Additional inputs- How have you modeled negative return scenarios?

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teacherman
Posts: 4
Joined: Thu Oct 01, 2015 12:24 am

Additional inputs- How have you modeled negative return scenarios?

Post by teacherman »

When it comes to retirement I want to be optimistic given my and my wife's frugality and the three legged stool we'll have working for us. I want to trust the overall positive results I'm getting using this wonderful software, but then I'm also trying to throw some wrenches into the plan and make sure I'm not wearing rose colored glasses.

One area where I feel shaky in using this tool is in regards to the standard deviation/return average. Overall I think I just don't fully understand how the Monte Carlo type simulation works because unless I start to bump up our spending input the portfolio value seems to always come out positive (i.e. higher portfolio value at the end of the year than at the start.) I'm not sure why there aren't years where I'm seeing a loss. For example, if I put 5% average return with 15% deviation, and lets say social security plus my pension cover 100% or close to 100% of our spending, why aren't there years where I see a 10% negative return on our overall portfolio value?

To force the issue, I've played around a lot with the additional inputs. For example, I'll add years here and there with a -30% return or to try to mimic a lost decade in which returns are zero year after year in the software. I'm not sure if this is the most straightforward way to make sure I'm accounting for downturns like the one we're currently in. I'm wondering how other people have used this feature to model different (negative) scenarios?

Some related questions,

-Would adding a larger standard deviation work to generate negative return years more frequently?

-Is there a place in the results where it gives an annual return percentage for each year? (maybe under detailed view?) (i.e. In this run, you got a 10% return for year/age 55, 5% for age 56, -15% for age 57, etc. I'm aware this would change each run, but am wondering if it exists. Might help me understand what's happening under the hood/behind the scenes in the Monte Carlo simulation.)

-For giggles, has anyone entered zero for returns and then used historical data to plug in annual returns in the additional inputs? Just to see how you circumstances would have held up across different 20-30 year periods? I'm considering doing this but am wondering if anyone found it interesting/useful? (obviously not for crystal ball purposes.)
jimr
Posts: 750
Joined: Thu Feb 28, 2008 6:48 pm

Re: Additional inputs- How have you modeled negative return scenarios?

Post by jimr »

The key thing to understand about the Monte Carlo approach is that because the simulation runs many paths through your retirement (10,000 actually) it's not possible to show every single data point from every year. What you see in the results is a highly summarized view of those 10,000 individual paths through your retirement plan. For each year, the simulation actually generated 10,000 returns (one for each path through your retirement). It'd be impractical to list all 10,000, but it's almost a certainty based on the return/std dev values you mentioned that several of those individual returns were actually negative.

One way to help understand this is to click on the "Portfolio Value Bands" checkbox at the bottom of the results graph. Instead of just showing the median results (from the 10,000 simulation paths), this also shows the bottom 10% portfolio value and the top 90% portfolio value on the graph. You can see the actual numeric value by mousing over the graph to see the year-by-year popup. Like the median result (which is what's shown by default), these values are generated for each year by sorting the 10,000 portfolio value results the simulation came up with and choosing the 1000th result (10% lower bound) and the 9,000th result (90% upper bound). The median is determined by choosing the middle (5,000th) result from the sorted list of results.

Does that help?
teacherman
Posts: 4
Joined: Thu Oct 01, 2015 12:24 am

Re: Additional inputs- How have you modeled negative return scenarios?

Post by teacherman »

Hi Jim,

Yes that does help. Remembering to use the Portfolio Value Bands to see that 10% range is something I haven't really focused on so I appreciate the reminder.

Thanks again for the great software. :D
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