Data used for simulations

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Mahesh
Posts: 4
Joined: Tue Dec 22, 2015 12:31 am

Data used for simulations

Post by Mahesh »

Hello:
I am new to this forum and happy to be on it. I love the FRP tool and am still learning to use it. The one question I have is what is the most recent data used for the simulations? Does the tool always take the most current x number of months? The reason I ask is the economy took a beating in 2008 and 2009 and are these considered in the simulations.

Thank you!

Mahesh
jimr
Posts: 699
Joined: Thu Feb 28, 2008 6:48 pm

Re: Data used for simulations

Post by jimr »

The simulation has two primary economic inputs: 1) the expected market return and standard deviation and 2) the expected inflation rate.

The default values for these were taken from simple historical averages and they should not be treated as economic predictions since the planner does not attempt to model the complex macro-economic factors that drive these inputs.

It's very simple to override the planner's 2 main economic inputs with values that you feel might be more appropriate given the current macro economic climate. Keep in mind that portfolio returns and the inflation rate are interconnected and it's essential that you understand the difference between nominal returns (which the planner uses) and real-returns. Real return is computed from a nominal return estimate by subtracting expected inflation. When you see a prediction of future returns, if it's listed as a real return, then you must add the expected inflation rate to it before entering it into the planner. So for example, Vanguard recently published a paper (see link below) estimating the future return of a 60/40 portfolio at somewhere between 3% and 5% real. If you expect inflation to be 3%, that means that the estimate converted to nominal return would be 6% to 8%.

Since return and inflation are so difficult to predict with accuracy, it can be most helpful to treat these as unknowns and use the planner's flexibility to model your retirement plan under a range of assumptions. The planner's sensitivity analysis feature can be especially helpful with this.


Finally, using google can be helpful to learn what various experts think these inputs may be. Here are a few links from a quick search using "expected future real return on stocks" with the search time frame limited to the past year:

https://www.bogleheads.org/wiki/Histori ... ed_returns

http://www.schwab.com/public/schwab/nn/ ... et-Returns

http://vanguard.com/pdf/ISGVEMO.pdf
Mahesh
Posts: 4
Joined: Tue Dec 22, 2015 12:31 am

Re: Data used for simulations

Post by Mahesh »

Thanks a bunch for your response Jim.
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