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Subject:  Re: Community Question Date:  9/25/2013  5:06 PM
Author:  Rayvt Number:  73309 of 99404

Question #2:
How much additional funds, beyond their projected natural living expenses, would they need to have in order to put all of the original amount into such a position?

I do not understand the question. Let's assume we are trying to figure out something about withdrawal rates & portfolio survival.

This might be an interesting exercise.

It is common to look at 30 year portfolio longevity. The statistics that is of primary importance is the portfolio survival rate -- the risk of the portfolio being exhausted before the 30 year mark. In looking at that, average performance is of small interest. Remember that a 6 foot man can drown wading across a river with average 4 foot depth. So even though average performance is interesting, what we really care about is worst-case performance. Typically, a portfolio failure rate of 5% is considered the outside limit of acceptable. Conservatively, a rate of around 2% is deemed adequate for mere mortals. 0% success rate is guaranteed only for the gods.

We have to start with some assumptions.
* The retiree is living off the income stream taken from the portfolio.
* The retiree is age 65.
* The retiree's income under consideration is the income stream from the portfolio. Other income such as pension, Social Security are independent and have no bearing here.
* The retiree only takes money from the portfolio -- never adds money for either new investment or paying fees. We consider only the net withdrawal from the portfolio.
* Portfolio value at retirement -- assumed to be at age 65 is $775,000.

One common strategy is an IUL, so we'll start with that. We'll declare this to be our "base strategy". We have an illustration which we'll accept as generic and reasonably accurate. At any rate, the costs & data that are in this illustration are internally consistent.

* Note: the portfolio value of $775K comes from this illustration.
* Internal costs consist of premium, policy fees, and insurance charge.
* The fees are constant but the insurance charge increases each year. To keep things simple we'll use the insurance charge at 75 as the average. This is 10 years into the 30 year portfolio.
* WIthdrawals are NOT increased for inflation.

We'll define the "bare minimum required income stream" as what the IUL will deliver. For any other amount just be scale the numbers.

The annual fees are $5600. $1980 fees plus $3620 insurance.
It shows the average growth as 7.7%.
The net (average) income stream available for withdrawal is: $54,075. ($775K * 7.7% - $5600)
The E/R is 72 bps (5600 / 775K)

S&P500 strategy.
The average total return for the S&P500 is 10.7%.
The internal fees are 0.09%, which is $697/yr.
The net (average) income stream available for withdrawal is: $82,200. ($775K * 10.7% - $697)

All that is of little importance. We don't care about the average. We care about the worst case. We don't want to run out of money.

The IUL illustration shows average, but not worst case. We have to look at the market historical data to find out what the worst case was.

Note that these figures below are not theoretical or average or predictions. This is from the actual historical data of the S&P500. It is not a prediction of the future, it is how things would have done in the past.

The worst case for the S&P500 (total return) was the 30 years from Nov 1955 to Nov 1985. When we plug these numbers into the historical data, using a withdrawal of $54,075, we find:
1) The IWR (initial withdrawal rate) is 7% (54075 / 775000)
* Note that IWR of 7% is more than the commonly accepted safe value of 4%.
2) The IUL runs out of money in the 20'th year.
3) The S&P account still has money in the 30'th year.

4) if we lower the withdrawal to $43,000, the IUL still has money at the 30'th year. Very close to the initial balance.
5) This IWR is 5.5% -- still higher than commonly acceptable.

The maximum safe withdrawl the retiree could take is $43,000.

Now we turn to one of the many internet retirement calculators, FIRECALC. Firecalc does a monte-carlo backtest of 113 30-year runs, using data for every starting point since 1871.

Parameters: $43K/yr, initial $775K, 30 years, 3% inflation, 100% stocks.
* Success rate: 56%. Not safe.
* 60% stocks, 40% bonds, 0% inflation: 97% success rate (3 failures out of 113)
* 100% stocks, 0% inflation: 96% success rate. (5 failures out of 113)

We can plug in the IUL assumptions into Firecalc.
* Success rate: 83%. (38 failures out of 113)
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