" A fellow named Bill Bengen initially used that [Monte Carlo] calculation discipline when he concluded that a 4% annual drawdown rate resulted in high portfolio survival odds for an extended retirement period."
Not exactly. He concluded that a 4% drawdown rate resulted in certain survival, not merely a high probability of survival: "
no client enjoys less than about 35 years before his retirement money is used up." Survival is typically taken in financial publications to mean lasting 30 years.
More importantly, for the most part he used actual not statistical data. He looked at rolling 50 year periods, starting with
1926 (i.e.
1926-
1976) and ending with the 50 year period
1976-20
16. Monte Carlo had nothing to do with this.
You may well ask: what "actual" data did he use for years that were in his future (his paper was published in
1994)? Well here he did use statistical data. But of the simplest kind, again no Monte Carlo simulation. He merely "extrapolated the missing years at the average return rates of
10.3 percent for stocks, 5.2 percent for bonds, and 3.0 percent for inflation -
a concession to the 'averaging' approach, but one that was unavoidable."
Bengen used actual returns over multiyear spans (i.e. he did not assume that year-to-year returns were random and independent). He filled in missing data by using constant annual returns (i.e. no variation of returns). Everything Monte Carlo is not.
Quotes are from Bengen's
original paper, cited in the NYTimes article linked to by MJG. See Figure
1(b) in that paper for how many years a 4% drawdown rate would last if started in any year from
1926 to
1976.
