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Comment author: michaelsullivan 06 June 2016 02:55:25PM 2 points [-]

So one of the major issues I've identified with why our gut feelings don't always match with good expected utility models is that we don't live in a hypothetical universe. I typically use log utility of end state wealth to judge bets where I am fairly confident of my probability distributions as per Vaniver in another comment.

But there are reasons that even this doesn't really match with our gut.

Our "gut" has evolved to like truly sure things, and we have sayings like "a bird in the hand is worth two in the bush" partly because we are not very good at mapping probability distributions, and because we can't always trust everything we are told by outside parties.

When presented with a real life monty haul bet like this, except in very strange and arbitrary circumstances, we usually have reason to be more confident of our probability map on the sure bet than on the unsure one.

If someone has the $240 in cash in their hand, and is saying that if you take option B, they will hand it you right now and you can see it, you can usually be pretty sure that if you take option B you will get the money -- there is no way they can deny you the money without it being obvious that they have plain and simply lied to you and are completely untrustworthy.

OTOH, if you take the uncertain option -- how sure can you really be that the game is fair? How will the chance be determined? The person setting up the game understands this better than you, and may know tricks they are not telling you. If the real chance is much lower than promised, how will you be able to tell? If they have no intention of paying you for a "win", how could you tell?

The more uncertainty is promised, the more uncertainty we will and should have in our trust and other unknown considerations. That's a general rule of real life bets that's summed up more perfectly than I ever could have in this famous quote from Guys and Dolls:

"One of these days in your travels, a guy is going to show you a brand new deck of cards on which the seal is not yet broken. Then this guy is going to offer to bet you that he can make the jack of spades jump out of this brand new deck of cards and squirt cider in your ear. But, son, do not accept this bet, because as sure as you stand there, you’re going to wind up with an ear full of cider."

So for these reasons, this gamble, where the difference in expected value is fairly small compared to the value of the sure win -- even though a log expected utility curve says to take the risk at almost any reasonable level of rich country wealth, unless you have a short term liquidity crunch -- I'd probably take the 240. The only situations under which I would even consider taking the best are ones where I was very confident in my estimate of the probability distribution (we're at a casino poker table and I have calculated the odds myself for example), and either already have nearly complete trust or don't require significant trust in the other bettor/game master to make the numbers work.

In the hypothetical where we can assume complete trust and knowledge of the probability distribution, then yes I take the gamble. The reason my gut doesn't like this, is because we almost never have that level of trust and knowledge in real life except in artificial circumstances.

Comment author: Lumifer 31 May 2016 02:43:43PM 1 point [-]

Yes and my question was how does he know? If he never had that amount of money available to him, his guesstimate of how much utility he will be able to gain from it is subject to doubt. People do change, especially when their circumstances change.

Comment author: michaelsullivan 06 June 2016 02:29:35PM 0 points [-]

Of course, but in relative terms he's still right, it's just easier to see when you are thinking from the point of the hungry hobo (or peasant in the developing world).

Standing from the point of view of a middle class person in a rich country looking at hypothetical bets where the potential loss is usually tiny relative to our large net worth+human capital value of >4-500k, then of course we don't feel like we can mostly dismiss utility over a few hundred thousand k, because we're already there.

Consider a bet with the following characteristics: You are a programmer making 60k ish a year a couple years out of school. You have a 90% probability of winning. If you win, you will win 10 million dollars in our existing world. If you lose (10%) you will swapped into parallel universe where your skills are completely worthless, you know no-one, and you would essentially be in the position of the hungry hobo. You don't actually lose your brain, so you could potentially figure out how to make ends meet and even become wealthy in this new society, but you start with zero human capital -- you don't know how to get along in it, any better than someone who was raised in a mumbai slum to typical poor parents does in this world.

So do you take that bet? I certainly wouldn't.

Is there any amount of money we could put in the win column that would mean you take the bet?

