Financial Services Review | 2010
Authors:
DOI: 10.61190/fsr.v19i4.4984
Journal: Financial Services Review
Year: 2010
Publisher: Academy of Financial Services
Document Type: Article
Open Access: All Open Access; Gold Open Access
Cited by: 0
The classic preretirement problem for the financial planner is to advise a client how much to save, how much must be saved each year to reach a specified goal, and how the investment assets should be allocated between fixed income and equity. The traditional solution is to assume a fixed rate of return for each asset class and test scenarios until the mixture of variables yields a solution that meets the stated savings goal and seems feasible for the client. This binary result (accept or reject the plan) ignores the inherent uncertainty. In this paper, we derive a stochastic model in which the rate of return and the rate of increase of annual savings are both variable and calculate the probability that a particular goal will be achieved, given any initial savings endowment, periodic additional savings amount, mixture of assets (represented by the return distribution), and time to the goal. The calcu-lations can be done on an Excel spreadsheet. We illustrate the use and numerical results of the model with a realistic retirement planning scenario and variations on it. While this solution is particularly important for preretirement planning, it applies quite generally to meeting any financial goal, such as saving a down payment for a house. © 2010 Academy of Financial Services. All rights reserved.
Retirement planning; Stochastic future value; Stochastic savings