Following up on the quantitative approach to managing portfolio uncertainty, I'll update the Ivy 5 portfolio as referenced in Mebane T. Faber and Eric W. Richardson's book, The Ivy Portfolio: How to Invest Like the Top Endowments and Avoid Bear Markets. On page 75 of their book, Faber and Richardson provide a sample Ivy Portfolio using five ETFs. They are: Domestic Stocks, VTI; Foreign Stocks, VEU; Bonds, BND; Real Estate, VNQ; and Commodities, DBC. Below is a QPP analysis of this five-ETF portfolio, and below that is a Monte Carlo analysis based on a number of assumptions. Those assumptions are listed below.
From time to time I post a blog entry that focuses on retirement planning. Since I've been discussing a quantitative approach to portfolio uncertainty management, this is a good time to retest the Ivy 5. Will the money last through the retirement years? It is important to address the assumptions, as that makes all the difference in the following Monte Carlo calculation.
1. Inflation is assumed to be 4%. Yes, that is high right now, but it may be low in the future.
2. The investor is 60 years old and plans to retire at age 65.
3. This analysis assumes the S&P 500 will grow at 7.0% per year. That percentage may be optimistic.
4. This investor already saved $500,000 and is putting away $6,000 per year until retirement.
5. The annual amount needed in retirement is $30,000 per year. Six percent is considered to be a high withdrawal rate.
The screen shot above shows the Monte Carlo calculation based on this five-asset-class portfolio. Note the rather high (50%) chance of running out of money by age 91. I would also worry about the 30% chance of running out of money by age 84, as there is a high probability this 60-year-old will reach that age.
The best options are to work longer, save more, or reduce the withdrawal rate. We might gain a few years through portfolio improvement, but that is not as certain as the other three options. Readers may have other ideas - if so, drop them in the Comments box.