Flexible Retirement Planner Support Forum

Jim,
(me again, still playing with FRP)
I started looking at the investments styles and I'm intrigued about what assumptions are being made about the contributions to returns of each of the allocations.
My initial assumption was that (excepting the S&P500 only choice) that the stocks for each of the scenarios have the same percentage return, ditto bond and intn'l (i.e. if stocks return 10% in one scenario then they will return the same 10% in all scenarios, with the exception noted, so that the total contribution to of stocks to the portfolio will be the percentage of stocks in the portfolio multiplied by the stock return - seem reasonable?).
HOWEVER this is not what I'm finding.
Here are the equations I used to solve for the partial returns of each component):
1. Risk Averse: 0.17S+0.77B+0.05I=0.065
2. Below Average Risk: 0.3S+0.6B+0.1I=0.075
3. Moderate Risk: 0.41S+0.45B+0.14I=0.085
4. Above Average Risk: 0.62S+0.17B+0.21I=0.1
4. Aggressive: 0.7S+0.07B+0.23I=0.105
(S=Stock return, B=Bond return, I=Intn'l return)

If I solve these as sets of three simultaneous equations I get six sets of results for S,B,I
which are VERY incomsistent:
B has an outlier of about +4%, but the other 5 results range from +5.1% to +5.5% (so not too bad)
S ranges from -8.9% to +42.7%
I ranges from -77.4% to +69.6%
(see what I mean about consistency?)

Am I doing something wrong?

The only conclusion that I can reach is that the same MIX of Stocks/Bonds/Intn'l are not being used for each of the scenarios. (For example going from Averse to Aggressive maybe stocks are going from stodgy, reliable "old" world (Averse) all the way up to highly speculative (Aggressive).

Would you care to shed some light on this (and in particular where did the numbers for the original mix and returns come from).

Thanks,

dave (smith)

Dave,

The fact that you've noticed some inconsistencies in the canned return/std data doesn't surprise me.

The truth is, I added them as an after-thought in the FRP GUI to make it more user friendly. They were an amalgam of a few historical index portfolio data sources with attempts to adjust for investment expenses.

I found it surprisingly difficult to find good sources for this info that include stocks, bonds, and international returns that are also adjusted for expenses. Data for just stocks vs bonds is easy to come by, but I felt that including at least three asset classes would be more realistic. The main problem is that historical data on international returns is all over the map depending on exactly what's included and how the data was acquired.

Anyhow, to the extent that the data are flawed, I think they're too conservative, but honestly I don't feel great about what's there now. If you know of any good sources that I could use to replace these, I'd be eager to check them out.

Jim

This retirement calculator does an excellent job in many ways. But the results are only as good as the assumptions. In 2010, with the stock market having given approximately zero return over the last 10 years, assuming 5% above inflation looks mighty optimistic. My opinion is that the market TIPS yield, currently about 1.5% real, is a hard data point that deserves a lot of respect and prominence.

Choosing an expected rate of return in retirement planning is certainly a tough problem and IMO there isn't a single right answer. Personally, I like to try multiple runs with different return/std dev values to see how sensitive my plan is to market performance. For plans with a long accumulation phase in front of them, it might make sense to use the additional inputs and model different rates of returns over different phases of the plan (more aggressive during accumulation, more conservative during withdrawal).

It is important to keep in mind that tools like the Flexible Retirement Planner don't make predictions. They only compute results based on the inputs that the user provides. This is why I'm a strong proponent of stress-testing the plan by varying the inputs to see the impact on the results.

Also, while it's true that after the last ten years, 5% real return looks optimistic, historically, the best results have come after periods of poor results and vice-versa. The long-term real compound annual growth rate for the S&P500 is over 6% real.

Here are historical returns in real CAGR for the SP500:


Finally, if you'd like to play it completely safe and use a real return around 1.5%, you probably don't need to use Monte Carlo simulation at all, since the variance (std dev) of a portfolio returning 1.5% real is probably quite small.

Jim