investing these days is really tough fortunately economicsbased financial planning offers clear ways to invest at risk while limiting or indeed eliminating your living standard downside larry kotlikoff is a professor of economics at boston university and the founder and president of economic security planning inc these are tough times for investors in risky assets no matter the asset class there’s a nightmare lurking we hold cash and get wiped out by inflation we buy stocks that immediately crash our bonds vaporize as powell gets serious we buy a new house just as the market peaks we snap up bitcoin at the “bottom” and watch it crater we buy foreign currencies and a global crisis strengthens the dollar you get the picture what’s driving us nuts is not fear of losing our money it’s fear of losing our lunch our bottom line is our living standard what we get to spend now and down the road as any squirrel will tell you running out of acorns midwinter is no picnic running out of spending power midretirement is no different fortunately there are ways to play the market but still control your downside living standard risk the chance of suffering a major drop in your sustainable spending for starters consider playing it perfectly safe by investing all your savings in treasury inflation protected securities tip s these are treasury bonds that are indexed for inflation treasury ibonds which are also inflationprotected government ious is an even better “safe” investment vehicle but there’s an annual limit on the amount of ibonds you can purchase to be clear tips and ibonds entail some risk hence the “safe” although it’s highly unlikely uncle sam could default on his io the forsure risk is paying higher taxes thanks to inflation when inflation increases tips and ibonds pay you larger coupon and principal payments to compensate your getting paid back in watereddown dollars but those inflationprotection payments are taxable by the feds fortunately not by the states and if inflation is high the tax bite can be nasty the safe assets only strategy involves a third risk rollover risk this references reinvesting the proceeds from your tips and ibonds investments but doing so at currently unknown future real yields setting aside these concerns as well as all the other risks you face the safeassetsonly investment strategy lets you play the market safely by simply ignoring it take a hypothetical 50yearold single georgian named sam sam’s major financial question is how to invest sam you see just retired with 5 million in regular assets he has no other resources no future social security benefits no retirement accounts no pension no nothing just 5 million sam wants to hold stocks but is super nervous about losing money suppose sam follows the safeassetsonly investment strategy further assume that he can earn zero percent real investing in a ladder of tips this is a conservative assumption since shortterm tips are as i write yielding a slightly positive real yield and longterm tips are yielding 074 percent real in implementing this zero real return assumption in my company’s maxifi planner financial planning i assumed a 3 percent inflation rate and a 3 percent nominal interest rate now let me give you a quick quiz please guess sam’s annual inflationadjusted living standard the amount in today’s dollars that he can spend each year through age 100 his maximum age of life answering this question is far tougher than it seems you need to factor in 50 years of future federal and state income taxes sam’s payment after age 65 of medicare part b premiums and how my assumed 3 percent inflation rate impacts each of these elements ok time’s up take a guess let me provide some consolation in advance if your answer is miles off the mark if you landed within 20 percent of the right number you’re far smarter than virtually all top phds in finance and economics who have taken similar quizzes from me and failed miserably the right answer is 83414 the phds typically are off by 20 percent some are off by 60 percent no wonder solving the problem requires doing iterative dynamic programming nobody not albert einstein reincarnated can solve this in their head maxifi took less than a half second that’s the power of three decades of professional engineering amazing improvements in computer hardware parallel and cloud computing and patentwinning computational algorithms to many people spending 83k real a year through the end of their days would suit them just fine but sam he’s been dreaming of retiring in aruba snorkeling in the morning surfing in the afternoon and zooming with his dermatologist in the evening sam runs maxifi’s new upside investing routine upside investing as i described in recent forbes and seeking alpha columns is simple as pie   you invest in the sp and tipsibonds and specify a period during which you’ll convert your stocks to tipsibonds   you build a base living standard floor assuming all stock investments are lost   you increase your living standard floor only when and if you convert stocks to tipsibonds in short you treat money in the market as gambling stakes and you don’t spend any winnings until you’ve left the casino in the meantime you assume you’ll leave emptyhanded and spend on that basis at your base livingstandard floor once you exit caesar’s palace you invest any winnings in tips or ibonds this lets you permanently raise your living standard floor hence subject to the above caveats your living standard can only head north during your stockconversion period hence the name upside investing another term for this used by my boston university colleague finance professor zvi bodie is safety first investing in his 2003 book with michael cowes called worry free investing and in his 2011 book with rachelle taqqu called risk less and prosper zvi and his coauthors emphasize buying tips to indemnify specific spending goals upside investing indemnifies your entire future base living standard floor let’s run sam through upside investing assuming sam invests just 20 percent of his regular and retirement assets in stocks and the rest in tipsibonds as the figure below shows sam’s base living standard is 67125 that’s 20 percent lower than the safe assets only strategy so upside investing involves a sacrifice a onefifth lower living standard until sam reaches 65 from that point on sam only experiences upside risk the percentile curves show how much that might be for example the orange curve is the trajectory that generates the 25th highest realized lifetime spending after sam has fully converted his