I hope others will chime in as well, but you can assume any likelihood you want. The risk level is yours to accept.Can others chime in on the premise that financial planning, in the context of my original question, should be based on the worst 5 to 10 percent outcomes?
I understand if this was a spending question because running out of money has severe consequences. But my question is, as you know, about accumulation. Accumulation has built in flexibility, in that if things don't turn out to be as expected, I will either work longer or spend less in retirement.
Thus, shouldn't I be basing my financial plans on the most likely outcome, which is the mean or median, plus or minus a fudge factor, say 2 standard deviations?? Thanks!
Historical S&P-500 returns from 1928-2017 were 11.5% ± 19.5%, yet most financial planners aren't going to use that average of 11.5% in their projections (assuming they're not using a Monte Carlo). From what other posters using a financial planner have said, many planners seem to assume only 6-7% nominal return (rather than 10-12%) and that's a way to assign a low percentile for failure (high chance of success). Using a flat percentage as if stocks can be modeled like a "magical CD "with a lower return rate has other issues (modeling volatility is critical), but some financial planners (perhaps most) are either too lazy to use a Monte Carlo or don't have the knowledge to use a more insightful tool that gives a likelihood distribution for a future balance rather than a single projection.
If you want to plan that your balance will reach the median, there's a 50% chance it will be more than the median projected balance and a 50% chance it will be less. Cumulative stock returns with increasing contributions are a log-normal distribution, so using the mean isn't a great idea (the mean±2σ is suitable when the distribution is normal/Gaussian, which it's pretty close to in a 1-year period for stocks).
Typically planning is done at a lower percentile for failure, which conversely is a high likelihood of meeting your accumulation goals. If the projections suggest you aren't going to achieve your accumulation goals (balance needed to retire, sometimes well before 65), then your options are save more or work longer (spend less is not not always a feasible option, but for those with very high earning/net-worth yet still spend very little, that can be an option as well).
Again, hopefully others will chime in about the notion of financial planners under-promising (low percentile for planning) and over-achieving (not having your clients come back to you to say you failed them, because there was a 90-95% chance of success, not 50%).
Statistics: Posted by bonesly — Tue May 28, 2024 12:21 am