When you start considering bets where a loss actually puts you in the Hungry hobo position, it becomes clearer that utility of money over a few hundred thousand dollars is pretty small beer, compared to what's going on at the lower tiers of Maslow's hierarchy.

Which is another way of saying that pretty much everyone who can hold down a good job in the rich world has it really freaking good. The difference between $500k and $50 million (enough to live like an entertainer or big-time CEO without working) from the point of view of someone with very low human capital looks a lot like the famed academics having bitter arguments over who gets the slightly nicer office.

This also means that even log utility or log(log) utility isn't risk averse enough for most people when it comes to bets with a large probability mass of way over normal middle class net worth + human capital values, and any significant probability of dropping below rich-country above-poverty net worth+ human capital levels.

Fortunately, for most of the bets we are actually offered in real life, linear is a good enough approximation for small ones, and log or log-log utility is a plenty good enough approximation for even the largest swings (like starting a startup vs. a salaried position), as long as we attach some value to directing wealth we would not consume, and there is a negligible added probability of the kind of losses that would take us completely out of our privileged status.

In most real life cases any problems with the model are overwhelmed by our uncertainties in mapping the probability distribution.

Comment author: adamzerner 26 February 2015 03:42:08AM *  0 points [-]

Outside view of your 1 2, 3 and 4: most people end up in trajectory number 4

I'm not sure how to word this well, but "most people" haven't lived in the year 2080. Because of a) the possibility of a singularity and b) the law of accelerating returns, the "most people" that you refer to doesn't seem like an appropriate reference class to me.

In particular let's look at 1

I think you're downplaying the chances that a singularity does happen in my lifetime. 90% of experts seem to think it will.

Interesting point abut 200 years ago though. I'm having a hard time imagining the standard of living for the poor in that time period being insufficient for me, but I've noted this as something to examine further.

Comment author: michaelsullivan 26 February 2015 05:34:02AM *  3 points [-]

I think you're downplaying the chances that a singularity does happen in my lifetime. 90% of experts seem to think it will.

I don't. (Edit: I meant this as "I don't think I am downplaying the chances", not "I don't think the singularity will happen")

It's true that I disagree with your experts here, and Lumifer speaks to some of my reasons. I even disagree with the LW consensus which is much more conservative than the one you quote.

That said, even taking your predictions for granted, there are still two huge concerns with the singularity retirement plan:

  1. Even given that it will occur in your/my lifetime, how do you know what it will look like and that it will lead to a retirement you are happy with even if you have no capital?

  2. If there is even a 5-10% chance that it doesn't happen, or doesn't provide what you want -- that is a fail when I am doing a retirement plan for most of my clients. I'm generally aiming for a 0+epsilon or at least <1% chance of failure if the client is able to follow the plan[*]. The only clients where building in a 10% chance of bust is ok are those who are in a real pickle, and there is no reasonable strategy to do better. Those clients' plans have to include downward adjustment of their goals if the initial trajectory is in or too close to the failure window.

[*] obviously most of the true failure chance happens when the client is unable to follow the plan at some point. Financially, some of that can be insured against (health and disability, life for dependent survivors) and some can't.

Comment author: Vaniver 24 February 2015 07:58:23PM *  1 point [-]

Obligatory links:

either are hugely committed to earning to give

See 80,000 Hours.

or intend to retire or do something risky or different at a very young age

See Mr. Money Mustache.

don't ever intend to not live relatively frugally

See The Millionaire Next Door.

Comment author: michaelsullivan 26 February 2015 05:07:17AM 0 points [-]

thanks for the links -- although I think some of the people in Millionaire Next Door skirt closer to what OP was referring to -- people who never spend money, not to retire early or do something interesting with their money, but just to hoard it.

I have known a few people who I considered pathological savers -- people who, like the fictional Scrooge, seem to save for the sake of saving, and do not ever enjoy the wealth they have created, nor do they turn it to a useful purpose in the world via large charitable donations. This is very rare in my experience, however. The only people i have known like this are in the generation that grew up during or shortly after the Great Depression.

