I have asked this before…and the answers always go back to the long term positive drift. How long can someone who was 50 in 2000 and wants to retire at 60 wait for this drift to start again?

This fictional 50 year old (now 56 year old) has less money in his 401k today than he did in 2000 (he might have more if you count his deposits, but his principal is still down) and was banking on retiring in 4 years, how is he going to make it?

Dr. Kim Zussman Provides Food For Thought:

This is not an important question for those aiming to shoot the moon out of the sky. However for those (of us) realistic about our escape velocities, it is the prototype of a very important question. (parenthetically, how do hedge fund investors “average” annual performance series of many big returns with occasional years -100%?)

At a given age how much to save, how to invest it, and what are the risks resulting from the various answers? Immediately one realizes that variability of inputs and sensitivity of compounding makes this estimation difficult:

  1. Initial balance
  2. Presumed years of retirement for self and spouse
  3. Assumed annual expenses and forcastable unusual expenses
  4. Inflation
  5. Risk-free rate of returns
  6. Assumed return of risky investments (ie, stocks, hedge funds), including effect of bad years at the onset of retirement
  7. Tax law changes

Here is a (kind of prescient 2000) article article which discusses the “flaw of averages” (neglecting extremal paths and, as mentioned by Scott, beginning post-contribution compounding with a down market).

The article mentions Sharpe’s Financial Engines*, which at one time was a site which used Monte Carlo simulations for mutual funds to model scenarios of withdrawal and return rates.

It seems prudent for financial advisers to educate clients about risk, including the path of worst-case scenarios (which no one on Wall St. is thinking about this Holiday season)

*(Cynic’s note: Profs who leave to create consulting businesses are suspect)

*(Capitalist’s note: In competitive economies, consulting businesses which enrich former profs only succeed if they enrich clients)


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