How do Nobel laureates Bill Sharpe and Bob Merton approach SORR.
Merton’s recommends identifying three categories of income.
Category 1
Minimum required income - funded by annuitization
Category 2
Conservative flexible income; some opportunity for limited reduction - funded by inflation-linked government bonds
Category 3
Desired additional income; nice to have rather than must have - funded by risky assets like stocks or a mix of stocks and bonds
Sharpe’s solution is the so-called ‘lock-box’ or ‘earmarking’ strategy:
•Pick a year in the future, let’s say 2040.
•Determine your minimum required expenditure and your desired expenditure in real terms for 2040.
•Estimate the risk-free investment (e.g. an index-linked government bond) required to cover the minimum required expenditure.
•Estimate the risky investments (e.g. stocks) required to fund the excess to get to your desired expenditure.
•Earmark those investments for 2040 and don’t touch them until 2040: put them in a 2040 ‘lock-box’.
•Repeat for all other years.
Each lock-box has its own investment strategy in terms of asset mix, whether or not you rebalance investments and so on. It separates out the risk-reward trade-off by each year and so avoids sequence of returns risk. It ensures that you spend enough as well as not spending too much.
Common to both our Nobel laureates is the idea that we need to choose the investments to match our expenditure needs and according to the risk we’re prepared to take. Short term fund volatility is irrelevant. Of course, we may find that there’s a gap between what we’d like and what we can achieve. We may have to take more risk than we’d like to give ourselves a chance of the income we want. But we should do that in full knowledge of the possible consequences.
The two methods take the retiree to almost exactly the same place, but I prefer Merton’s simpler method to the more complicated lock-box approach of Sharpe.
Link to article - How do Nobel laureates approach retirement?
https://thegoslingfactor.com/investment ... etirement/
BobK
Merton’s recommends identifying three categories of income.
Category 1
Minimum required income - funded by annuitization
Category 2
Conservative flexible income; some opportunity for limited reduction - funded by inflation-linked government bonds
Category 3
Desired additional income; nice to have rather than must have - funded by risky assets like stocks or a mix of stocks and bonds
Sharpe’s solution is the so-called ‘lock-box’ or ‘earmarking’ strategy:
•Pick a year in the future, let’s say 2040.
•Determine your minimum required expenditure and your desired expenditure in real terms for 2040.
•Estimate the risk-free investment (e.g. an index-linked government bond) required to cover the minimum required expenditure.
•Estimate the risky investments (e.g. stocks) required to fund the excess to get to your desired expenditure.
•Earmark those investments for 2040 and don’t touch them until 2040: put them in a 2040 ‘lock-box’.
•Repeat for all other years.
Each lock-box has its own investment strategy in terms of asset mix, whether or not you rebalance investments and so on. It separates out the risk-reward trade-off by each year and so avoids sequence of returns risk. It ensures that you spend enough as well as not spending too much.
Common to both our Nobel laureates is the idea that we need to choose the investments to match our expenditure needs and according to the risk we’re prepared to take. Short term fund volatility is irrelevant. Of course, we may find that there’s a gap between what we’d like and what we can achieve. We may have to take more risk than we’d like to give ourselves a chance of the income we want. But we should do that in full knowledge of the possible consequences.
The two methods take the retiree to almost exactly the same place, but I prefer Merton’s simpler method to the more complicated lock-box approach of Sharpe.
Link to article - How do Nobel laureates approach retirement?
https://thegoslingfactor.com/investment ... etirement/
BobK
Statistics: Posted by bobcat2 — Sat Feb 08, 2025 6:59 pm