Based on 50,000 ages of death for the second member of the couple, as well as 50,000
sequences of asset returns through each age of death, we were able to investigate the present value for the cost of retirement based on different asset allocation and product allocation strategies.
In this Part 1, first, we look at the
tail of an asset return distribution and compress our knowledge on Value - at - Risk (VaR) to extract the essence required to understand why VaR - stuff is not the best card in our deck.
We have learned from the lessons in the 1980s and early 1990s that the
erosion of asset returns from higher inflation could be detrimental to an unprepared portfolio, including a portfolio with too much cash.
[9] This risk involves the
exposure of the asset return to shocks in overall market liquidity, the exposure of the asset own liquidity to shocks in market liquidity and the effect of market return on the asset's own liquidity.
For institutional investors with long - standing liabilities, ranging from defined benefit plans and variable annuities offered at insurance companies, a risk control strategy may provide a smoother
path of asset returns and could more closely align the performance of the institution's assets to the characteristics of its liabilities.
Crucially, much of the positive
impact of asset returns simply offset the headwinds to funded status seen from «interest cost, service cost, the drag from outflows for benefit payments and, importantly, actuarial losses from lower discount rates.»
I calculate and compare the income levels and risks these two methods produce over retirees» lifetimes using a historical
simulation of asset returns, interest rates, and inflation.
The first is to lock in retirement income prior to retirement in order to avoid the possibility that a poor
sequence of asset returns will jeopardize retirement income sustainability.
They project net portfolio performance at the asset level based principally on the Capital Asset Pricing Model (CAPM, alpha plus market beta)
of asset returns.