Comment author: Lumifer 24 February 2015 08:29:41PM 1 point [-]

Two comments.

Inflation is very relevant. Especially when you are talking about annuities -- SS is more or less inflation-adjusted, if you invest your retirement money into equities it will inflation-adjust by itself, but if you buy an annuity that pays you $58K/year, that usually means $58K nominal dollars (inflation-adjusted annuities tend to be much more expensive).

For many people it is the case that they have paid off their mortgage by retirement age. Not having to pay a mortgage tends to noticeably reduce the living expenses.

Comment author: michaelsullivan 26 February 2015 05:01:52AM 0 points [-]

Agreed that inflation adjustment is important -- it usually makes sense to annuitize a portion of your portfolio to reduce longevity and market risk. The ballpark I was using is based on a 1% per year increase. hedging more against inflation with a higher escalator or CPI adjustment would be more expensive. Not adjusting at all would be less.

On housing -- it doesn't always make the most sense from a financial standpoint to pay off your mortgage. If you do, on the one hand, that's less money that you need for living expenses, on the other hand, it's net worth tied up in home equity -- tends to be close to a wash in terms of the net worth required to retire at various points. In the current low mortgage rate environment, many people would need more net worth to support expenses with a paid off house than without.

Comment author: michaelsullivan 26 February 2015 04:44:48AM 0 points [-]

To answer your specific question, there are a bunch of potential alternatives.

You can use a Roth IRA to have access at least to your contributions without penalty, and have tax deferral and tax free earnings.

You should probably put enough to get the full match into your 401k no matter what, as long as you expect to become vested for the company contribution, since taking that out early and paying penalties is still a win versus forgoing the free money your employer is offering.

You can invest in plain old retail investment accounts. You will pay tax every year, but it's possible to minimize the tax hit with tax-efficient investing strategies (low turnover, paying attention to specific gains and losses -- or use tax efficient mutual funds).

You can get some of the tax advantages of retirement savings without the restriction on when you can use the money using permanent life insurance as a savings vehicle. This is very popular with wealthy clients who want to save more than roth and 401k's will allow and have high marginal tax rates. Drawback: To the extent you don't otherwise need life insurance, or fit well with this kind of plan, it may not make sense versus eating the taxes in a retail (non-qualified) investment account. Look at your individual case carefully. (Disclaimer: I make money from selling life insurance.).

The possible implied alternative of not saving at all seems foolish unless you have a very good use for the money now. if living cheap is so easy, why not do it now? you can always spend your money later. If you want to start startups, having some money saved for that is a good idea. If you want to give away a lot, the world will not lose very much by you giving it away plus reasonable investment earnings later versus doing it right now. Saving money retains flexibility. There is no reason it must be permanently earmarked for retirement.

As a planner, I would say that most people I run into, if they save enough, are saving too much in retirement focused vehicles, and not enough elsewhere. I see a lot of people in their 40s and 50s who have 5-15x salary in their 401k/403b, but a barely sufficient (or not even) emergency fund, and essentially zero other assets they can use without penalty before age 59.5. My general recommendation is to have a good portion of your savings outside the retirement 59.5 gate if possible without losing matches or giving up too much tax efficiency.

Comment author: adamzerner 24 February 2015 11:55:37PM 0 points [-]

It's clear if you plan to live a reasonably frugal lifestyle working a normal job you can save up a substantial nest-egg in 10-20 years to float you indefinitely if you're only a little bit lucky, probably requiring a lot less luck than hoping you strike gold on a startup.

True. The way I see it, the benefit to that is the marginal increase in retirement safety. And the cost is the forgone opportunity of doing something important in those 10-20 years. What do you think of those trade offs? In particular, I'm currently thinking that there's already a really high chance that I can retire comfortably because of 1, 2 and 3.

