing our accounts included the unexpected opportunity to request that the agencies never again allow my credit history to be accessed by someone offering pre-authorized credit cards. This should cut by junk mail problem in half.

Another possible solution is to use an “Identity Theft Protection Plan” like the ones reviewed in this Huffington Post article entitled, "Do Identity Theft Protection Services Work?"

Most are not free, although when major breaches occur like the one at Target, the breached company frequently offers a year of such a service free to their customers who may have been exposed. To make my point, I currently have three such services monitoring my credit paid for by three different companies that "may" have offered up my personal credit information to hackers.

A credit freeze protects us from thieves opening new accounts but it doesn’t protect existing accounts. ID Theft services supposedly cover both. Fortunately, most credit cards and debit cards don’t hold us responsible for fraud if we report it in a timely manner. Debit cards, however, can handle the response to fraud claims in a less convenient manner than credit cards. 

The conversion of American credit cards to chip-and-pin technology is largely underway and offers a higher level of credit card fraud protection that has been available for a decade or more in Europe and Asia. You may already have a card or two with the embedded computer chip. Now, we have to wait for a zillion American merchants to convert to chip-and-pin readers and systems that actually use the chip. Then, as a side benefit, when we travel to Europe, we won't have to look like someone out of the 1980's whipping out a stack of traveler's checks.

My recommendation to retirees, given the likelihood of fewer new credit accounts to be opened, is to implement a credit freeze at all three major credit agencies. Again, instructions on how to do so can be found here. For younger households that need more frequent access to credit reports, a credit freeze may be more burdensome, but possibly worth the extra effort. 

And, of course, take advantage of your free annual credit report and review it carefully. To avoid free credit report website offers with strings attached, use the official one promoted by the FTC. It's free, as in free.

And lastly, I recommend that you assume your private and sensitive financial information has already been hacked.  Even if it hasn’t been, you’re safer assuming that is has. Check out my next post, "Have You Already Been Hacked?"

The Risk of Retiring (or Being Retired) Early

Financial journalist, Mark Miller, recently asked me to provide input on a piece he is doing about retiring early. Early retirement is clearly out of reach for most American workers, but as I was working on the article with him, I realized that early retirement issues provide important insights into "normal age" retirements, say from age 65 to 70, and also into the risks faced by the roughly 50% of workers who retire early because they have to. (PDF from Employee Benefits Research Institute. See Figure 34.)

The writer suggested that his research into the topic showed that the answer, more often than not, is "don't do it." That's probably correct, "more often than not", but maybe a better way to say it is that retiring early is probably riskier than most people realize.

There are at least three major financial challenges of retiring early. First, although no healthy person knows how long he or she will live, retiring early increases the expected length of retirement and the number of years we spend in retirement is the greatest unpredictable determinant of retirement cost. (The amount we spend can be a greater factor, but unlike life expectancy and other key factors, spending is at least somewhat within our control.)

It is also a major factor in determining a sustainable withdrawal rate.

When you retire early, you add more years of retirement expenses and, as a result, you add more financial risk. You have to spend a smaller percentage of your retirement savings portfolio annually to mitigate that risk.

Second, retiring early ends savings contributions when they will typically be greatest. Third, retiring early means drawing down savings until Social Security benefits or pension income kicks in. This places additional stress on savings early in retirement that increases the risk of outliving your savings.

Let's look at longevity and sustainable withdrawal rates first.

Longevity risk is the risk that a retired household will outlive their retirement savings. The major factors contributing to longevity risk are how long retirement lasts, how much we spend each year of retirement and how aggressively we invest.

We predict how long retirement might last using life expectancy calculations at our retirement age. We can predict a median life expectancy, and we can also calculate the probability that we will live to some advanced age, such as 95 or 100. A 65-year old American male retiring today, for example, has a median life expectancy of 83 years (86 for a female) and a 6% chance of living to age 95 (13% for a female).

A retiree who decides to retire early increases the risk of a long, costly retirement. The 60-year old male in this example has a 6% chance of surviving a retirement of 30 years or more. Deciding to retire five years early at age 60, however, creates a 6% chance of a 35-year retirement and more than triples the risk of a 30-year retirement from 6% to 19%.

