We had our first of two United States-based CIO forums, titled "Risk: From Chance to Choice," last week in Los Angeles, CA. One of the questions Mike Ryan asked me as part of the investment and portfolio strategy panel was, to paraphrase, "Why does longevity risk matter?" My answer, which I've expanded on a bit due to time limitations at the forum, is below:
I'll point to a Canadian philosopher that goes by the name of Drake in answering this question. He's famous for popularizing the acronym YOLO, which means "you only live once." YOLO is a modern version of carpe diem. YOLO and carpe diem are usually assumed to imply some sort of overly self-indulgent and short-term view of behavior. But the second, usually forgotten, part of the carpe diem phrase changes the meaning: carpe diem, quam minimum credula postero. Seize the day, and put very little trust in the future. This isn't about indulgence. Horace was telling us to take advantage of today, because the future is uncertain. In other words, you can only control the present, so do what you can, while you can, to make the future better. I'd like to think Drake was, too.
Considered that way, YOLO gives us pretty good advice about longevity risk. We will only live once, which means our strategies need to work for our specific lifetime. They can't just work most of the time, because we don't get an average outcome. We're either successful or we fail.
Here's an example. Say you're a gambler, and you believe you have a strategy that gives you a slight edge over the house, but also has a 5% chance of bankruptcy. You can make money by dividing your bankroll up between 1,000 people and sending them all to the casino at once. Fifty people will walk out having lost everything, but you know what your expected profit will be on the day. This example is analogous to portfolio diversification.
On the other hand, if you take your entire bankroll into the casino everyday for 1,000 consecutive days, you will eventually go bankrupt. There is no edge, even though you are using the same strategy as earlier. This example is analogous to life.
That perspective should change how we think on risk over the lifecycle. Your overall plan—investments, objectives, spending, legacy, insurance, etc —it all has to fit together in a way that doesn't have any chance of failure. It doesn't mean that we have to be overly conservative, but we should each dig deeper into the potential ways our plans could go wrong. Our lifecycles will not match the economic cycle. We need to make sure our financial plans break that connection.
Michael Crook, Head Americas Investment Strategy, UBS Financial Services Inc. (UBS FS)