Comment author: michaelsullivan 26 February 2015 04:18:36AM -1 points [-]

In a relatively healthy economy, to a first approximation in the medium and long term, the amount of money you make approximates how much good you are doing. As a liberal, I'll be the first to say that this has a lot of flaws as a benchmark, but in general, if you cannot find people willing to pay for, or donate to support what you are doing without you having to live on ramen forever, there has to be some question about whether what you are doing is providing value to the world comparable to a standard job in tech, finance, sales or a professional discipline, as long as you are moderately careful about who you work for in the latter cases.

Comment author: michaelsullivan 25 February 2015 04:11:35AM 5 points [-]

Outside view of your 1 2, 3 and 4: most people end up in trajectory number 4, so thinking this is the least likely scenario needs some really good evidence.

In particular let's look at 1: How do you plan on an event that has a reasonable probability of not happening in your lifetime, and about which you know relatively nothing (if we could well predict what will happen on the other side, it won't be anything like a singularity).

Who is to say that a singularity results in happiness for everyone -- even for a positive one? From the standpoint of someone sitting in the 18th century, flipping into life today would be like a singularity -- even poor people have luxuries not dreamed of 200 years ago. That said, it's a lot more pleasant to have money or marketable skills than not, even in the cushy rich world. Try being actually poor in the US to see what it's like. See how well you can live on $800/month (a typical very small social security benefit) with no savings and no family support.

For 3: from your perspective right now, there doesn't seem to be any reason to stop working. Past a certain relatively young age, however, anyone who is not good at selling themselves, developing a network, or established as a well known expert in their field will find themselves at a huge disadvantage in the job market, and may no longer be able to get interesting jobs for good pay. At that point, someone who followed the moustache plan in their 20s and 30s doesn't really care -- they can try as many new startups as they want and give the finger to the "norma"l job market, never worrying about whether they will have enough to eat and live in a comfortable home.

If you have never saved any money, you may end up forced into plan 4 in your 40s often at jobs that are uninteresting and do not pay very well. I've seen it happen to a lot of smart people.

Do I think it's worth trying startups young? Yes. And realistically a few failures in a row will probably sap your will to start a new one in any case, so there isn't that much risk of getting past easily hirable age, so I recommend looking to do it early on.

That said, whenever you are making good money, some long term savings is a good idea -- money gives you future flexibility, and the hedonic hit you take to save 15-20% of your money when you are making a solid middle class income is barely noticeable.

Comment author: diegocaleiro 23 February 2015 06:00:22PM -1 points [-]

This is only related, but not exactly to the point:

I don't get the math people here (in the US, where I'm living) use.

People will frequently cite 2M to 4M as a good stopping poing to never work again. This is a LOT of money. It's a completely unbelievable amount of money for 99.9% of humans in history. In a completely stagnant economy, this could sustain you for 200 years in present day Brazil, having a good time.

Then people say they don't eat out because it's expensive. Say you eat every day, for a counterfactual difference cost of 5 dollars per meal, accounting for lost time and cutlery costs. That's 400x5 2000USD per year. In the next 40 years, this amounts to a mere 80.000. This is so much less than the difference between 2M and 4M.

Then people say they don't sign up for cryonics, which costs like 1000 per year.

Then people use lift and uber to go places which on a daily basis could cost half a million dollars over a lifetime.

Anyway, I think the world is somewhat financially mad. I also think I know two classes of Americans, one which earns 100k plus (many of which programmers) and one which earns 17-28k (most of which students or researchers). And I mix their data up in my mind, and come up with a very peculiar idea of the American reasoning about money.

