How Risky is Your Retirement Income Risk Model?

Abstract

Adequately sustaining lifetime income is a critical portfolio objective for retired investors. This article provides a brief review of various retirement income modeling approaches including historical back testing, Monte Carlo simulations, and other risk modeling techniques. Implausible assumptions underlying risk models may mislead investors concerning the risk and return expectations of their investment strategies. We compare risk models, evaluate their credibility, and demonstrate how overly-simplified models may distort the risks retired investors face. Failure rate differences are stark: 4% at the low end versus 49% at the high end. The article ends with general comments regarding model risk and practitioner investment advice.

Keywords: The 4% rule, Monte Carlo simulation, Portfolio Sustainability, Retirement Income, Risk Modeling

JEL Classification: C15, D31, G11