# Help me understand the "recommended" living standa

Hello,
I'm lost.

How does the program determine the "recommended" living standard trajectory? (or any other recommended amount).

If this is explained someplace in the documentation or site, please point it out to me.

Thank you.

1

"living standard" differs from average consumption per household member because we take into account economies in shared living as well as the relative costs of children. You can read the living standard numbers that are generated for your family's plan as what you would need as a single person to spend on your consumption to have the same living standard as you enjoy in your household.

Call me if this is unclear. We have a non-linear equation relating household consumption to living standard. The variables in the equation include the number of adults, number of children at each age, the age-specific relative cost of children and the economies of share living.

My number is 617 834-2148. best, Larry

2

Using the Monte Carlo report - Probability of Living Std Range..

In the early years, I find that there is a large probability of the living standard falling within 75% to 125% of the recommended trajectory in column D

As we go out a few years, there is quite a large probability that the living standard falls between 25 - 75 % of the recommended trajectory.

My questions is - When using Monte Carlo, how is recommended trajectory in column D computed?

Why wouldn't Column D be set lower to allow a larger probability of the living standard to fall above 75%?

Conversely, how do I manipulate the number in Column D to give me a larger probability of the living standar being above 75%? (I know I can do it by modifying my portfolio)

Finally, how do I "use" this recommended trajectory? Should I try to live well within that number or use that number for annual consumption?

Thank you.
Regards,
c.

3

When you run the program with Monte turned on, all the numbers shown in the Main and Detailed reports are generated assuming you earn, each year, the mean (expected or average) return on the assets you tell the program you'll be holding in that year.

In other words, when you run the Monte, the Main and Detailed reports are generated just as they'd be if you ran the program with Monte turned off except they use each year's expected return for that year's rate of return rather than use a single rate for all future years.

In the Monte Reports, on the other hand, we are showing the results of running/simulating 500 life paths. To see what's going on, imagine you run the program this year with Monte turned on and spend based on recommendation in the Main Report. Now a year goes by, and it's January 1, 2008. You earned a return on your assets in 2007 that differs from the mean return, which is what the Main Report assumed. Your assets on January 1, 2008 are, thus, going to be different from what the Main Report for 2007 said they'd be in 2008. So you run the program again for 2008 and it tells you, in the Main Report, what to spend. You spend this and cotinue in this manner through time. Each year you'll have a recommened level of spending and an associated living standard. At the end of your life, you'll look back and see a path of past living standards. This is one of the 500 paths of living standards that we generate and then use to show the variabiilty across the 500 paths of your living standard in each future year.

Now I realize that what we are showing here is the results of very agressive assumed spending behavior. (Our next variant of the Monte Carlo program will modify this assumption and base spending/draw down rates on what's called expected utility maximization, which will take into account users' risk aversion.) But I wanted to show users who might be basing their spending on expected returns that spending this way will lead to a lot of downside living standard risk as they age if they invest in risky assets.

best, Larry

4

Thank you. You explained that very well. I look forward to the next revision. Now to load my program with 2007 values so I know what my true financial picture will look like. (I bought the program a couple of months ago, so it inflated my holdings by a year.)

Happy New Year to you & thanks for the excellent support your provide.

Regards,
c.

5

> imagine you run the program this year with Monte turned on and
> spend based on recommendation in the Main Report. Now a year
> goes by, and it's January 1, 2008. You earned a return on your
> assets in 2007 that differs from the mean return, which is what the
> Main Report assumed. Your assets on January 1, 2008 are, thus,
> going to be different from what the Main Report for 2007 said they'd
> be in 2008. So you run the program again for 2008 and it tells you,
> in the Main Report, what to spend.

Larry,

When I first started using ESPlanner, I was confused by the Monte Carlo output until you patiently explained the above to me, and I've noticed that this question continues to come up in the forum. I think the hurdle that we as new users have to get over is that everywhere in basic ESPlanner, the emphasis is on finding a simple annual spending level that we can reasonably expect to sustain to age 95 or so. When we move on from the basic program and turn on Monte Carlo, we are still looking for this magic number, and when we see the "recommended trajectory" column in the MC output, we assume we've found it. It takes a moment to realize that this is really just the same figure as given in the basic report, and that the odds of its being sustainable for life are not some comfortably high value but in fact may be well under 50%. The word "recommended" seems odd in this context and I wonder if it doesn't cause some needless confusion.

