Moshe A. Milevsky - The 7 Most Important Equations for Your Retirement: The Fascinating People and Ideas Behind Planning Your Retirement Income

Other books by Moshe A. Milevsky

Strategic Financial Planning over the Lifecycle: A Conceptual Approach to Personal Risk Management with N. Charupat and H. Huang (Cambridge, 2012)

Your Money Milestones (FT Press, 2010)

PensionizeYour Nest Egg with A. Macqueen (Wiley, 2010)

Are You a Stock or a Bond? (FT Press, 2009)

Lifetime Financial Advice: Human Capital, Asset Allocation and Insurance with R. Ibbotson, P. Chen and K. Zhu (CFA Institute, 2007)

The Calculus of Retirement Income (Cambridge, 2006)

Wealth Logic (Captus, 2002)

Insurance Logic with A. Gottesman (Stoddart, 2002)

Money Logic with M. Posner (Stoddart, 1999)

Copyright 2012 by Moshe A. Milevsky

All rights reserved. No part of this work covered by the copyright herein may be reproduced or used in any form or by any meansgraphic, electronic or mechanicalwithout the prior written permission of the publisher. Any request for photocopying, recording, taping or information storage and retrieval systems of any part of this book shall be directed in writing to The Canadian Copyright Licensing Agency (Access Copyright). For an Access Copyright license, visit www.accesscopyright.ca or call toll free 1-800-893-5777.

Care has been taken to trace ownership of copyright material contained in this book. The publisher will gladly receive any information that will enable them to rectify any reference or credit line in subsequent editions.

The material in this publication is provided for information purposes only. Laws, regulations, and procedures are constantly changing, and the examples given are intended to be general guidelines only. This book is sold with the understanding that neither the author nor the publisher is engaged in rendering professional advice. It is strongly recommended that legal, accounting, tax, financial, insurance, and other advice or assistance be obtained before acting on any information contained in this book. If such advice or other assistance is required, the personal services of a competent professional should be sought.

Library and Archives Canada Cataloguing in Publication Data

Milevsky, Moshe Arye, 1967

The 7 most important equations for your retirement : the fascinating people and ideas behind planning your retirement income / Moshe A. Milevsky.

Includes bibliographical references and index.

ISBN 978-1-1182915-3-5

1. RetirementPlanning. 2. Financial plannersAnecdotes.

I. Title. II. Title: Seven most important equations for your retirement.

HG179.M51846 2012332.024014C2012-901735-3

ISBN 978-1-11834740-9 (ebk); 978-1-11834741-6 (ebk); 978-1-11834742-3 (ebk)

Production Credits

Cover design: Ian Koo

John Wiley & Sons Canada, Ltd.

6045 Freemont Blvd.

Mississauga, Ontario

L5R 4J3

www.wiley.com

To the memory of my grandfather, Rav Hillel Mannes, PhDc; a German gentleman, scholar and orthodox Jew.

Introduction

An Equation Cant Predict Your Future But It Can Help You Plan for It

Most books about retirement planning are written as guides, instruction manuals or how-to books. The authors tell you what to do, when to do it, and what to expect. I know this quite well because I have authored many such tomes myself.

Rest assured, this is not one of those books.

This book tells stories which I hope will lead into conversations. It is a narrative involving seven people, their discoveries and the conceptual innovations that made it possible for you to stop working and enjoy the money you have accumulated, one day. These protagonistsor scientific heroesdidnt achieve their breakthroughs while hunched over a laboratory workbench, peering through a microscope or trekking through jungles. They made their discoveries sitting in front of a blank sheet of paper, but while thinking very carefully about life and money. And, like the greatest thinker of them all, Albert Einstein, they too expressed their discoveries using a very beautiful language called mathematics. Alas, the seven equations profiled in this book arent as famous or as elegant as the simplicity of E = MC2, but they are far more practical for your retirement.

You see, time is running out. North American baby boomers are getting within shouting distance of their golden years. Most have finally grasped thatdespite the dreamy commercials and brochuresretirement isnt a long vacation that begins at the mythical age of 65. Its a gradual winding-down process, possibly involuntary, with austere financial implications. The timeworn questions about proper savings rates, the best mutual funds or the ideal size of your nest egg number have been pushed aside by a pragmatic economic reality: This is what I have, give or take a few more years of saving. How do I make it last?

In other words, it is time to have some conversations about retirement income planning, also known as de-accumulation planning. The stories in this book should lead you into those conversations. These conversations should take place with your family and loved ones and possibly with a professional financial advisor as well (whether you love them or not).

Today, there are two cold, hard facts about aging consumers heading into the second decade of the 21st century: i) most are not saving enough money to maintain their current standard of living, and ii) many are financially illiterate. Alas, study after published study continues to document a shocking lack of knowledge about basic financial affairs and a correspondingly miniscule financial cushion for retirement.

These two problems are obviously linked.

Yes, I know from many years of teaching experience that financial conversations are often dry and humorless. So I promise to do my best to lighten up the topic by keeping the technicalities to a minimum and focusing on the art.

Art, you say?

Yes. In my mind, famous equations are like beautiful Picassos. Even if I dont quite understand the painting or the mathematics I can certainly appreciate the beauty and genius behind it. The seven equations presented in this book typify, at least for me, the conciseness, elegance and beauty that the best of the best equations demonstrate. By the end of this book, if youre not already inclined to appreciate mathematical equations for what they are, I hope youll agree about the beauty.

Heres a brief outline of whats ahead.

In the first chapter, I will start by asking a simple question: How long will your nest egg last, if you were to stop contributing today, and instead withdraw a fixed amount each year while earning a fixed interest rate each year for the rest of your life? Although neither of these fixes are realistic in practice, this sort of analysis provides a quick and sobering assessment of whether you can maintain your standard of living, or when the money will run out if you cant. The underlying mathematics of this first equation is rather simple, and does not require any complex algorithms. Along the way, youll learn about the 13th-century Italian educator and mathematician Leonardo Fibonacci and his remarkable technique for solving such financial problems.

In the second chapter, Ill address the length of life itself. Here is the motivating question: Given your family history, current lifestyle and recent medical experience, what are the chances that you, your spouse, or both of you, will reach age 90, 95 or even 100? In this chapter youll learn about longevity risk and learn about the work of famous British actuary Benjamin Gompertz. He discovered and formulated the first natural law of human mortality almost 200 years ago. His equation is used daily by medical researchers, demographers and insurance specialists.