Independent financial advisors who use Nest Egg Guru are probably already aware that one of the most appealing features of our flagship Retirement Spending App is that it is the ONLY software that makes depletion risk tangible to clients by presenting remaining balance data in 5-year increments. No other software provides this level of clarity. The classic straw broom illustrations commonly produced by Monte Carlo simulation software just don’t cut it.
However, what you may not know is that the Retirement Spending app is also one of the very few programs that realistically incorporates the current historic low interest rates into its simulation model. To illustrate this, the table below presents the Nest Egg Guru Spending App results from a test of a $40,000 (4%) initial withdrawal rate of a hypothetical $1,000,000 portfolio with a 60:40 asset allocation and a 3% annual C.O.L.A. In the simulation model we assume that stocks ae comprised of 45% S&P 500 Index, 30% Russell 2000 Index, and 25% MSCI EAFE Index. We assume a constant 2% return and that cash earns 0%. We also assume that the allocation remains constant via annual rebalancing and that the client pays 1% total internal/external portfolio management fees.
Table 1. Depletion Risk Made Tangible – Output from a test of the 4% Rule
As you can see, the million-dollar initial portfolio runs out of money in less than 30 years in the bottom 20% (bottom 1,000 sims) of the 5,000 randomly sampled bootstrapping simulations. In fact, a full 28% of the portfolio simulations produced shortfalls prior to the end of the 30 year time frame. So much for the vaunted “4% Rule.”
In contrast, if you test the 4% Rule using similar portfolio constructs on most popular Monte Carlo simulation apps such as Money Guide Pro or eMoney (using their default return and standard deviation assumptions) or on a program such as Big Picture App that uses historical back-testing, you will find that results are considerably more optimistic. In my experience, most of these apps will still produce so-called “probabilities of success” of 90%.
The problem of overoptimism in financial planning software has been trumpeted recently in a couple of articles by Morningstar’s David Blanchett –
– The False Promise of Historical Returns (Advisor Perspectives, March 15, 2021)
– Low Rates aren’t going anywhere. Here’s what that means for retirement planning (ThinkAdvisor, March 13, 2021)
Here is Blanchette’s commentary about popular Monte Carlo simulation software –
“I’ve seen retirement projection tools that use 100,000 runs, which, in my opinion, is a bit absurd, based on purely historical returns. That’s ridiculous. You could do a projection that includes a billion runs based on historical returns that would be less useful than one projection with 100 runs that are based on more realistic forward-looking returns.”
The founders of Nest Egg Guru maintain that the bottom 1%, 5%, and 10% simulation results in Nest Egg Guru’s Retirement Spending app realistically capture the risk retirees face today if the stock market goes through another period similar to the first decade of this century at a time when interest rates are at or near historic lows.
Users of our software are also aware that ours is the only truly client-facing app suite that our subscription cost is far lower than comparable simulation apps.
J.R. Robinson is a co-founder of Nest Egg Guru and the owner of Financial Planning Hawaii. He and Nest Egg Guru co-founder Jack C. De Jong, Jr. Ph.D., CFA, MBA have co-authored numerous journal papers on retirement portfolio sustainability. Their latest research contributions, A Case Study in Sequence Risk: A 20-year retrospective on the impact of the 2000-2002 and 2007-2009 bear markets on retirement nest egg sustainability, may be found on SSRN.