What I'd like to be able to extract from the MC output (and I'll guess I'm not the only one) is a level consumption trajectory that survives some user-defined percentage of the MC runs: 80%, or 95%, or whatever it takes to give me a warm feeling about the result. I see people trying to tease this sort of information out of the MC reports, but can it actually be done?

Regards,
Scott Mitchell

6

Hi Scott:

I hope you don't mind if I jump in or follow along with this conversation.

I'm learning this too. As you say, it's easy to get a report on the basic side of things just by putting in a high average return. What you don't see on that side alone, of course, is the amount of risk (variability) that percentage (portfolio mix really) will entail. So the MC side reveals this variability.

I've been using the living standard trajectory report--the one that gives column heading with 5th, 25th, 50th, 75th, and 95--to help me see the worst case scenario and the best case scenario (and the middle case scenarios). So I think to myself: what living standard number would I find just too low for comfort, and I scan down the first or second column (5th and 25th) to see if that number or a lower number appears in that trajectory. I guess if you have very little risk tolerance you'd not want to see that lowest number in the first, second, or even third column. I have a bit more tolerance, so if it appears in the second column (25th) I'm ok with that as long as it doesn't appear very often.

The other thing I note in that grid is how much the living standard changes between best and worst in any given year. If best and worst are not much different, that's good. If they are wildly different, then that's a voltile portfolio.

The problem I'm having now is that if I put in all REITS (just as an experiment) or all TIPS (just as an experiment), I get a very weird and inexplicable pattern that I've already told Larry about. He said they were looking into that and would get back with me.

So for now, I'm not running the MC.

Best,

Dan

7

Dan,

No worries; it's wasn't my thread either ;)

I've been doing about the same thing you have, scanning for low values in the first couple of trajectory columns. Sometimes I'll also average all the values in a column, reasoning that this might approximate the level spending you could sustain with a given degree of confidence. But this sounds a little fishy to me somehow.

Really I like the way the data is presented, and I'm sure it's more "real" than what I'm asking for - after all I doubt many people run a calculator once at age 50 and use the result to fix their spending forever more. But I think a simple, level annual spending figure would be a useful result if you're trying to do something like compare different asset allocations.

Regards,
Scott

8

Scott:

Yes, I think averaging those numbers in the column may not be the thing to do because the column as a whole already reflects "weighted" numbers. That is, I think the column is ranked based as 5th or whatever based on the present value of the annual amounts--which makes the early amounts more valuable than the later amounts. But this quickly eludes me if I think about it too much.

But another way to think about this is to look at the probability chart--the one that reports the numbers across a row that equal 100. That is, you probably see 100 in the column 75%-100% in the first year etc. So then, just to get a summary sense of the spread of things I copy/paste that entire table over into Excel (use paste-special to paste as text so that each number goes into a different cell). Then sum the numbers in the first two columns and compare that with the sum of the numbers in the other four columns or whatever--I can't recall how many columns there are. But anyway, you get a snapshot that divides the averages into two groups, those above 75% and those below 75%. You might have 40% below 75 and 60% above 75% above.

I don't know if that makes sense.

Another thing I've found very helpful in comparing, and this doesn't involve the monte carlo. I run a scenario and copy/paste the consumption column into Excel. Then I change something, and run it again. I copy the new conumption column into Excel beside the first column. Then, highlight the two columns, create a line chart, and visualize the trajectory of the two that way. Somehow this seems much easier to see than clicking back and forth between the two tables and trying to remember what one column looked like and the other column. If you get fussy about it, you can title the columns and run three, four, five or more columns and create a simple line chart and look at the way you give to yourself in some years and take away in others. It's a very easy way to compare trajectories when you are just experimenting and don't want to keep saving each trial with a new folder.

