# Dangerous Calculations

Many financial advisers and financial plans depend on the use of so called "Retirement Calculators" to forecast sustainable distributions. You can find them on many financial websites. Plug in your investment, income requirements, age, etc., and the calculator spits out a "safe" distribution amount projected to last through retirement plus a projected estate to pass on. Retirement calculators have been used to allocate assets, to plan for future expenses, to project an estate, and to provide comfort to investors that the math supports the distributions! They often are employed as selling and management tools for the investment industry and their projections are included in many financial and estate plans.

Unfortunately, you would be hard pressed to find any Finance Professor who believes these calculators are useful or accurate in projecting a safe distribution stream from an equities portfolio over one's lifetime let alone build an estate. They can be dangerous. Retirement Calculators, ignore volatility, ignore sequence risk, ignore market risk, ignore asset liquidations to fund distributions, ignore geometric returns (wealth effect) which are always 1%-2% lower than the arithmetic returns over the long term, and assume a straight line average arithmetic growth. It doesn't work that way. The consequence for income beneficiaries in the real world will be cannibalization of assets in a volatile market that will have dire impact on long-term sustainability.

Fortunately, in recent years retirement calculators have been generally debunked and many financial and brokerages now use a Monte Carlo simulation to forecast outcomes incorporating the portfolio's Standard Deviation (risk). Monte Carlo simulations run iterations on the portfolio assuming distributions and a random range of performances over time. This is done several thousand times to produce a spread of outcomes and a probability curve of sustainable returns, e.g. over 75% the iterations fell within a positive range on a bell curve. Investment recommendations are then based upon the percentage of positive outcomes on the curve, even if a smaller percentage of outcomes actually shows substantial declines and impaired sustainability.

Here too there are problems. The variables in the simulation change over time depending on performance and market action. Those who invested in January 2008 ultimately discovered that the simulations or calculations they originally relied upon as safe were stale by October. Continuing distributions per plan lead to foreseeable disaster within a decade even as markets recovered.

A simulation or retirement calculation is merely a point-in-time projection that requires active monitoring. All income-dependent investors need to recalculate or re-simulate and reallocate their portfolios, revising distributions if ever the principal balance declines 8%-10% below investment. In my experience however, many investors stay the course and cannibalize their accounts by continuing to take distributions at the original level either out of necessity, ignorance, or upon erroneous advice, leaving those investors a decade later in mid-retirement unable to sustain their lifestyle or provide an estate. Even the smallest of portfolio declines should raise red flags for accounts in distribution and should not be ignored because over time the market will recover. While markets do recover, rarely does principal in distribution accounts