A Risk-Based Model For Retirement Planning

Abstract

This paper presents the use of @RISK simulation to estimate the value of a long-term investment in a diversified portfolio along with the risk associated with that investment. A number of possible investment scenarios in fixed income and equity securities are presented. Each simulation considers a possible set of portfolio weights for combinations of the different securities. The initial constraint is that the sum of the investment weights is equal to one. The simulation model creates future scenarios by randomly choosing past scenarios, giving higher probability weights to more recent years. The estimated future value of the investment is deflated to determine the amount in today’s dollars. Finally, for each portfolio scenario, the model determines the value at risk VAR, which captures the maximum possible expected portfolio value.