I love the program. I'm still a bit dubious about the MC though for reasons I stated earlier.

Dan

9

I read this document and it explains how to interpret some aspects of the monte carlo analysis. Hope it helps you too.
http://www.bos.frb.org/economic/conf/lcsi2006/papers/kotlikoff.pdf

Regards,
c.

10

Yes, that's great. Well written piece. I have to say that steady standard of living as the aim really changes the way you think about this stuff. And you can see the results so dramatically in the living standard trajectories.

I feel I'm better understanding the MC, but I am having a hard time getting the variation down. I try very conservative portfolios and the whole things drops--yet my recommended trajectory remains very good. I think the MC is not working correctly. He said they were working on it.

Thanks for sending that article. The concept has sort of taken over my view now and I have a hard time switching back to the received way of thinking about this stuff.

Dan

11

One of the things that still puzzles me is how to read the trajectory report. The Income Trajectory report is a good of example of what confuses me. It shows my income in every column (very low through very high) as 25k short of what I know it will be. For example, last I heard, I was not having my pay cut by 25k this year, yet the MC INCOME trajectories show me short 25k in every category (very low through very high) the next ten or fifteen years. What sense does that make? I mean, even limiting the analysis to 2007, how could it be off 25 thousand in the very first year? I understand that market conditions would cause it to vary in years when I'm dependent on draw down on funds in the future, but in 2007 I'm only dependent on my salary which ain't going to change--so how is the analysis off so far right out of the 2007 gate? Projections would vary in future, market-dependent years, but nothing about my Income is market dependent this year, so why is it projecting me short 25k? If there is some statistical explanation, then I have to simply say, the analysis then is of no value since it is so far off on the very face of it. i.e., I don't need MC analysis to tell me my income in 2007--and yet it does give me the number and it's off by 25k!

Perhaps this is just related to other problems still being worked on with the MC, and I should wait until these things are fixed. But I'm at the point now where I need to use the Monte Carlo to compare risk in different scenarios, yet the output on this analysis just doesn't make much sense. Should we put "Beta" on the website and stop charging for the Plus version until these things are fixed?

Dan Royer

12

Recommended living standard refers to spending per adult on everything apart from taxes, special expenditures, housing, retirement and reserve fund contributions, and insurance premiums. If this doesn't address your question, please call me at 617 834-2148. thanks, Larry

13

Hi Dan,

We're about to start working on the Monte bug you reported. Sorry it's taken so long. I presume that the problem with the income report is related to the Monte bug we're seeing.

We should have this fixed in a few days.

Larry

14

Yes, I understand living standard trajectory. I also think that I understand INCOME trajectory--which is what I was referring to in the post above. If there is no INCOME from assets, it seems odd to me that the INCOME trajectory could be off by as much as 25 thousand dollars in the very first year (2007). When INCOME is dependent on assets in the future, and thus market flux, I can understand the variation. My MC shows no variation in INCOME trajectory from left to right from very low to very high, BUT has wildly miscalculated the amount based on the obvious reported earnings for 2007 and the next several years. I feel odd that I'm the only one that notices this. But I'm a HUGE fan of this software and want to trust its MC output since that adds so much dimension to the analysis. I'll be patient.

Dan

15

Ah, I was about to post a question along the lines of this thread, which helped clear up some of my confusion, but I still have a question.

Even though I've "told" ESP my income this year will be a certain amount, when I run the MC, the "recomended" income trajectory is a very different amount, which I entered the first time I set up a profile. I cannot seem to find a way to get the program to change the recommended trajectory EVEN THOUGH it shows the correct amount...in fact, I believe the initial inputs, despite my changes, are what the program is using for all trajectories. Am I right/wrong, how do I correct this?

Thx.

