Longevity Risk and Market Risk

Yesterday’s post made a point about saving up a sufficient amount to meet your retirement needs. And the point was this: that in a world of many uncertainties, the uncertainty of how the financial markets will treat all of us exceeds the uncertainty of how long your particular lifespan will be.

And today’s point is this: So what! You have to live with both uncertainties. You don’t get to choose one or the other.

There is a silver lining of sorts: The financial risk of an extra-long life is presumably independent of the risk of an extra-crummy market environment. (Then again, maybe they’re not independent. Maybe suffering through a bad market environment makes you want to die. I know it’s making me pretty sick.)

Assuming they are unrelated, your true financial risk is that you will suffer through both bad situations simultaneously. This point was made by Messrs. Blanchett and Blanchett in the article discussed in January 14’s post. (I shouldn’t refer to long life as bad. Long life is generally a good thing. It’s just the financial aspect of it that’s bad.)

How does this affect Goldilocks from yesterday’s post? If she saves enough to meet her projected needs for an average life expectancy in an average market environment, she actually has about a 75% chance of not running out of money while still alive. That’s not too bad. (Caveat: These percentages incorrectly use the historical performance of the financial markets to measure the likelihood of future success. It's wrong to do that, but I do it anyway. Like eating potato chips.)

Unfortunately, Goldilocks gains only diminishing returns in her level of certainty as she increases her savings. For example, building up her retirement savings by an additional 30% gets her from a 75% up to about an 88% chance of not outliving her life retirement savings.

Don’t you just hate uncertainty?