annual spending on this trajectory is 106704 the higher percentile trajectories those with realized lifetime spending ranked 25th to 100th do even better hence sam has a 75 percent chance of winding up on one of the 25th to 100th highest trajectories each of which comes with a living standard that’s at least twothirds higher than sam’s 67125 baseline sam’s 50th percentile ends up above 130k hence he has a oneintwo chance of ultimately doubling his base living standard what if sam’s stocks do poorly they could in the extreme go to zero in this case sam will be left spending 67125 right to the point his personal video game flashes game over losing everything is of course highly unlikely what about sam’s landing on the 5th highest percentile in this case sam’s ultimate living standard floor is 91027 which is higher than his safe assets only living standard and since this is the 5th percentile value it means that sam ends up spending above 91027 in 95 out of 100 cases so far we’ve considered sam’s a investing only in safe assets and spending accordingly and b investing onefifth of his assets in stocks letting them ride for 15 years before gradually converting to tipsibonds and most important not spending a penny based on money in the market until it’s been converted to safe assets maxifi planner also implements full risk investing we used to call it monte carlo analysis but changed its name since both upside investing and full risk investing feature monte carlo simulations full risk investing works like this you specify your current and future asset portfolios and how aggressively you wish to spend through time out of all your resources risky as well as safe you specify your spending behavior via an asif rate of return for example you tell the program you intend to spend each year as if you’ll earn for sure 2 percent real on your assets whatever their current value the higher you set your asif rate of return the more you’ll spend in the short run and the greater will be the potential decline downside to your living standard let me repeat aggressive spending like aggressive investing entails more downside living standard risk suppose for example that sam says “screw it i’m going for broke i’m going to invest all my money in stocks and spend aggressively through time out of whatever i’ve got indeed i’m going to spend as if i’ll always earn 6 percent real going forward the figure below shows sam’s living standard outcomes going for broke rather than investing just 20 percent or zero in the market certainly produces a much higher upside the 95th percentile curve generally lies far above that in the above upside investing figure and if sam ends up on the 5th percentile trajectory he still gets to spend a lot more over the short term than he would following upside investing but sam could hit some very tough times under this particular implementation of full risk investing for example sam’s 5th percentile trajectory spending drops below 40k in some years and that’s the 5th not the lowest lifetime spending trajectory worse this particular monte carlo simulation shows two out of 500 trajectories in which sam loses everything with plenty of years left to starve this is a clear example that spending based on wall street’s whispered mantra stocks are safe in the long run and you’ll personally earn the market’s very high average 30year real return is hogwash codswallop flapdoodle blether as well as many words that are far less polite what if sam runs full risk investing assuming for spending purposes that the market will yield a zero real return and investing 5050 in stock and bonds with these inputs maxifi generate no cases in which sam runs out of money instead sam’s 5th percentile spending is rarely below upside investing’s base living standard moreover by spending more cautiously sam increases his upside late in life by investing less aggressively sam narrows the spread of his 5th and 95th percentile trajectories his living standard cone as i call it in my new book money magic and in spending more cautiously sam tilts his living standard cone upward in short when you engage in full risk investing which most people appear to do you have two levers to limit your living standard downside one is to invest less aggressively the other is to spend less aggressively comparing the first and the third figure you might conclude that full risk investing beats upside investing provided sam invests in a diversified manner and spends very carefully but maxifi’s report shows the minimum annual living standard across all trajectories for the simulations underlying the third figure this minimum which did not arise under the 5th percentile trajectory is 21057 that’s miles below upside investing’s base living standard floor of 67125 in short spending your chickens before they’re hatched always comes with risk there are five morals to this story   you can control your living standard risk by determining how aggressively to spend as well as invest   you can see your living standard risk by running maxifi’s monte carlo simulations of your living standard outcomes   investing only in safe assets the safe assets only strategy can eliminate living standard risk due to investing but leaves you with no upside potential   spending only out of safe assets upside investing eliminates downside living standard risk but at a price spending for sure in the short run and possibly for good less than under the safe assets only strategy   investing in both risky and safe assets and spending annually out of all your assets  full risk investing entails higher shortterm spending and potentially a terrific upside but comes at the risk of tough living standard times and if you invest andor spend too aggressively potential financial ruin this is not your grandfather’s wall streets investment analysis sit down with your certified financial planner zoom with your registered investment adviser meet with your chartered financial analyst consult your certified fund specialist talk with your chartered financial consultant convene with your chartered investment counselor engage with your certified investment management analyst facetime with your chartered market technician reach out to your certified public accountant call any of the mutual fund companies big or small talk to your 401k provider even check with your knowitall uncle ask them to show you the distribution of your living standard annual discretionary spending per household member trajectories if you invest based on their advice my guess they wont have the slightest clue