16

What the MC (and, indeed, all of ESPlanner) uses for "income" is the aggregate of:

Employment earnings
Social Security
Interest on regular assets
Withdrawals from retirement accounts
Income from real estate (it's in the 2.9 release, coming out soon)
Income from sale of home
minus a whole bunch of things

So your "income" number entered on the Earnings screen may or may not be closely related to what ESPlanner considers to be your "income". This aggregate "income" is the "recommend" income plotted by ESPlanner in the MC reports. As many people observe, the probability of keeping this income level drops over time which actually is the result predicted by the math according to Larry after he worked a couple of cases by hand because he wasn't sure the MC was right. The technical reason for this is that the current Monte Carlo implementation doesn't model likely changes in consumption behavior based on simulated actual returns, we're working on exactly this problem and should incorporate this change in a future release.

Having rambled for a while now and re-reading your post, if you're saying that the recommended income stays the same no matter what you put into for data, then that's a bug and we need to look at it.

Best,

Dick Munroe[/]

17

munroe wrote:What the MC (and, indeed, all of ESPlanner) uses for "income" is the aggregate of:

Employment earnings
Social Security
Interest on regular assets
Withdrawals from retirement accounts
Income from real estate (it's in the 2.9 release, coming out soon)
Income from sale of home
minus a whole bunch of things

So your "income" number entered on the Earnings screen may or may not be closely related to what ESPlanner considers to be your "income". This aggregate "income" is the "recommend" income plotted by ESPlanner in the MC reports. As many people observe, the probability of keeping this income level drops over time which actually is the result predicted by the math according to Larry after he worked a couple of cases by hand because he wasn't sure the MC was right. The technical reason for this is that the current Monte Carlo implementation doesn't model likely changes in consumption behavior based on simulated actual returns, we're working on exactly this problem and should incorporate this change in a future release.

Having rambled for a while now and re-reading your post, if you're saying that the recommended income stays the same no matter what you put into for data, then that's a bug and we need to look at it.

Best,

Dick Munroe

yes, your final comment is what I'm experiencing. furthermore, I just changed my life expectancies from 95 to 90, to see what would happen, but all the reports still have me living to 95. Yes, I did click "apply" to effect the age change. I'm using version 2.8.5.1.

The specific income issue is that I plugged in about \$236k for 2007, in my initial profile setup, then changed it to \$100k. Income is shown as \$100k in all the graphs, BUT the recommended income is still \$236k...which if I understand correctly, means the projections have not changed at all; I'm just being informed that there's a discrepancy between recommended and my input. Hope this is clear.[/]

18

Well take a look at the problems you report today. best, Larry

19

I read LarryÃƒÂ¢Ã¢â€šÂ¬Ã¢â€žÂ¢s earlier post about how to interpret the Monte Carlo reports and think I understand it. However, just to be sure, IÃƒÂ¢Ã¢â€šÂ¬Ã¢â€žÂ¢d like to try re-explaining it in my own words, to see if I have it right (and maybe itÃƒÂ¢Ã¢â€šÂ¬Ã¢â€žÂ¢ll benefit others as well).

LetÃƒÂ¢Ã¢â€šÂ¬Ã¢â€žÂ¢s suppose that I have \$500K in savings, a portfolio that will earn 10% per year on average, IÃƒÂ¢Ã¢â€šÂ¬Ã¢â€žÂ¢m single (so we donÃƒÂ¢Ã¢â€šÂ¬Ã¢â€žÂ¢t have to worry about the difference between consumption per adult and total consumption), I am going to live 40 more years, and that I run esplanner with Monte Carlo turned on. Esplanner will generate a trajectory as follows: First, it assumes that I earn the average (10%) return on my savings every year for the rest of my life and computes what I can consume for the first year. LetÃƒÂ¢Ã¢â€šÂ¬Ã¢â€žÂ¢s suppose that is \$40K. Then it ÃƒÂ¢Ã¢â€šÂ¬Ã…â€œrolls the diceÃƒÂ¢Ã¢â€šÂ¬Ã‚Â and finds that I earn only 6% on my portfolio. Hence at the end of the year I have about (\$500K - \$40K)*1.06 = \$488K (letÃƒÂ¢Ã¢â€šÂ¬Ã¢â€žÂ¢s just assume no inflation to make it simpler). So, for the next year, esplanner again assumes I earn the average 10% return for the rest of my life (which is now 39 years) on my nest egg (now \$488K). LetÃƒÂ¢Ã¢â€šÂ¬Ã¢â€žÂ¢s say consumption for this second year comes to \$38K this time (smaller because I made less than expected on my investments the year before). Esplanner then rolls the dice again ÃƒÂ¢Ã¢â€šÂ¬Ã¢â‚¬Å“ letÃƒÂ¢Ã¢â€šÂ¬Ã¢â€žÂ¢s say I get another bad roll, only 3%. So at the end of the second year I have (\$488K ÃƒÂ¢Ã¢â€šÂ¬Ã¢â‚¬Å“ \$38K)*1.03 = \$463K. For the third year, esplanner again assumes that I earn 10% for the rest of my life and, using the new nest egg value of \$463K, computes another consumption level. ItÃƒÂ¢Ã¢â€šÂ¬Ã¢â€žÂ¢ll be lower again, say \$35K. And so on. Thus IÃƒÂ¢Ã¢â€šÂ¬Ã¢â€žÂ¢ll have a series of 40 consumption levels, one for each year of my life: \$40K, \$38K, \$35K, etc. Esplanner generates 500 of these series.

