Portfolio Stress Test: Part I

Stress Testing the Curie Portfolio

Investors experienced a traumatic year in 2008 and it will likely happen again.  Are you prepared to deal with the risk? In the next two blog entries I will walk readers through a portfolio stress test using the Curie Portfolio.  To work through this analysis, I will use the Monte Carlo software, Quantext Portfolio Planner (QPP).  Most of you are familiar with Geoff Considine's software program as we use it frequently here at ITA Wealth Management.  In the first screen shot, I pulled the investments and various percentages from the Curie TLH spreadsheet.  In this analysis, I am assuming an inflation rate of 3.5% and a projected return for the S&P 500 of 7.3% annually.  Keep in mind that the current inflation rate is 1.14%.

Critical information in the table below is the projected annual return of 9.4% with a projected standard deviation of 17%.  These are rounded percentages. This gives us a Return/Risk ratio of 0.55, or below our desired value of something greater than 0.60.  With a lot of work, we can push that ratio above 0.70 in this market, but it is not easy to find the right combination of investments to reach that level.

Another critical piece of data is the Diversification Metric (DM).  This portfolio generates a 43% DM value or above our 40% threshold.  We are satisfied with the diversification, but the risk is a little high and we will see how that plays out in Part II of this stress analysis. 


In the following shot, we see how this portfolio works out for a 50-year old planning on retiring at age 66.  This investor already saved $500,000 and expects to withdraw $40,000 per year.  Until retirement, the investor will continue to save $1,000 per month or $12,000 a year, adding $192,000 to the current account.

In the screen shot below, you will observe the various probabilities of running out of money from age 88 to well over 100.

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Running Out of Money In Retirement

A few months ago I posted a blog entry about the probability of running out of money in retirement. What I did not do in that entry was run a stress test on a portfolio to examine what might happen should a retired investor experience another three standard deviation dip as we came through in 2008 and early 2009.  Later today I plan to take either the Schrodinger or Curie Portfolios as the asset allocation models for the stress test.  This will require some assumptions such as the age of the investor, amount saved, withdrawal rate, and the usual inflation rates we use when running a QPP analysis on a portfolio.

As I recall, I did the stress test on a sample portfolio shortly after the market bottomed in 2009.  There are several reasons for running such portfolio tests. 

1) Are we taking risk into account with our retirement portfolios? 

2) Is the portfolio large enough to retire? 

3) Is the asset allocation appropriate to meet retirement needs?

On a little different note, February 14th marks the three-year anniversary for ITA Wealth Management.  You will not find entries going back that far as the server where I once housed this blog was hacked and I lost over 1000 entries.  Most of that basic material is now available, but the stress test material is gone and it is now time to once more analyze a portfolio to see what might happen when the next bear market strikes.