Saturday 26 July 2014

Monte Carlo or Bust

Luckily for me I don't have to plan my retirement from the angle of "how long will my money last". I have an index-linked BD pension that, although modest, when combined with my husband's pension (also DB), state pension and flat rental, is enough to live on and will last as long as I do.

I feel very fortunate because the prospect of running "pension pot" figures through financial modelling software, and feeling confident enough about the results to be able to make firm decisions based on them, is daunting. Especially when you remember that sticking to the "safe side" and over-funding might very well leave you with a surplus that has cost you precious years of freedom, only to remain unspent because you died before the last row on your spreadsheet.

However, despite the fact that I don't need to use this kind of tool "in anger" I was interested to see how the modelling worked so I took a look at Firecalc which is one of the calculators widely recommended for the job. What surprised me most of all is that there doesn't seem to be a UK version so the figures you enter have all to be converted to $s. Also all the data that the calculations are based on is taken from the American markets. However it maybe just that my Google searches just didn't turn up the right results. I was looking for a direct UK equivalent to Firecalc but it is quite likely that a similar type of "Monte Carlo" simulating process is used by many of the other calculators on the market. More investigation needed.

Firecalc works by running your living costs, portfolio value and life expectancy through a series of calculations and gives you a % likelihood of "success" which has been assessed based on how the markets have performed in the past.

"FIRECalc shows you the results of every starting point, since 1871. You can get a sense of just how safe or risky your retirement plan is, based on how it would have withstood every market condition we have ever faced."

I ran my figures through it and this is the result:

FIRECalc Results

Your spending in every year after the first year will be adjusted for inflation, so the spending power is preserved.
Because you indicated a future retirement date (2019), the withdrawals won't start until that year. Your contributions will continue until then. The tested period is 5 years of preretirement plus 32 years of retirement, or 37 years.
FIRECalc looked at the 107 possible 37 year periods in the available data, starting with a portfolio of $212,206 and spending your specified amounts each year thereafter.
Here is how your portfolio would have fared in each of the 107 cycles. The lowest and highest portfolio balance throughout your retirement was $212,206 to $2,932,303, with an average of $1,054,551. (Note: values are in terms of the dollars as of the beginning of the retirement period for each cycle.)
For our purposes, failure means the portfolio was depleted before the end of the 37 years. FIRECalc found that 0 cycles failed, for a success rate of 100.0%.
Understanding the charts below: Don't try to follow any individual line -- with most scenarios, there are just too many of them. But if you look at the mass of lines, and the zero axis, you can get a clear visual representation of how frequently your strategy would have failed (dropped below zero) or succeeded. The objective of presenting the information this way is to allow you to get a "big picture" sense of the way your strategy would have performed historically.

Year-by-Year Portfolio Balances



                         The zero line is shown in red.

What my results mean
Predictably the success rate is 100%. However, what is interesting is the vast difference between the highest and lowest potential value of my portfolio - £1,727,271 down to £125,000. This is food for thought, as it seems that there is every chance I could have a substantial amount of savings left that won't be needed to live on in retirement.

I did sort of know this because the period of time I am trying to fund at the moment comes before our pensions kick in, not after. Despite knowing this I have felt reluctant to stop pumping up the ISAs as much as we can. However, it might be better to review this and investigate putting more in my private pension now to help us both retire another year earlier? However I'm not sure what the impact of not working for a further year would have on my LGPS pension so I need to work this out.


Two additional points to Note:

  • I need to start to think about how we want to manage inheritance - How much to leave (or gift before we die?).
  • Do we need to put something in place to manage potential care costs? Should we earmark some (or all) of the ISA fund for this? What is the best way to manage this?




2 comments:

  1. I only got a success rate of about 90%, good enough for me right now...I think! No need to panic!

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  2. 90% is pretty good. It all depends on how early you want to retire. I'm only aiming for 60 which used to be the norm for a lot of people so my task is fairly small compared to that of someone who is aiming for 50-55.

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