Retiring early has an obvious upside. A retiree who doesn’t live long after retiring will enjoy a longer retirement by doing so. The longevity risk of early retirement is that the retiree might turn what would have been a long and expensive retirement into one that is even longer and more expensive. Turning a 5-year retirement into a 10-year retirement by retiring five years early probably won't cause problems, because the retiree should have planned for an even longer retirement. But, turning a 30-year retirement into a 35-year retirement just might. Of course, the retiree has no way of knowing how long retirement is actually going to last. 

The table below shows the cost of retirement to age 95 with spending of $80,000 annually and discounted at a rate of 2% per year. Column three shows the percent increase of the cost incurred by retiring 5 years earlier than the previous row's retirement age and column 5 shows the probability that an American male retiring at that age would survive to age 95 or beyond. For example, retiring at age 65 would cost 14.7% more than retiring at age 70 and retiring at age 60 would cost 11.6% more than postponing retirement to age 65, assuming both retirees survive to age 95.

The table above shows near-worst case cost, a retirement to age 95. For comparison, the table below shows similar costs assuming the retiree lives to the median life expectancy for a U.S. male at that retirement age in 2015. For example, retiring at age 60 would cost 16.7% more than postponing retirement until age 65, assuming the person lived to his median life expectancy at the retirement age.

Notice that the costs of retirement are lower than in the previous table because expected years in retirement is smaller, but the percent increase in cost from earlier retirement is greater. The chart below shows the probability of a retiree experiencing a long and costly retirement as a function of retirement age. For example, an American male retiring at age 60 has about a 19% chance of a retirement lasting 30 years or more, but that probability for the same person retiring at age 65 is only about 6%.

Reducing the amount of annual spending that is sustainable increases the amount you need to save for retirement. The annual sustainable spending rate grows quadratically as the length of retirement becomes shorter. (All sustainable withdrawal calculations in this post use Milevsky's formula for sustainable spending without simulation (PDF) and assume a maximum 5% portfolio failure rate and a 40% equity portfolio with real mean return of 4.6% and standard deviation of 7%.)

That means that target retirement savings decay quadratically as the length of retirement becomes shorter.

An American male retiring at age 60 has a life expectancy of about 22 years and can spend about 3.6% of his retirement savings portfolio annually. Retiring at 70, he has a life expectancy of about 14 more years and can spend about 4.3% of savings annually, about 20% more. To support $50,000 annual spending from savings, the retiree at age 60 would need to save about $1.39M, while the retiree at 70 would need to save $1.163M, or 16% less.

So, those are the first couple of challenges with retiring early, whether voluntary or not. You risk adding years to a retirement that you couldn't have known in advance was going to be a long, expensive one and with that increased longevity risk, you need to save more before retirement or spend less after. Expected retirement costs more because it lasts longer, but also because it is riskier.

This is a consideration for fortunate workers who have a realistic option of retiring early, but it is a severe penalty for workers who have not adequately saved and find themselves leaving the workforce before they had planned. For workers between these two extremes, this demonstrates the value of working even a few extra years.

Next, I'll look at the second factor,  Retiring Early: Lost Savings.

Retirement Expectations: A Reality Check

I got into an interesting discussion with some friends on FaceBook the other day about what Americans can reasonably expect from retirement. It made me think about what my own expectations had been and I realized that I had never really had many.

(Embarrassing full disclosure: I never thought much about retirement at all until I was about 50.)

Oh, I saved a lot of money in defined contribution plans over the years, but not because I was thinking about the future. I had a high-paying career and the tax deferrals were instant gratification. I knew down deep that I would have to pay those taxes someday, that they were merely deferred and not avoided, but I didn't give that much thought. I was interested in the current year's tax savings.

Surely everyone knows by now that a large majority of Americans under-save for retirement. Baby Boomers haven't saved enough and they get most of the venom from the press, but younger cohorts are in even worse shape.

How badly prepared are we?

