What does it mean to have a 75% probability of success?
After all, a 75% probability of success sounds like a grade — and not a particularly good one. It also sounds as though there is a 25% chance that your retirement will be a complete and unmitigated failure. Neither interpretation is necessarily accurate.
A new paper from David Blanchett at PGIM, aptly titled “Successfully Failing,” takes on that conventional measure and suggests that it may not simply be confusing. It may actually lead retirees — and those advising them — to make less-than-optimal decisions.
Success ‘Measures’
Probability-of-success calculations generally run a retirement strategy through hundreds or thousands of different scenarios. If the retiree’s assets last through the prescribed retirement period, the scenario is labeled a success. If the money runs out before the end, it is deemed a failure.
It’s all — or nothing.
A scenario that comes up $1 short is a failure. So is one that comes up $100,000 short. A portfolio exhausted in the final month of a 30-year retirement receives the same failing grade as one depleted after 15 years.
For that matter, the success side can be just as uninformative. A plan that finishes the period with $1 remaining is successful. So is one that leaves the retiree with $1 million —though those outcomes may say very different things about how much the retiree could have enjoyed spending along the way.
In effect, probability of success answers one narrowly defined question: In how many of our modeled scenarios did the portfolio avoid hitting zero before a date we selected? That may be useful information for academics or retirement planners, but it doesn’t strike me as the question actual people are trying to answer.
Goal ‘Oriented?’
Blanchett suggests an alternative: goal completion percentage. Rather than sorting every outcome into one of two buckets — success or failure — it measures how much of the desired spending was actually funded.
Consider the paper’s simple example: a retiree wants to generate $100 annually for 10 years. Across 10 modeled scenarios, only half provide the entire $1,000. That produces a probability of success of just 50% — a number likely to send most retirees scrambling for the nearest spending cut. And yet, averaged across those same scenarios, 96% of the desired spending is funded.
Same assumptions. Same outcomes. Very different — and arguably much more useful —description of the result.
Most people can probably get their arms around being able to fund 96% of what they hope to spend. They can consider what comprises the other 4%, whether they are willing to do without it and what adjustments might close the gap. That seems more tangible than being told that their retirement plan has a 50% chance of “failure.”
It also acknowledges something these models frequently overlook: retirees (not to mention non-retirees) don’t generally set a spending plan on the day they retire and then blindly follow it for the next 30 years. They adjust. They postpone a trip, replace a car later than anticipated, reduce gifts or make other changes as their circumstances evolve. A disappointing market doesn’t automatically cause them to spend their portfolio down to zero without noticing.
Indeed, Blanchett estimates that viewing the same risks through goal completion rather than a traditional probability-of-success threshold could allow some retirees to spend 20% more without taking on additional risk. That is potentially a significant improvement in retirement — not because the investments performed better, but because the measurement did. Not to mention the understanding of what the measurement means.
Successfully ‘Failing?’
That said, goal completion percentage isn’t a perfect measure. Knowing that a plan funds 90% of projected spending still doesn’t tell us when the shortfall occurs — or what kind of spending will have to be sacrificed. Funding 90% of a budget containing substantial discretionary travel is different from funding 90% of one already pared down to food, shelter and healthcare.
Still, it gives retirees something that probability of success generally doesn’t: a sense of the size of the potential problem. And that creates an opportunity to make informed choices rather than merely reacting to the absolutism of a passing or failing grade.
After all, a retirement that delivers 96% of what you hoped for may technically have “failed” by some measures.
But a measurement that can’t help folks distinguish that kind of outcome from financial catastrophe surely has.
- Nevin E. Adams, JD
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