Reverse engineering to the required retirement time horizons

This article is a part of a series; click here to read Part 1.

Using the portfolio return and volatility assumptions determined in Exhibit 1.1, we then reverse engineer fixed return assumptions and sustainable spending levels for a desired retirement time horizon and the targeted probability of success. The investment portfolio is modeled using 100,000 town simulations for these portfolio returns, assuming a lognormal distribution.

Exhibit 1.2 presents the implied compounded real returns for various planning horizons and probabilities of success. As these are real return factors, they'd support inflation-adjusted spending. The arithmetic average portfolio return is 4 percent real with a customary deviation of 10 percent. However, for preferring a tough and fast return assumption, one must account for the likelihood of success they search for the spending plan in terms of both a planning horizon and probability of success. for instance, if the retiree sought a 90 percent chance that portfolio distributions are sustained through age ninety, this might imply an assumed fixed real rate for the portfolio from the 10th percentile of outcomes at 0.5 percent.


Exhibit 1.2 Fixed Rates of Return Assumptions for a Sixty-Five-Year-Old Reverse Engineered Inflation-Adjusted Compounded Returns for RetirementThis article is a part of a series; click here to read Part 1.

Using the portfolio return and volatility assumptions determined in Exhibit 1.1, we then reverse engineer fixed return assumptions and sustainable spending levels for a desired retirement time horizon and the targeted probability of success. The investment portfolio is modeled using 100,000 town simulations for these portfolio returns, assuming a lognormal distribution.

Exhibit 1.2 presents the implied compounded real returns for various planning horizons and probabilities of success. As these are real return factors, they'd support inflation-adjusted spending. The arithmetic average portfolio return is 4 percent real with a customary deviation of 10 percent. However, for preferring a tough and fast return assumption, one must account for the likelihood of success they search for the spending plan in terms of both a planning horizon and probability of success. for instance, if the retiree sought a 90 percent chance that portfolio distributions are sustained through age ninety, this might imply an assumed fixed real rate for the portfolio from the 10th percentile of outcomes at 0.5 percent.


Exhibit 1.2 Fixed Rates of Return Assumptions for a Sixty-Five-Year-Old Reverse Engineered Inflation-Adjusted Compounded Returns for RetirementThis article is a part of a series; click here to read Part 1.

Using the portfolio return and volatility assumptions determined in Exhibit 1.1, we then reverse engineer fixed return assumptions and sustainable spending levels for a desired retirement time horizon and the targeted probability of success. The investment portfolio is modeled using 100,000 town simulations for these portfolio returns, assuming a lognormal distribution.

Exhibit 1.2 presents the implied compounded real returns for various planning horizons and probabilities of success. As these are real return factors, they'd support inflation-adjusted spending. The arithmetic average portfolio return is 4 percent real with a customary deviation of 10 percent. However, for preferring a tough and fast return assumption, one must account for the likelihood of success they search for the spending plan in terms of both a planning horizon and probability of success. for instance, if the retiree sought a 90 percent chance that portfolio distributions are sustained through age ninety, this might imply an assumed fixed real rate for the portfolio from the 10th percentile of outcomes at 0.5 percent.


Exhibit 1.2 Fixed Rates of Return Assumptions for a Sixty-Five-Year-Old Reverse Engineered Inflation-Adjusted Compounded Returns for Retirement



We should make some observations about this 0.5 percent return value. First, it's but the assumed 1 percent real return from holding bonds. In other words, to realize the specified success rate from the diversified portfolio, one finishes up assuming a lower return, and so a lower spending amount, than bonds could ensure. The flip side of this, though, is that 90 percent of the time the retiree could expect to earn the next effective return than this number and will even be able to grow their wealth throughout retirement as they otherwise are spending but would are feasible. Conversely, the bond ladder would lock-in the 1 percent real return throughout retirement without an opportunity for upside.



The other interesting aspect is to notice that the fixed return assumption increases for extended retirement horizons, as it is 0.8 percent for planning through age ninety-five and 1 percent (matching the bond yield) for planning through age 100. the rationale that returns increase with the time horizon is because to sustain spending for extended, the spending amount must decrease, which reduces the impact of sequence-of-returns risk.

This concept is seen more clearly in Exhibit 1.3, which provides the corresponding spending numbers for the returns within the previous exhibit. Returning to the identical example, if the retiree seeks a 90 percent chance that spending lasts to age ninety, they'd choose between the 10th percentile of paying outcomes. that's $42,633 of annual inflation-adjusted spending. To sustain spending through age ninety-five with the identical success rate, spending would want to cut back to $37,194. this is often a 3.72 percent withdrawal rate from retirement date assets, and it might be the quantity that corresponds to the 4 percent rule-of-thumb with these market expectations for a thirty-year retirement. If sustainability with 90 percent success was instead hunted for thirty-five years through age 100, then the annual spending number falls further to $33,418. Again, it's because the spending amount decreases that the return assumption can increase; the lower spending rate reduces the exposure to sequence-of-returns risk and reduces the impact of investment volatility within the retirement program.

Exhibit 1.3 Sustainable Spending for a Sixty-Five-Year-Old with $1 Million of Assets Reverse Engineered Inflation-Adjusted Sustainable Spending Amounts for Retirement


Source: Own calculations with 100,000 town Simulations for a 50/50 portfolio of stocks and bonds. These calculations are supported the web portfolio returns shown in Exhibit 3.11. The portfolio's real arithmetic return is 4% and variance is 10%.



This is an excerpt from Wade Pfau’s book, Safety-First Retirement Planning: An Integrated Approach for a Worry-Free Retirement. (The Retirement Researcher’s Guide