I’m going to create 2 portfolios, one high risk and one low risk, and run them through the meat grinder called Monte Carlo. I’m using a simple 2 fund portfolio of US Stocks and Total US Bonds, such that both portfolios reside on the efficient frontier. One is an asset allocation of 40/60, a bond heavy allocation the other 70/30 a stock heavy allocation. There are plenty of people that run 70/30 or even worse.
I’m starting with 4M in each portfolio, and I’m taking the first 1M off the top and stuffing that in a Roth IRA in each instance. The Roth serves the purpose of a backup portfolio, which I don’t count in the day to day WR of the other 3M. In other words the Roth stays closed to withdrawal unless needed. A portfolio closed to withdrawal does not suffer SORR. It’s end value will simply be it’s start value plus interest, inflation adjusted. A portfolio open to WR is liable to SORR and inflation. This study will look at a 25 year ride (actually 10,000 25 year rides) and create a distribution of what the future might look like for each portfolio.
These are the efficient frontier data for each portfolio. You can read the risk and return and Sharpe ratio for each.
When I plug the 70/30 portfolio /into Monte Carlo I choose 3M and 110,000 as portfolio size and fixed withdrawal rate inflation adjusted. I choose historic inflation. 3M and 110,000 is a WR of 3.7% in either portfolio. Monte Carlo has a cool feature in that it dissects the internals of various statistics and each portfilio has a very different ride through its 10,000 simulations.
You can read off things like Max Drawdown, the percentage of drawdown the portfolio suffered according to centile, quite informative! in 10% of the cases the portfolio suffered a 95.71% drawdown and an ending balance of only $128,636 left in the bank after 25 years. It tells you safe withdrawal rate and perpetual withdrawal rate for 25 years, an important statistic The WR is tied to the term of withdrawal, so you don’t get to pull fuzzy numbers out of the air and try to apply them to other scenarios like assuming if 4% never fails over 30 years it won’t fail over 50 years. If you want to treat the portfolio as a perpetual source of money you have to reduce the WR from 3.7 to 2.94 or $88,500/yr.
Look at the difference between 10% and 25%! Inflation adjusted end value for the 25% cohort is 1.7M while its 65K for the 10% cohort. Here is the graph
In the 70/30 case at the 10% centile if you start with 3M you’ll end with just under 2M and your chances of success are 9887/10000 for 25 years.
Plugging in 40/60 all else the same
In the 40/60 case max drawdown is -40% (not 95%) but the end balance is 1.4M not 65K much safer. Both portfolios give you 25 years of 110,000 buying power inflation adjusted, but the 40/60 is a kinder gentler ride. The success is 9998/10000 only 2 failures. The graph
the inflation adjusted end balance of the 40/60 is 2.27M or 320K more than the 70/30. The reason of course is the drawdown. It takes a LONG time to recover a 95% drawdown. If it’s 95% down it’s 190% back up. Perpetual withdrawal in the 40/60 is a little bit better at 3.02% or $90,900/yr
So there ya go, a quantitative way to determine your post retirement risk profile through number crunching. Remember you also have that Roth over to the side which has been growing unencumbered by SORR. About the only thing that can derail you is if we actually switch to a bullet based economy where money is no good. No need for side gigs