How risky is your retirement income risk model?

Abstract

Adequately sustaining lifetime income is a critical portfolio objective for retired investors. This article provides a brief review of various retirement income modeling approaches including historical back testing, Monte Carlo simulations, and other more advanced risk modeling techniques. Implau- sible assumptions underlying common risk models may mislead investors concerning the risk and return expectations of their retirement investment strategies. We compare risk models, evaluate their credibility, and demonstrate how an oversimplified model may distort the risks retired investors face. Differences in sustainability rates are stark: 4% failure at the low end versus 49% failure at the high end. The article ends with general comments regarding model risk and practitioner investment advice.