Saturday, December 30, 2006

How 1% improvement in return makes our lifetime savings plan work

Based on a comment from Ann on our post discussing Quicken's Financial Planning tool, I decided to experiment with long term investment return assumptions.

Our initial assumption would be earnings of 8% (I assume including inflation / non-real returns) before retirement and 4% before retirement.

Ann wisely questioned our assumptions asking if it made sense to keep all of our investments in what would appear to be mostly fixed income asset classes (for a 4% return) - especially if we were going to draw on the proceeds over 30 years. Perhaps, Ann recommended, we could invest a portion of our assets in more aggressive asset classes.

Ann raised an excellent point - frankly I would probably do so. I was very curious to see the effect of a single extra percentage point of return.

Using Quicken 2007's What If function, I decided to model increasing our retirement returns from 4% to 5%. What an amazing difference - just at the push of a button our situation changed entirely from:

(before) - a three year shortage where we would have to sell assets or reverse mortgage our house


(after) - an extra three years plus of money, so we can live longer if we decide to do so!

Ann, thank you! It was a very interesting experiment.

Actually, it's in line with a number of industry articles I've been reading that advocate higher equity asset allocations for retirees due to increased longevity.

Of course, with the end of one's financial plan uncertain - do we really know how long we live - volatility can be especially challenging.

My gut says to keep 4% just to be safe and motivate me to earn more money, but when it comes time to retire to put retain a larger percentage of assets in higher producing asset classes.

What would you do? Are you retired at this time? How are you allocating equity versus fixed income? What do you plan to do?



Anonymous said...


To see how my Mom's assets are invested. Still too much cash IMO. After any significant market correction we'll add substantially to the equity side.

But she hardly spends any money from this and pretty much lives on the government etc. pensions she receives.

makingourway said...

Moom, thanks for sharing.
I'm a bit confused - why does she have soooo much cash. Wouldn't she do better with a bond ladder? Why would she keep more than 2 years expenses as cash?
Also if her basic expenses are covered by her pension, why not invest 75% of her assets in stocks - maybe dividend payors? She could do very well with a diversified passive index portfolio. This would preserve her legacy for future generations.

StealthBucks said...

Sorry, again ick, ick, ick Go research Monte carlo simulation. Quikens technology is bad, bad, bad. It doesn't really calculate risk and reward. It just figures a static, fixed rate of return. You need life probabilities not fake end of plan numbers. My Monte carlo simulation shows my wife dieing with eitjer 2 billion bucks or owing a cool 5 mil at death. That's basic quicken. What I do get is a 95% probability that no matter what, we'll be fine and live on a nice $300K after tax for ever. Ditch Quicken speak it is very 80's. Should you have any concerns I can give a few web sites to start on. Good luck...