This article was updated on March 30, 1999.
From the front page of the Wall Street Journal, March 30, 1999
With the Dow Jones Industrial Average climbing over 10,000 and many of the highly paid Wall Street pundits who told you to sell at 5,000 on the Dow advising you to sell again (that is, if you have any stocks left to sell), what should you do?
If the stock market dropped by 50% could you stay retired? Or would you suffer an untimely, pride swallowing, return to the workforce. Can you ensure you remain a member of the leisure class that occupies La Jolla and Del Mar?
In a continuing spirit of public service, Retire Early has given this question a lot of thought and developed a financial planning tool for interested readers. Retire Early's Calamity Planning Spreadsheet allows users to analyze the effect of a plummeting Dow on their retirement income. It allows you to measure the effect of changes in asset allocation, inflation rates, and your annual withdrawals for living expenses.
This program assumes the value of the stock portion of the retiree's portfolio drops by the amount input by the user in the 2nd year. Dividends earned by the equity (stock) holdings are assumed to decrease by 10% in the year after the Stock Market Drop. (For example, at a 2.00% yield, a $100,000 stock portfolio would have $2,000 in dividend income. After a 50% drop in value and a 10% decrease in dividend income the $50,000 portfolio would have $1,800 in dividends for a new yield of 3.60%.) The stock portion of the portfolio then increases in value at the rate of inflation until it returns to its initial amount. Thereafter the rate of increase for the stock portion of the portfolio then returns to the historical rate of return input by the user.
The Calamity Planning Spreadsheet is shown below (Figure 1.). The input parameters that the user must define are in the upper left hand portion of the spreadsheet. The items requiring input are shown in blue. Each of input parameters are explained in detail below in Figure 1.
The "results" area of the spreadsheet shows three items: 1) The number of years required to recover the value of the stock portfolio after the drop in the 2nd year, (2) the dollar amount of the annual withdrawal for the first year (the annual withdrawal in increased for inflation each year.), and, 3) Portfolio value at T+55 years. This is the value of your portfolio after 55 years. The idea is to make sure that this is a positive number.
You may want to print this page so that you can refer to these instructions while you work with the Calamity Planning Spreadsheet.
The user must input the following parameters starting in column B of the spreadsheet with the Year. The values in the cells requiring user input appear in blue on the spreadsheet.
Year Enter the current year. (date)
Stocks Percentage of your portfolio in equities
Total Return. Enter the percent return for each asset class (stocks, REITs,
bonds, cash). The total return is comprised of two components:
1) capital appreciation, and, 2) interest and dividends. For
bonds that you hold to maturity and cash the capital appreciation
should be zero.
Years to Recover Stock Market Value This is the number
of years needed to recover your initial stock value, assuming
the stock portion of your portfolio increases at the inflation
Run some scenarios.
The Calamity Planning Spreadsheet allows you to input different parameters and see the results immediately. Use your imagination. Investigate the effect of a 1% increase in the inflation rate or a 1% decrease in your annual withdrawal. It will make you think.
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Copyright © 1999 John P. Greaney, All rights reserved.