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
1730:
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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