The Employment Benefits Research Institute (EBRI) has prepared a "Retirement Readiness" report since 2003. A recent report (download PDF) from 2012 states,

"EBRI’s updated 2012 Retirement Security Projection Model® finds that for Early Baby Boomers (individuals born between 1948–1954), Late Baby Boomers (born between 1955–1964) and Generation Xers (born between 1965–1974), roughly 44 percent of the simulated lifepaths were projected to lack adequate retirement income for basic retirement expenses plus uninsured health care costs."

How do we compare to the rest of the world?

Natixi Global Asset Management produces a ranking of retiree welfare by country (PDF). In 2015, they rank U.S. retirees 19^th in the world, slightly worse than France, slightly better than Slovenia, and four rungs below the Czech Republic.

A critical factor in the cost of retirement, of course, is longevity. The longer we live after we retire, the more our retirement costs. I suppose there is some "good news" in our world rankings, in a morbid sort of way. The CIA Fact Book ranks the U.S. 49^th in life expectancy, slightly worse than Portugal, slightly better than Taiwan. (You can find the full ranking here.)

At least we don't have to fund Japan's retirements, with life expectancies of 84 years, let alone Monaco's nearly 90.

So, the problem that has evolved, for both Baby Boomers and younger cohorts, is that advances in medicine have extended our life expectancies significantly since World War II (though not as far as Portugal's, let alone Monaco's) and that has significantly increased the possible cost of retirement. Unfortunately, longer life spans increase the number of years at the end of our lives, while our earning years still end around age 65. We have the same length careers to fund potentially much longer lives.

For someone who lives to 95, that means perhaps 70 years of adulthood will have to be funded by about 40 years of working career. We get some help from Social Security retirement benefits, a few of us have pensions, and we can leverage time and our investments if we start saving early. But that's still a pretty tall order.

Wade Pfau wrote a paper in 2011 entitled, "Safe Savings Rates: A New Approach to Retirement Planning over the Lifecycle." (PDF) He calculated that the amount of our paychecks that we needed to save historically sometimes approached 25% for a household that needed to replace 70% of pre-retirement income with 30 years to accumulate savings. That's a lot when a household is doing all they can to raise a couple of kids and put them through college. (For some periods, the saving requirement was significantly less, but we can't know that in advance.)

That brings me around to how to think about retirement savings. We shouldn't think about retirement savings as this year's tax break, as they were marketed to Baby Boomers, or as a way to make our retirement years a little more golden.

We should think about retirement savings as transferring some of the wealth from those 40 working years to fund the last 30 after retirement. It isn't fun to think about the fact that in addition to supporting our families before we retire – which probably seems like an enormous challenge on its own – we need to earn enough to also support ourselves and our spouses for what could be a very long retirement.

If I were giving my twenty-something children retirement saving advice, that's what I would tell them. Save like you understand that the money you earn today has to pay the bills today and the bills after you retire. Because it does.

I would also tell them that funding a decent retirement in the U.S. is an extreme challenge that requires sacrifice while they are working and a great deal of good luck throughout their lifetimes.

Many households simply won't earn that much, or be that lucky, and that is the reality that ERBI is reporting. It's not the prettiest picture, and it's one you can't wish away.

Retirement Expenditures and Costs of Retirement

Some great questions and comments about my previous posts on spending in retirement, beginning with Spending Typically Declines as We Age, suggest that I should add a bit more to my explanation. Or as Ricky Ricardo might have said, "I got some 'splainin to do."

Will the cost of retirement decline as you age?

The fact is I don't have any idea how much you will spend late in retirement, nor does anyone else. I can't predict what a household's finances will look like in two or three decades (which is why glide path discussions don't much interest me). My arguments about declining expenses as we age and dynamic updating are about how much you can spend now based on what you now know, not about how much you will spend later in life.

(Reminder to readers: Hover your mouse pointer over yellow text for further explanation. Double-click any chart to see a larger version. Orange text is a hyperlink. "PDF" denotes that clicking will download a PDF of the referenced document.)

