Frequently Asked Questions

  Retirement Quant  

General Questions
Retirement Strategies
Retirement Income
Asset Allocation

New Features Wanted
Questions About Results

Compare Strategies
Questions on JFP paper

General Questions

Q: How are the red, yellow, and green dots in the analyses set?
A: The "traffic lights" are set according to the success rate of the particular scenario simulated.  If the success rate is greater than 95%, the light is green.  If the success rate is between 85% and 94%, the light is yellow.  Success rates below 85% are red.

Q: When I vary an expense reduction I'm not seeing any change in projected values of income or assets.  Is this correct?  Where should I look to see the effect of an expense reduction?
A: The Retirement Quant only worries about expenses prior to retirement.  That's because it is calculating how much you save towards retirement.  Once you are in retirement, the program is only concerned about your desired retirement income level.  That's because there are so many different ways you can withdraw money from your accounts that have different tax consequences.  The assumption is that you know what your retirement income target is and that it includes taxes.  See the

Q: How would I model TIPS (Treasury Inflation Protected Securities)?
A: With Release 6, TIPS are now a pre-defined asset class.  You do not need to do anything special.

Q: Do I enter an annuity in future dollars or today's dollars?
A: Enter all dollar amounts in today's dollars.

Q: I'm using decision rules and am uncomfortable with the freezes and cuts the Retirement Quant says I may get.  What can I do?
Being comfortable with retirement is important.  Here is a suggested approach.  Turn off all the rules and look for a level that gives you 99% or 100% success.  If you can live with that, you should be great.  Levels above that amount are possible but come with the risk you will run out of money.  Decision rules can reduce that risk but come with risks of their own, namely variable income over your lifetime.  The good news is, you will probably withdraw more in total but you may have to take a cut(s) at some point.  It is one of those "no free lunch" deals.   If you turn on decision rules, turn on the Modified Withdrawal Rule first and see if that gets you to the level you want.  If you are still short, then add the CPR and PR.  Play with their parameters to adjust the risk level you can live with.

Q: Is there a difference between "income" and "PV of final purchasing power"? 
A: The income in constant dollars at the end of of a lifetime is the same as the PV (present value) of final purchasing power.

Q: Are there strategies that can mitigate the risk of early portfolio failures?
A: Try using decision rules.  Something like the Capital Preservation Rule can kick in and ‘rescue’ the portfolio if things go south early in retirement.  One thing a person can also try is to start with a lower initial withdrawal rate and couple that with the Prosperity Rule to give raises when the portfolio is really ‘safe’ and gradually increase real withdrawals.

Q: Why do some retirement strategies generate a retirement income profile that looks like a wave?
A: Here’s what I think happens.  In retirement strategies that allow for real raises, I can believe that in early years the real income increases because on average the markets do well.  Not all scenarios will give raises, clearly, but on average I can see it.  These raises then continue until they become too large (again on average) and need to be corrected back down.  The degree of oscillation depends upon how good the timing is of the corrections.  Poor corrections will allow large swings.

Q: How exactly are taxes handled?
A: Before retirement, taxes are taken out of your income and the remainder is applied to the expenses you have specified.  This is because before retirement, the simulator is calculating your asset growth and hopefully you are saving something each year and adding it to your assets.  The situation changes when you reach retirement.  Then the assumption is that you will probably start to draw down your assets.  Now asset withdrawals are very complicated when you consider tax-advantaged and taxable investments, different asset allocations in each account, pre and post-tax contributions, minimum required distributions, etc.   The approach taken here is that in retirement, you want to maintain a level of income.  Yes, your net income will certainly be different based upon how you've invested but that is for you to work with your financial planner.  To simulate all of that here would too much; it would provide maybe more precision but not likely more accuracy.

Q: Are Monte Carlo simulations really any good?
A: There are a number of ways to model the future.  The simplest is to just take some average returns and inflation rate and do arithmetic out into the future.  If in 1992, companies had forecasted the number of floppy disks that way, we should be buried in them by now.  Another approach is to use actual history and look at different historical periods and see how a portfolio would have done then.  That's a reasonable approach but as we all know, history is not a guarantee of the future.  Read the book "Fooled by Randomness."  Monte Carlo simulators simulate thousands of possible futures.  Are they perfect?  Certainly not.  Not all simulated futures are equally likely, for example.  The approach one should take is that this is one tool to use in evaluating your financial future.  Do not take all numbers as gospel but get an idea of the effect of different strategies on your financial future.

Retirement Strategies

Q: Where do the income annuity default rates come from?
A: They are quotes from for $100,000 annuities for a males with a spouse and 100% survivorship for the spouse.  The rates were retrieved in July 2007.  Rates have quite likely changed and you should obtain current quotes which match your situation and insert those values.

