"Certainty of Lifestyle: Contrasting a Simulation Over a Fixed Period Versus Multiple Period Models"
The purpose of this paper is to demonstrate the differences between the commonly used Monte Carlo simulations that assume a static withdrawal based on a fixed mortality period and initial capital, versus the use of Monte Carlo simulations that re-estimate withdrawal amounts utilizing period life tables for longevity, in addition to the variable remaining capital of each simulation, both for each individual year within the model. Such models may be called Conditionally Adjusted Sequential Retirement Periods models (CASRP). The model approach demonstrates that, although a fixed period simulation has a failure rate at some future age, the multiple period model doesn’t run out of funds unless catastrophically spent. This paper explains why funds are available at superannuated ages and demonstrates methods that remove the fear of failure (running out of money before life) to give more control and insight to retirees over the future of their funds. The authors find there is a difference between a single fixed period Monte Carlo simulation, and a model made up of a series of connected simulations.
The model approach results in a series of solutions at each age, rather than a series of computations that result in a single solution from a traditional fixed period Monte Carlo simulation. Essentially, this is akin to calculating your own "Personal Mortality Credits." The paper describes "multi-casting" of simulations which is much more reflective of real life aging than the dynamic approach commonly in use up to now.
Link to paper (click on title below to go to paper):
The observations and a discussion of the paper is in these two blog posts:
Linked, and cover photo, with permission by the Financial Planning Association, Journal of Financial Planning, November 2016, by Larry R. Frank Sr., MBA, CFP®; Shawn Brayman, BSc, MES.
The working paper (see available link below), documenting the research project, won the CFP® Board Best Research Paper Award at the 2016 Academy of Financial Services annual conference.
This paper was presented to the Academy of Financial Services in Las Vegas NV, Oct 20 and 21, 2016 (see Proceedings for papers presented in the past). A working paper with data is available at Social Sciences Research Network (data and appendices).
Also distributed in:
PENSION RISK MANAGEMENT eJOURNAL Vol. 10, No. 28: May 4, 2016
ECONOMETRICS: ECONOMETRIC & STATISTICAL METHODS - GENERAL eJOURNAL Vol. 9, No. 48: May 10, 2016
MICROECONOMICS: LIFE CYCLE MODELS & BEHAVIORAL LIFE CYCLE MODELS eJOURNAL Vol. 6, No. 17: May 11, 2016