Now for each of the 40 years left in my life, there are 500 computed consumption levels. These are ranked from lowest to highest for each year. For each year, the 5th percentile that appears in the Monte Carlo ÃƒÂ¢Ã¢â€šÂ¬Ã…â€œVariability of Living StdÃƒÂ¢Ã¢â€šÂ¬Ã‚Â report is the 25th lowest consumption level, the 50th percentile is the one in the middle (number 250 or 251), and the 95th percentile is the 25th from the top. Is this correct?

I am a little less certain about the meanings of ÃƒÂ¢Ã¢â€šÂ¬Ã…â€œvery lowÃƒÂ¢Ã¢â€šÂ¬Ã‚Â, ÃƒÂ¢Ã¢â€šÂ¬Ã…â€œlowÃƒÂ¢Ã¢â€šÂ¬Ã‚Â, etc. on the trajectories report, but here is my guess. Somehow each of the 500 paths, as described above, would be valued (perhaps just by adding up the values for the 40 years). Then those 500 values would be ranked and one near the bottom (25th?) would be called ÃƒÂ¢Ã¢â€šÂ¬Ã…â€œvery lowÃƒÂ¢Ã¢â€šÂ¬Ã‚Â, etc. The "very low" trajectory on the graph and in the tabular report would be a complete series generated in one of the 500 simulations.

Another question is how to use this information. It seems to me that if one can get by, trying to keep consumption at the ÃƒÂ¢Ã¢â€šÂ¬Ã…â€œvery lowÃƒÂ¢Ã¢â€šÂ¬Ã‚Â level should give a person a very high likelihood of making it through life without running out of money. But I am not sure whether that is being too conservative.

20

I'm still waiting for an answer about the apparent discrepancy noted in my earlier post. I sent Dick my entire file back in April, so he could search for a bug...I sound like I'm whining, but actually I just need the information. Circumstances have changed, and I am faced with the almost immediate decision whether to retire now or begin a 2-3 year process or rebuilding my business.

Scott Burns' column a couple of weeks ago answered a reader's question..."here's how much i have, how much can I spend down per year?" which is exactly the question I need an answer to.

Well, maybe I'm whining just a teeny bit....

21

We've found and fixed a lot of small bugs in the MC that showed up (among other places) in the reporting of income. If you're still having problems with the latest update, then send me your database and a description of the problem and I'll take a look at it. I could have sworn we looked at all the reported problems.

Best,

Dick Munroe

22

munroe wrote:We've found and fixed a lot of small bugs in the MC that showed up (among other places) in the reporting of income. If you're still having problems with the latest update, then send me your database and a description of the problem and I'll take a look at it. I could have sworn we looked at all the reported problems.

Best,

Dick Munroe

Well, I did this very thing back in April, Dick, sent you the entire DB, and never heard anything back from you. I'll do it again, but I sure do need a more timely response.

23

My apologies. I thought I had registered and gone through all the databases I had received during the update processing. Usually we're a lot more responsive than this.

Best,

Dick Munroe