Comment author: michaelsullivan 24 February 2015 07:45:27PM 1 point [-]

I think it is partly about mixup, and partly because many people don't think clearly about their financial planning until forced to. If someone who makes 100k+ and spends most of it wants to retire in the same style they are used to living, they may well need 2-4M to do so comfortably and safely if retiring early. Social security is progressive, the max you can get as a single person is around 42,000/year. To get that, you must work for 35 years at a high income level and wait to draw your check until age 70. Then you still need to produce another 58,000 somehow from your own assets, which at current recommended withdrawal rates requires almost exactly 2M to do and maintain your wealth. Now, you could purchase an annuity for much less, but few people are comfortable dumping all their money into such vehicles. At current life income annuity rates, that would be a bit less than 1M$ to provide 58,000/year to a 70 yo. So you only need about 900K, but what if you want to retire at 65, or 60, or 55? Then you need to take less SS, or live off assets until age 70, or maybe you can't take it at all yet, and must live off assets alone. Whether you need 2M or 4M or more depends on when you retire, and how much risk of breaking your plan you are willing to take.

It's my job to model this for people. Most are surprised that they don't need 2 million or more, because their needs are more modest than above, and they don't plan to retire very early. That said it's different for everyone, and when younger people talk about stopping/reevaluating their career because they have enough money to retire, they usually mean in middle age not at normal retirement ages. At 40, unless your lifestyle is very frugal by the standards of people who are able to save 2-4M in that time frame (generally 100k+ earners), you probably do need that much to retire comfortably.

It also depends a lot on how you feel about your work. Most higher income earners have found a niche where they feel reasonably good about what they do (it's hard to create a lot of value when you feel like a cog or a moocher), and enjoy at least big parts of their jobs. In that case, why would you retire before you had plenty? OTOH, if you are burned out and it's a struggle to go to work every day, you might be willing to live on a lot less if you knew you could quit now, or soon.

Note: I know very few people who actually live like they are poor today in order to have great wealth tomorrow. Those who are very frugal while working, either are hugely committed to earning to give, or intend to retire or do something risky or different at a very young age, and don't ever intend to not live relatively frugally. Certainly they intend to either give away or enjoy the fruits of their industry long before a typical retirement age.

Comment author: is4junk 22 February 2015 10:08:37PM 0 points [-]

Thanks for the insights. I am not in the industry. I hadn't thought about the tax and creditor aspects of life insurance. I can see how those could become murky really quick.
As for the cryogenics, yes I was thinking of some sort of life insurance policy. Maybe I should take it off my list since 'permanent death' would be financially devastating. My thinking was you probably have other things to focus on if you can't pay it out of pocket.

As for house and renter insurance, I don't think the insurance company's profit is a good indicator of how much expected value they are for an individual - maybe a best case scenario. For example, these factors would vary by individual. Who is subsidizing them?

  • Subsidizing irresponsible dumb-asses (deep frying your frozen turkey indoors would qualify)
  • Subsidizing those with more stuff, better record keeping of it, and flat out liars
  • Subsidizing those who manipulate the claim adjuster better (are they as sympathetic to your case?)
  • Subsidizing bad law
  • Subsidizing moral hazard
Comment author: michaelsullivan 24 February 2015 04:19:03AM 2 points [-]

I think the biggest thing people who haven't thought about this deeply miss is how large the potential liability exposure is if you don't carry property and casualty insurance. As your wealth rises, and the financial hit from losing your house becomes small enough that you could realistically self-insure (say net worth 10-20x home value), it starts to be pretty much mandatory to carry some kind of umbrella policy to insure against crazy liabilities, and nobody will sell you an umbrella if you don't also have house/auto/etc. insurance. Like all insurance, this is -EV, but it's so cheap compared to the potential loss that it's generally crazy to go without it. The wealth threshold at which it could plausibly make sense to self insure entirely is in the super-rich range: probably around 100Mil$US

While you are probably subsidizing some dumb-asses to a degree, the bulk of your property risk is due to things out of your control like severe weather.

What most people should do, once they have a solid emergency fund is take a much higher than normal deductible on their auto and home/renters insurance. 5000-10000 deductibles will save a lot of money, but still keep you insured against catastrophic loss. Threshold for this is when you have a comfortable emergency fund, and I'd suggest a deductible equal to what you could save again in 6-12 months of belt-tightening without affecting your longer term financial planning. Health insurance, about the same, except most people are forced now to take a large deductible whether or not they can afford one.

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