Hoadley Retirement Planner
(Using Monte Carlo Simulation)
The Hoadley Retirement Planner uses Monte
Carlo simulation to examine the range of possible outcomes of a savings
and investment strategy and the likelihood of being able to achieve
standard of living goals during retirement.
The key to effective retirement planning is to
avoid focussing solely on expected returns. Instead, the risks of a given
strategy
should be explicitly modelled
to highlight the probability of being unable
to meet planned expenditures during retirement. If the risk is unacceptably
high then changes should be made to the plan -- such as altering the investment portfolio's
asset allocation mix to reduce volatility -- to improve
the odds of success.
The Hoadley Retirement Planner lets you model
both the risks and returns of a long term savings and investment plan taking
into account planned expenditure during retirement. Because the Monte
Carlo simulation is very fast (around two seconds for 10,000 iterations), “What if” scenarios can
easily be prepared to see the impact of varying key inputs such as
inflation, expected return, volatility, and spending during
retirement.
Unlike most retirement planning software applications which simply calculate an
expected median balance for each year of the plan as if these returns are a
sure thing, the Hoadley Retirement
Planner lets you drill down by year to reveal the expected distribution of
the balances. Highlighting the range and probability of outcomes should be
a key objective of any retirement plan.
To use the retirement planner you first define one or
more investment accounts and specify their initial balances. Usually
at least
three accounts would be defined, covering taxable, tax deferred and tax
free investments. But these categories are not fixed and other types
of accounts can be set up by configuring the way investments and
withdrawals from accounts are to be taxed.
Other inputs, all of which can vary over time and which can be optionally indexed for inflation, include annual
contributions to investment accounts, expected average investment returns
and volatilities, other income, such as pensions and annuities expected
during retirement, and anticipated expenditure levels during retirement.
Asset allocation, which determines the overall portfolio
return and volatility, is the most important part of any retirement plan. To help the user
with this
process the Retirement Planner includes a "Performance Estimation"
worksheet. The worksheet provides a simple way of examining various
asset allocation strategies from conservative to aggressive. The
overall portfolio return and volatility is calculated for each asset
allocation strategy and compared with the most "efficient" combinations of
assets from an efficient frontier constructed from the same inputs.
There is no silver bullet for arriving at an appropriate
asset allocation. But the performance estimation worksheet can be a valuable
aid in understanding the implications of asset
allocation decisions on portfolio returns and volatilities, and in
selecting an efficient mix of asset classes -- the highest return per unit
of risk -- commensurate with the investor's
tolerance for risk.
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Retirement Planner Outputs |
The Median portfolio balances chart shows
the balance of each investment account over the life of the plan.
All outputs are adjusted for inflation and shown in today's dollars.
To reveal the uncertainty (risk) associated with the plan,
each bar on the chart, which represents the balances
for each account as at a specific age, can be expanded to show the probability distribution
of these balances. The account balance distribution chart (example
below) is the key to understanding the risks (both downside and upside) of
the plan.
The example below is a cross section of the same
retirement plan shown above for the bar representing the median balance at
age 64. It clearly highlights the wide range of possible outcomes (from $373,000 to
above $1,998,000 in the example below) at age 64. The higher the volatility of
the portfolio, the lower the median balance and the wider the range of
outcomes.
The distribution chart can also be shown as a
cumulative probability chart. This lets you see at a glance the proportion
of balances expected to be below a specific value. For instance the
chart below, which is the cumulative version of the chart above, shows that
at age 64 there is a 20% chance of the total of fund balances being below
$715,000.
The probability of the plan failing is also calculated by
the planner. This represents the likelihood of being unable to fund
all expected expenditure during retirement.
Finally a summary for each year of the plan can be
displayed showing cash in and out and the total portfolio balance at the end
of each year of the plan. Yearly portfolio balances are split into three percentile groups: 10th percentile
(10% of balances will be equal to or lower than the 10th percentile); median
(ie 50th percentile); and 90th percentile (10% of balances will be greater
than the 90th percentile).
The Hoadley Retirement Planner Simulator will run on versions
of Microsoft Excel 2002 and above on Microsoft Widows 2000 or above.
The
Hoadley Finance Add-in for Excel version 10.1p or later must be
installed before using the Simulator.
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Download the
Hoadley Retirement Planner |
The Hoadley retirement planning software is free
but
requires the full version of the
Hoadley Finance Add-in
for Excel.
Register and download.
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