Inflation Sensitivity Study

I ran a short sensitivity test on the Taken At Face Value condition.

Baseline Conditions

I assigned Stock A an initial dividend yield of 3.5% per year and a dividend growth rate of 8% per year. I assigned Investment B an initial dividend yield of 6.1% and a growth rate of 2%.

I assumed 3% inflation and 2% (real) interest for the TIPS.

Results

I started without making any deposits or withdrawals from the TIPS. I varied Stock A and Investment B allocations. I found that the best allocation [using an increment of 10%] is 20% Stock A and 80% Investment B.

With 20% Stock A and 80% Investment B, the minimum withdrawal rate was 5.54% of the original balance (plus adjustments to match inflation).

With 4% inflation, the continuing withdrawal rate was 5.03% at the same allocation (20% Stock A, 80% Investment B). It was 5.11% with a 30% Stock A (fast growth) and 70% Investment B (high yield) allocation.

With 5% inflation, the continuing withdrawal rate was 4.26% with 20% Stock A and 80% Investment B. It was 4.66% with a 50% Stock A and 50% Investment B allocation.

Conclusion

These results are consistent with my previous findings. The worst case outcome: a continuing 5% annual inflation rate reduces the buying power to 84% of the original level. This is a very gentle failure mechanism in light of the assumed inflation rate.

Have fun.

John Walter Russell
December 31, 2007

Taken At Face Value
Taken At Face Value: Upside