The simulation output from Example 11.7 indicates that an investment heavy in stocks produces the best results. Would it be better to invest entirely in stocks? Answer this by rerunning the simulation. Is there any apparent downside to this strategy?
EXAMPLE 11.7 INVESTING FOR RETIREMENT
Attorney Sally Evans has just begun her career. At age 25, she has 40 years until retirement, but she realizes that now is the time to start investing. She plans to invest $1000 at the beginning of each of the next 40 years. Each year, she plans to put fixed percentages—the same each year—of this $1000 into stocks, Treasury bonds (T-bonds), and Treasury bills (T-bills). However, she is not sure which percentages to use. (We call these percentages investment weights.) She does have historical annual returns from stocks, T-bonds, and T-bills from 1946 to 2007. These are listed in the file Retirement Planning.xlsx. This file also includes inflation rates for these years. For example, for 1993 the annual returns for stocks, T-bonds, and T-bills were 9.99%, 18.24%, and 2.90%, respectively, and the inflation rate was 2.75%. Sally would like to use simulation to help decide what investment weights to use, with the objective of achieving a large investment value, in today’s dollars, at the end of 40 years.
Objective To use simulation to estimate the value of Sally’s future investments, in today’s dollars, from several investment strategies in T-bills, T-bonds, and stocks.
WHERE DO THE NUMBERS COME FROM? Historical returns and inflation rates, such as those quoted here, are widely available on the Web.