Rebalancing and failure questions

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thegarv
Posts: 1
Joined: Sat Aug 06, 2011 3:32 pm

Rebalancing and failure questions

Post by thegarv »

Hi Jim,

Great simulator!!!

Two questions for you:

1) There's no rebalancing in your algorithm, right? I didn't see anything in the documentation or source code, but thought I would check just in case. Being able to rebalance (e.g., by selling bonds instead of stocks during a down market) considerably ups the likelihood of my portfolio succeeding, as you are well aware.

2) When viewing results, it's difficult to discern why my portfolio would fail in later years. I think it's because you use the median withdrawal, as opposed to the mean or the bottom 5% percentile, etc. In any case, here's my question. If my probability of success is 98%, what the heck is happening in the market when the simulation fails the other 2% of the time? I'd really like to find some year-by-year worst-case scenario results, but in the absence of these, can you describe what might be going on? Is it long-term mediocre results? A couple of terrible years at the beginning? Something else?

Thanks very much. :)

-thegarv

jimr
Posts: 606
Joined: Thu Feb 28, 2008 6:48 pm

Re: Rebalancing and failure questions

Post by jimr »

thegarv wrote:1) There's no rebalancing in your algorithm, right? I didn't see anything in the documentation or source code, but thought I would check just in case. Being able to rebalance (e.g., by selling bonds instead of stocks during a down market) considerably ups the likelihood of my portfolio succeeding, as you are well aware.
First, thanks for posting and for the kind words about the planner.

As for 1), the simulation doesn't decompose the assets in the portfolio, so the mean and std dev return should take into account any benefits from rebalancing. However, since the results are generated by simulation, and not history, the big question is whether using just a mean return and standard deviation is adequate to describe how your portfolio will perform.

Unfortunately, the short answer is that we know it's not adequate. We know that portfolio returns in real life are not normally distributed, have fat tails, especially on the low side, and are basically impossible to correctly model in a simulation because there's so much we don't know.

So does that mean the planner is useless? I certainly don't think so, but you have to understand that we're trying to simulation something that's truly unknowable. IMO, one of the best things you can do is to test your plan by "forcing" some worst-case assumptions like a big drop in the stock market shortly after you retire. This gives you a chance to test how robust your plan is, even in adverse conditions.

Hope that helps,

Jim

jimr
Posts: 606
Joined: Thu Feb 28, 2008 6:48 pm

Re: Rebalancing and failure questions

Post by jimr »

thegarv wrote:2) When viewing results, it's difficult to discern why my portfolio would fail in later years. I think it's because you use the median withdrawal, as opposed to the mean or the bottom 5% percentile, etc. In any case, here's my question. If my probability of success is 98%, what the heck is happening in the market when the simulation fails the other 2% of the time? I'd really like to find some year-by-year worst-case scenario results, but in the absence of these, can you describe what might be going on? Is it long-term mediocre results? A couple of terrible years at the beginning? Something else?
You bring up a good point. This is something I've struggled with in the GUI for the planner. Deciding what data to save, out of the 10,000 simulation runs, is a tough call. I always wish I could show more data, but it makes the GUI very cluttered.

As far as what actually occurred to result in those late failures, it's anyone's guess. It could have been a rocky start or it could have been bad luck in later years that sent things over the edge.

One clue might be the "average spending shortfall" output that's shown in the graph under the probability of success.

Here's a snippet from the documentation that describes it:
The Average Spending Shortfall shows the average percent of total planned retirement spending that couldn’t be funded in those simulation iterations that failed. For example, consider a retirement plan with level spending planned for 40 years. Further, assume that when the retirement plan fails, on average it fails in simulation year 30. Such a plan would have an average spending shortfall of 25%. This is because on average 1/4 of the retirement plan’s spending wouldn’t get funded in those iterations that failed. Note that for a plan with a 90% probability of success, 90% of the iterations had no shortfall at all. The shortfall depicted by the average spending shortfall only applies to the iterations where the plan failed (eg 10% of iterations in the case of a 90% probability plan). For an example of how a plan’s inputs can affect the magnitude of the spending shortfall, run a plan with an “aggressive” investing style, then rerun it with a “risk averse” style and notice the change in average spending shortfall.
Jim

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