Simulations that Realistically Model Spending Patterns

   TIP$TER provides a "targeted annual retirement budget" input plus three flexible retirement parameters to realistically model a retirement spending pattern. 

    A rational investor would curtail their spending after a large market fall, if not curtailing it would significantly increase their shortfall risk.  Likewise, most rational investors would increase their retirement spending if they could easily afford to without materially increasing their risk of shortfall.  TIP$TER's Retirement Budget Constraints realistically model this behavior.

    The first constraint – the "Absolute minimum retirement budget" constraint – is straightforward: it's as low as the retirees can afford to go, even if it results in a significantly increased risk of eventual shortfall.  This is the thriftiest budget the retirees are willing to live on.

Realistic ceiling

    How would rational retirees change their spending habits in response to a bear market? Wouldn’t they recalculate the amortized retirement budget their depleted portfolio should be able to sustain, going forward, and adjust their lifestyle accordingly?

    TIP$TER's second constraint – the "Max bear market budget" constraint – is designed to model this defensive behavior.  When this value is set to 100% (which is its default value), TIP$TER models a retiree's portfolio on the assumption that the retiree, in any given year of a simulation trial, would cap his/her spending at a level that the portfolio would subsequently support if it subsequently delivered the median expected performance for that portfolio. 

    In any given simulation, TIP$TER® annually recalculates the median expected budget, going forward, that the simulated portfolio is likely to be able to sustain based upon your chosen asset allocation. TIP$TER® sets the "ceiling" at a value equal to the median expected sustainable budget times the “scaling” factor (default = 100%) you enter.

    However, that ceiling cannot go any lower than the "Absolute minimum retirement budget."

Realistic floor

       How would a rational retirees change their spending habits in response to a bull market? Wouldn’t they want to take advantage of the good times?  Wouldn't they calculate whether they could spend more? After all, they could convert their entire bull-market-fattened portfolio to safe assets like TIPS and safely increase their budget to the amount the risk-free portfolio could safely sustain every year thereafter.

    TIP$TER's third constraint – the "Min bull market budget" constraint – is designed to model this opportunistic behavior.  When this value is set to 100% (which is its default value), TIP$TER models a retiree's portfolio on the assumption that retirees, in any given year of a simulation trial, would spend at least as much as the amortized budget that their savings – if suddenly exchanged for a risk-free portfolio – would safely sustain (and still leave enough behind to meet the retirees' "Leave this much for your kids/heirs" goal).

    In any given simulation, TIP$TER® annually recalculates the sustainable retirement budget, going forward, that a simulated portfolio would be able to sustain were it converted to TIPS.  TIP$TER sets the "floor" at a value equal to the sustainable TIPS-supported retirement budget times the “scaling” factor (default = 100%) you enter.

How to model a fixed retirement spending policy

    Prospercuity realizes that, in order to compare TIP$TER outputs to those of other simulators, some might still want to model a fixed retirement budget.  To do so, make sure that (1) the "Absolute minimum retirement budget" constraint is equal to the "Targeted annual retirement budget" value and (2) the "Min bull market budget" constraint is set to 0%.

    Setting the "Absolute minimum retirement budget" constraint equal to the "Targeted annual retirement budget" eliminates the ceiling.  Setting the "Min bull market budget" constraint to 0% eliminates the floor.  Under these conditions, TIP$TER models a fixed retirement budget.

How to model a variable retirement spending policy that is always pegged to the "Max bear market budget" value

    Academics may want to model a variable retirement budget that is always pegged to the median retirement budget that a given portfolio could be expected to support.  To do so, set (1) the "Absolute minimum retirement budget" constraint to zero and (2) the "Targeted annual retirement budget" input to an impossibly, ridiculously high number.  The first setting abolishes the floor.   The second setting sets the target retirement budget so high that it will always equal the ceiling value dictated by the "Max bear market budget" variable. 

 

Next: TIP$TER's Asset Allocation Risk/Reward Spectrum Chart

Previous: Provides meaningful measures of simulated portfolio performance