RFI Retiree Risk Profile - Historical Returns on Portolios


RFI Retiree Risk Profile - Historical Returns on Portfolios


RFI's projections of future availability of spendable funds is dependent on the assumed rate of return on financial assets held by the retiree.  Retirees who are very risk averse will use a low assumed rate of return and those who are less risk averse will use a higher rate of return.

To aid the retiree in deciding rate rate to assume, RFI includes a database of historical rates of return on portfolios ranging from 100% stocks to 100% interest bearing instruments. By analyzing the distribution of historical returns over various holding periods, the retiree can decide how much risk he or she is willing to take.

Let's start by selecting a portfolio mix of 80% common stock and 20% interest bearing instruments.   Enter 80% in cell G7 and the 20% value in cell G8 is calculated automatically.  Then click the "Calculate Historical Returns Table" button.

The result is shown below and in RFI in rows 17-30:

The table shows the annualized rate of return on the 80/20 portfolio for a variety of holding periods at different percentile levels in the historical distribution.  As an example, look at the 3rd column in the table labelled "925 10 Year Holding Periods".  Since the table is based on monthly data from January 1926 - December 2012, there are a total of 925 10 year sequences in the data. The 2nd percentile row has a return of -3.6% - this means that of the 925 10 year sequences, 2% (or ~18) had an annual return of    -3.6% or less.  Similarly, the 30th percentile row shows a return of 6.6% - this means that 30% of the 10 year sequences (~277) had an annual return of less than 6.6% (of course this also means that 70% of the sequences had an annual return greater than 6.6%).


The upshot is that if a retiree is considering a 10 year deferred annuity and is comfortable with a 20% risk they should use an expected rate of return of 4.7%.


Note that when you are defining a scenario in RFI it is easy to see guidance on which rate to use.  In the image above, Scenario 1 is defined with a 10 year annuity deferment term.  When you place your mouse over the "Assumed Rate of Return" cell for Scenario 1 the distribution of returns for 10 year holding periods is displayed for reference.


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