TIP$TER projects the safe, sustainable retirement budget that a tax-deferred portfolio fully invested in Treasury Invested Protected Securities (TIPS) would support.  Then, it projects and compares the volatile range of retirement budgets that a diversified portfolio would support.
Largely Meaningless Simulation Outputs

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Simulating the effect of a financial plan on terminal wealth

    The outputs given by most financial planning simulators have little value.  Typically, the principal outputs they provide are the "success rate" (the probability of not outliving your money before the end of your plan) and the terminal wealth (the amount of money you have left at the end of your plan, by which time you are presumably dead).

    Here are some examples of the simulation outputs illustrated in several reports last reviewed in July 2009 of some of the leading financial planning software vendors:

    EISI's NaviPlan*

  •     Includes retirement income need shortfall graphs on pages 15 and 16 of this sample report
  •     Forecasts "net worth at death" on page 15 of the same report
  •     Includes "goal coverage" graphs on pages 17 and 18 of the same report
  •     No graphs illustrating the variable retirement budget supported by different percentile trials versus time

    PIETech's Money Guide Pro*

  •     The "portfolio value" graph on page 20 of this sample report
  •     The "Safety Margin (Value at End of Plan)" data on page 21 of the same report
  •     No graphs illustrating the variable retirement budget supported by different percentile trials versus time

    Financeware*

  •     Uses a "Target End Value" goal on page 5 of this sample report
  •     The "Investments" graph on page 11 of the same report.
  •     No graphs illustrating the variable retirement budget supported by different percentile trials versus time

    For most people, the goal of financial planning and investments is to have a better-off life, not a better-off death.  You might think that the major providers' simulations would illustrate the risks and rewards of a financial plan in those terms.  The fact is, they either don't do it at all, or they don't do it very well.

    None of these reports illustrate the impact of different simulation trials on a variable retirement spending plan.  But each of the reports make sure to forecast one's terminal wealth under a plan.  As if the ultimate goal of financial planning is to die rich.
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     TIP$TER, by contrast, models a realistic retirement budget, one that fluctuates between (1) a floor set to a level equal to the retirement budget that any given chunk of savings could safely sustain, and (2) a ceiling set at a level equal to the median retirement budget that the particular portfolio is likely to be able to sustain.  (The ceiling, however, cannot fall below an absolute minimum retirement budget parameter).  For more information, click here.

    Equipped with these realistic, true-to-life spending parameters, TIP$TER generates graphs like the one below illustrating the distribution of retirement budgets supported by multiple simulations.

    You won't find anything like this in the reports generated by the major financial planning software providers.

No comparison to TIPS as a baseline

    The commercial alternatives to TIP$TER also don't measure "success" in terms of how much larger your retirement spending is likely to be than if you kept all your money in TIPS.  Not even close.

    This is a significant flaw.  After all, the average person is always mentally comparing his or her investment portfolio with a stay-safe (e.g., just keep it in CDs) approach.  But other than grossly exaggerating the potential growth of an equity portfolio, commercial alternatives to TIP$TER do practically nothing to illuminate the basic comparison with a safe alternative that the average Joe and Jane already makes.

    Some of the most respected research on equity premiums suggests that long-term real equity returns will be close to 4-4.5%, which is only about a 2% premium to the late July 2009 long-term TIPS yield.  So to fail to project and compare the survivability of a TIPS-portfolio, and the retirement budget that could be sustained by it, is outrageous.

    Prospercuity's philosophy is different: that the most informative way to choose an asset allocation is to compare the distribution of retirement budgets supported by simulations trials of different asset allocation plans with the projected sustainable retirement budget that would be supported by an all-TIPS portfolio.

Risk measures not actuarially adjusted

    The simulators in many commercial financial planning software programs actuarially adjust their "success rate" outputs. But few, if any, free simulators do the same.  The very popular FIRECalc program, for instance, doesn't.  Neither, as best as we can tell from online documentation, does the Flexible Retirement Planner.

    TIP$TER not only adjusts its "shortfall" risk output on the basis of the period life table actuarial information, but also calculates the "life-weighted average" retirement budget supported by each simulation trial.  Furthermore, each simulation trial is ranked by its "life-weighted average" retirement budget.  Consequently, a trial in which a user spends disproportionately more in the early retirement years will be weighted more heavily than a trial in which a user spends disproportionately more in the waning years, when there is a good chance the user won't even be alive to spend it.

Next: The Pension Protection Act of 2006

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*NaviPlan and Profiles are trademarks of Emerging Information Systems Inc., which which Prospercuity claims no sponsorship, connection, affiliation, or association.
Financeware, Inc., is a trademark of Financeware, Inc., which which Prospercuity claims no sponsorship, connection, affiliation, or association.
Money Guide Pro is a trademark of PIETech, with which Prospercuity claims no sponsorship, connection, affiliation, or association.