Sustainability of adequate lifetime income is a critical portfolio objective for retired investors. There are a number of ways to ascertain the likelihood that a portfolio’s investment strategy is suitable to its cash flow requirements. This article provides a brief review of various retirement income modeling approaches including historical back testing, Monte Carlo simulations, and other more advanced econometric risk modeling techniques. Unfortunately, many commonly used risk models are based on implausible assumptions and may mislead investors concerning the risk and return expectations of their retirement investment strategies. We compare risk model outputs, evaluate their credibility, and demonstrate how an over-simplified model may seriously distort the risks faced by retired investors. The differences in sustainability rates are stark: an 8% failure rate at the low end versus a 53% failure rate at the high end. The paper ends with some general comments regarding model risk and practitioner investment advice.
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