Q: Why does the constant, and sometimes even the future, dollar income fall when using the strategy that resets the withdrawal rate every five years to the safe (99%) rate?
A: It is because the increase in safe withdrawal rates between five year periods does not necessarily keep up with inflation.  For example, if you retire at age 65 and have a life expectancy of 99, then you have 40 years remaining in retirement and will use the 4.7% as your withdrawal rate.  At age 70, you have 35 years remaining and will set your withdrawal rate to 5.0%.  5.0/4.7 = 1.064, which means you would get roughly a 6% raise over your original withdrawal rate at age 65.  But in the intervening 5 years you got raises for inflation.  If inflation averaged only 3%, you would have seen more than a 15% raise in your nominal income,   But when the withdrawal rate got reset with a 6% increase, you could very well see a decline.  It all depends upon how well your portfolio did relative to inflation.

Q: The paper in the Journal of Financial Planning talks about values for Fall and Exceeds but they don't appear in the Retirement Quant decision rules.  What happened?
A: The original Fall and Exceeds inputs were defined in terms of a percentage change from the original withdrawal percent.  This was, in retrospect, a sort of clumsy way to express them.  Retirement Quant uses specific percentages to determine when to give a Raise or Cut.  For example, if one wants to start with an initial withdrawal rate of 5% and would have defined Exceeds as 20%, that would mean that if the withdrawal rate reached 6%, a cut would be made.  Rather than put that Exceeds value of 20% into the simulations, it is more obvious and probably easier for a person to implement, if the actual 6% was put in as the limit.

Q: Does Retirement Quant do any market timing for withdrawals?

A: It does allow for two different withdrawal strategies based upon asset class returns.  One is the portfolio management rule (PMR) which determines the source(s) of each year's withdrawal.
  • Following years where an asset class has a positive return that produced a weighting exceeding its target allocation, the excess allocation is sold and the proceeds invested in cash to meet future withdrawal requirements.
  • Portfolio withdrawals are funded in the following order: (1) overweighting in equity asset classes from the prior year-end, (2) overweighting in fixed income from the prior year-end, (3) cash, (4) withdrawals from remaining fixed-income assets, (5) withdrawals from remaining equity assets in order of the prior year's performance.
  • No withdrawals are taken from any equity following a year with a negative return if cash or fixed-income assets are sufficient to fund the required withdrawal.

The other is called the Fastest Horse Rule.  It basically says one should withdraw first from the asset classes which have the lowest historical returns. I.e. keep your money on the fastest horse.  The PMR was proposed by Guyton in his original paper.  The Fastest Horse Rule was made up because there are other withdrawal strategies that might help and this gives one comparison.  We are not believers in market timing.  Check how the PMR and FHR work for yourself. 

Retirement Income

Q: On the "Retirement Income Analysis" page, something is wrong with PV of final retirement income.  The value drops to $XXX at some income level and stays there.
A: This is working correctly.  Notice that the probability of success has dropped below 95%.  Therefore, the only income you can have with 95% certainty is your retirement income, such as a pension.  Your assets have run out at the 95% confidence level.

Asset Allocation

Q: Does "Variance Limit" also apply only to investment assets and not account for an annuity in the percentage calculation?
A: The Variance Limit is compared to whatever you expressed as your retirement income need and therefore includes an annuity. 

Q: Is there a way to mimic TIPS?  And why aren't they included anyway?
A: TIPS are now included with Release 6.  Try it.

New Feature Requests

Q: Why doesn't Retirement Quant do XXX?
A: The answer depends upon the specifics of XXX.  The answer is one of: (1) it requires access to data to which we do not have the rights and some of the owners want a whole lot of money for it, (2) it is really difficult and not likely to be done, (3) we would like to do it but have not gotten to it yet.  If you have ideas, send them to us.

Q: Why doesn't Retirement Quant have XXX asset class?
A: See answer to above question.  In addition to getting the rights to the data, the data needs to have a reasonable history.  For example, it is not reasonable to project 30 or 40 years in the future based upon 4 years of data.  Revisit what happened to Long Term Capital Management.  However, if you know a ticker symbol for an index or other asset that represents what you want, starting with Release 6 you can include it yourself.  Create your own asset classes.

Questions About Results

Q: When I run Retirement Quant, I get different results than what I get from running the calculator at Vanguard, Fidelity, etc..  Why?
A: Retirement analysis is driven by the assumptions going into the program  The assumptions for the returns of different asset classes and especially their standard deviations will have a big effect on the results..  Some programs, for example, assume that inflation will increase at a constant rate such as 3% (i.e. the standard deviation is 0).  Requirement Quant models a fluctuating inflation rate.  If you can match all the assumptions, the results should be similar but may vary due to other factors.  In Retirement Quant, go to the Assumptions dialog and change the assumptions to match those in the other simulator and re-run the analyses.  One should not get caught up in the difference between say 96% and 98%.  What is most important is which strategy gives a higher value and why.  It is good practice to try to validate your analyses with other tools.