The Banerjee and Blanchett studies show that retirement expenditures typically decline with age. Expenditures, however, are not the same as the generally accepted definition of “cost". Think of expenditures as consisting of non-discretionary spending (“basic costs") and discretionary expenses (“lifestyle costs”). In fact, Blanchett showed that the group of retirees with high net worth and low spending are the ones most likely to experience an increase in expenditures, not because their costs go up in many cases, but because at some point they realize they can safely spend more money on their lifestyle than they have been.

No one knows if your spending or your costs will decline as you age, but these studies (and many others) show they are very likely to. Banerjee shows that expenditures decline for two out of three retired households. That is the best initial assumption until experience with your actual retirement results indicates that you are on a different track. (You can refine that initial assumption, as I explained in Retirement Spending Assumptions and Net Worth.)

Is it dangerous to assume that costs will decline?

Not really, and for two reasons. Theoretically, using this approach, if we assume costs will decline and they don’t, we will spend money early in retirement that we might come to need late in retirement. That’s a risk.

It's important to note that the risk of overspending early in retirement isn't exclusive to a plan that assumes decreasing spending. 

But, Banerjee showed that spending declines for about 66% of retirees and increases for about 16% in real dollars. If many of the 16% of retirees who eventually spend more do so because they realize they can afford to, then the danger zone is the 18% chance that spending will remain flat.

However, assuming declining costs in order to provide the most accurate assessment of how much money a retiree can spend today isn’t a one-time calculation, at least it shouldn't be. These calculations should be made annually (see Dominated Strategies and Dynamic Spending). A retiree who initially assumes declining expenditures but ends up in the 18% or so of retirees who don’t see declines in spending should quickly notice the divergence from plan and correct spending within a few years. Annually adjusting spending and assumptions about future spending should should provide for a quick and relatively smooth correction. This is the first way we hedge the risk of assuming declining expenditures.

The second hedge is control of our discretionary spending. We can budget discretionary spending to target a planned decline in spending as we age to increase the probability that our spending does, in fact, decline as we assumed it would. In other words, we have some control over those spending declines. As Blanchett shows, the larger the portion of our budget that consists of discretionary expenses, the more our spending is likely to decline with age. If your spending is largely non-discretionary, then your expectations for spending declines should be modest from the beginning.

There are other arguments for assuming flat spending, including building in a margin of error and having the excess available to pass to heirs. Perhaps the first argument is a matter of personal choice, but I prefer to make the best prediction that I can of future expenses and allow for a margin of error separately. I like to understand both the expected costs and the risk, and not have risk tossed in as an afterthought.

Assuming flat spending as a safety margin is, after all, quite arbitrary. Why not assume a half-percent annual increase in spending, instead of flat spending? Without studies like Banerjee and Blanchett, most retirees and planners couldn’t identify the magnitude of that margin, let alone determine if that is the correct safety margin. Regardless, in my opinion, the risk of running out of savings should be addressed in the floor portfolio, not as additional margin in the risky portfolio.

I have a similar concern with planning legacies as an afterthought of spending, first because I believe that any serious concern about a legacy deserves its own plan and, second, because Scott, Sharpe and Watson (PDF) have shown that planning with “reserves” (hedging sequence of returns risk with over-saving) can be very costly.

In my next post, Retirement Expectations: A Reality Check, I'll write about what we should hold as reasonable expectations of retirement. Hope to see you there.

Spending Rules That Fit the Patterns of Retirement, and Some That Don't

I noted in a recent blog post that Spending Typically Declines with Age after we retire. In a follow-up post, Retirement Spending Assumptions and Net Worth, I explored two recent papers on retirement expenditures that suggest how much spending might decline for you based on how much you plan to spend annually on non-discretionary expenses and your net worth.

I also pointed out that spending rules typically assume that spending will be flat throughout retirement, contrary to what Blanchett, Banerjee and several other researchers have found in studies of data for actual reported retirement spending.

The question most of these spending rules answer is, "how much can I safely spend from savings this year assuming I will spend that same amount every remaining year of retirement?", when the question retirees actually mean to ask is "how much can I safely spend from savings this year given what I assume I will need to spend in the future?"

