Expectation Risk: A Novel Short-Term Risk Measure for Long-Term Financial Projections

Abstract

Presenting the results of long-term financial projections, particularly those of common interest in retirement planning such as portfolio value and retirement income, can be difficult using traditional risk measures . Long-term projected distributions tend to be very wide and offer limited insight to practitioners into what kind of adjustments might be required along the way to avoid undesirable outcomes. Short-term projections, where available, lack information about final, long-term outcomes. As a complement to the pure long-term and short-term risk measures associated with these distributions, we propose a third measure, expectation risk, which reflects the short-term risk in long-term outcomes. This measure is derived from the short-term distribution of long-term expectations. In the following, we demonstrate how to calculate these distributions for simple cases of portfolio value and retirement income. Further, we show how expectation risk can be used to estimate the magnitude of short-term adjustments that may be required to obtain a desired long-term income.