Q: I made a run using 100% large cap value stocks, no bonds or cash and didn't turn on decision rules, no pension or annuity.  This simulation had better performance than a diversified portfolio of multiple asset classes, with better success rates etc..  Shouldn't diversification help?
A: Try doing this: first test using just the S&P500 and then perform analysis using the Asset Allocation function (1) Using the S&P500 only, if you look at equity/bond trade-offs, there is no improvement in the success rate over about 50/50 but the earliest failure does get earlier at the % equities goes up.  That is another indicator of risk and shows that the risk does increase as you increase the % equities.  If you do a variety of equity/bond trade-offs (use the radio button), you’ll see that 60/30/10 equities/bond/cash has the highest success rate (with 70/20/10) with the same behavior that the earliest failure gets earlier the higher the percent equities.  So, with S&P500 only equities, you can reduce the risk by diversifying and adding cash to the mix makes a noticeable difference.  All this is what one might expect.  (2) Using 8 asset classes and using only large cap value and bond trade-offs, we get the same behavior as with the S&P500.  Adding more asset classes and comparing them to 100% large cap value or 100% REITS shows that the 100% in those two asset classes gives better results than wide diversification.  Why? (3) Compare using 100% large cap value with 50% large cap value and 50% REITS.  Adding REITS does improve the success rate. Adding REITS and International Equities also increases the success rate and lowers the average return.  Why? (4) Go into the Assumptions dialog and go to the bottom and click on “Treat asset returns independently” .  This should show us how ‘pure’ diversification might work.  Go back to Asset Allocation and run the tests.  Now you will see that adding more asset classes makes a noticeable difference in the success rate.  Uncorrelated diversification really helps. 

Bottom line: the equity asset classes are correlated. 

Adding uncorrelated assets is what reduces risk and that's what many hedge funds are after. Yes, the large cap value looks better than the other equities because of historical returns - which may not hold going forward.  That is always a function of the input data and one reason that it is unwise to try to model some of the newer asset classes with little historical data.

Compare Strategies

Q: When I compare strategies, the strategy that resets the withdrawal rate every five years always has a 100% success rate even though the final income is lower than I need.  Why?
A: Whether a strategy succeeds or fails depends upon whether you have the desired income throughout retirement.  If you select this strategy, you are willing to live with the rule which includes buying an annuity at age 85, even though this may cause your income to drop.  The rule is designed to have some income to last your lifetime.  By definition, this strategy is successful.  However, should you create your own custom strategy trying to mimic this strategy, it will very likely have a low success rate; because at age 85 there will probably be a big drop in income as you use up the original 85% of your assets and purchase an annuity with the remainder.


Questions on JFP Paper

We have a couple of questions about how to apply the model. 

Q: You indicated in your article that when you tested the model for a 40 year time horizon, 5.3% IWR, and the following decision rules, you had a 99% success rate:

  • CPR: Exceeds = 20%, Cut = 10%

  • Prosperity: Fall = 20%, Raise = 10%

  • Modified withdrawal rule

We also understood that this particular model yielded the greatest PV total of all the different scenarios.
A: Right on both accounts.

Q: No client wants to be the 1% that failed.  So, either you tweak the knobs above to generate a 100% success rate, or alternatively, you extend the time horizon to build in a cushion (e.g. for a 60 year old, assume a 45 year horizon instead of 40 years).  Also, different clients have different time horizons based on starting age, etc.  This all leads to a question about IWR as a function of time horizon.  Have you done any work  determining appropriate values of Exceeds, Cut, Fall, and Raise for a given time horizon such that you maximize IWR while still achieving a 99% or 100% success rate? 
A: In my paper, I show what works for a 30 year time horizon.  I haven't done the work, but it would be a rather straightforward exercise with Retirement Quant to look at any time horizon.  One would first set a retirement age and expected lifetime.  For example, you could test 50 years by retiring at 50 with a lifetime of 100.  Then it would require a few runs of setting the decision rules to see the effect to come up with appropriate values. 

Q: Or alternatively if that is too complicated, setting Exceeds, Cut, Fall, and Raise to the values above and then determining the maximum IWR as a function of time horizon that achieves the 99% or 100% success rate? 
A: That works too and would only require the click of one button - that is one of my built-in functions.  It may not give you the 'optimal' strategy in terms of maximizing total withdrawals but it should get you pretty close. 

Q: It's possible that some clients would want to maximize PVtotal rather than IWR.  Have you done any analyses as above to determine IWR as a function of time horizon where you are instead maximizing PVtotal (while still achieving the 99% or 100% success rate)? 
A: In the work I did, you will see that for a given time horizion (in my paper 30 or 40 years) there are a number of different IWRs that will achieve the same maximum PVtotal.  The different IWRs will produce the different income profiles (uniform, aggressive or progressive).  So your question needs to be refined a bit to something like: for a uniform withdrawal profile, what IWR will maximize the PVtotal and achieve a 99% success rate?  Again, I've got the numbers for 30 and 40 years and I don't think it would be too much trouble to do it for other time horizons

  In the News
  How to Order

© 2016 All Rights Reserved

 Retirement Quant