The difference can be substantial. Quoting Blanchett from Estimating the True Cost of Retirement (PDF), 

"When combined, these findings have important implications for retirees, especially when estimating the amount that must be saved to fund retirement. While many retirement income models use a fixed time period (e.g., 30 years) to estimate the duration of retirement, modeling the cost over the expected lifetime of the household, along with incorporating the actual spending curve, result in a required account balance at retirement that can be 20% less than the amount required using traditional models."

Sustainable withdrawal rate models make this flat-spending assumption, though it isn't difficult to change the models to fit a different spending assumption. I ran my own Monte Carlo model assuming a 50% equity allocation with constant spending and estimated a 95^th-percentile safe withdrawal rate of 4.1%. Then I modified the model to spend 1.5% less in real dollars for each year of ten thousand 30-year scenarios. The second model estimated a 95^th-percentile safe withdrawal rate of 5%. That's 22% more annual spending, or $9,000 a year more "sustainable" spending than the SWR model suggests for a $1M initial portfolio balance.

Looked at from the wealth accumulation perspective, a retiree would need to save 18% less to generate the same annual spending if she expected expenditures to decrease 1.5% a year on average rather than assuming expenses would remain flat throughout retirement as most spending rules assume.

The ARVA (PDF) spending strategy model, or annually recalculated virtual annuity, is more problematic. ARVA assumes that the correct sustainable amount to spend in the current year is the amount that an inflation-protected life annuity purchased in the current year would pay out. The retiree doesn't actually need to buy the annuity, she can simply base spending on what would happen if she did. An inflation-protected annuity will pay out the same amount throughout retirement and it isn't clear to me how ARVA could be adapted to predicted declines in spending needs as we age.

This problem extends to life annuity strategies, in general. Inflation-protected life annuities will pay out a flat rate throughout your lifetime in real dollars that will not match declining expenditures. From that perspective, nominal life annuities may not be quite as bad as they seem, since inflation will eat away at the real annual payouts, but expenditures will probably decline, too. The problem is that even "normal" inflation of 2% to 3% is greater than the estimates of expenditure declines, so this is a poor way to match income and expenses. Runaway inflation could be devastating.

Moshe Milevsky's formula for calculating sustainable withdrawal rates without simulation also seems problematic, as it, too, assumes the sustainable spending that it calculates will continue to be spent throughout retirement. It isn't clear to me that regularly rising or declining spending could be incorporated into his probability models, let alone irregular net spending, but his math is well above my pay grade. Milevsky's formula doesn't accommodate the loss of a first spouse except under the assumption that spending doesn't decline. Based on his responses to similar questions in the past, I would guess he would tell us that these scenarios would have to be calculated individually with numerical analysis if we want to avoid simulation.

As I mentioned in Retirement Spending Assumptions and Net Worth, it is probably more common for a retiring household to experience irregular spending throughout retirement, and the SWR model can easily be modified to accommodate that expenditure, as well. I repeat that chart here for your convenience. The red columns show irregular spending. Your spending in retirement is much more likely to resemble this than a straight line.

Bond ladders work well with any spending pattern including irregular ones. It is simple enough to match bond purchases to different amounts of future spending.

If spending increases as we age in retirement, most spending rules will overestimate the safe amount to spend in the current year. It is more likely that your spending will decline over time, in which case these models will provide current-year safe spending amounts that are too conservative. With irregular spending, it's hard to know where to begin with most spending rules.

My last three posts have followed a theme. First, spending is more likely to decline as we age than to remain flat.

Second, by looking at our own non-discretionary spending and net worth, we may be able to determine a more accurate assumption for our own retirement expenditures.

And, third, most spending rules aren't based on a realistic financial model of actual retirement. They assume flat spending, fixed lifetimes (e.g., 30 years), constant risk aversion, and average market returns and they make other spherical cow assumptions that simplify the math but can lead to inefficient saving and spending.

I suggest modeling your expected expenses and income to consider expected market returns, life expectancy and expected expenditures. They are all "stochastic variables", which means they have a random probability distribution that can be analyzed statistically, but can't be predicted precisely.