Coin Tosses and Acorn Counting
At a recent conference, a professor was discussing the withdrawal rates inside Monte Carlo simulations, which are popular in the financial planning world. In these simulations, a portfolio is developed, historical returns are used, and generally, a 4% withdrawal rate is demonstrated. The probability of success is based on the equity and bond allocation, which is adjusted until a high success rate is reached. The client receives a finished analysis and says, “Wow! A 90% likelihood of success! I’m good to go!” Unfortunately, the day that you commence withdrawals from your portfolio can be a huge factor which can dramatically upset that success rate. For example, if you begin withdrawals in a low interest rate environment, like the one we are in currently, it can drop your probability of success down by almost half. Suddenly a portfolio with 40% stocks and 60% bonds in retirement is no longer a “sure thing”. It’s a coin toss.
For instance, if last year you made 1% on your portfolio, you did better than many of our friends who were investing traditionally, because you didn’t lose money. However, if you took 5% out as a withdrawal, and have continued on the same trajectory in 2016, you may want to consider making some changes. This is likely not the year to get aggressive with your spending, or to begin donating large amounts to charity. Rather, it may be a good time to count your acorns.
- Greg Stewart, CIO