I am trying to wrap my head around the proper way to do this. I would like to simulate the portfolio value adjusted for inflation with a fixed withdrawal rate.

To simulate withdrawal rate, I will need to adjust my portfolio nominal return series to real return using CPI. After getting real return series, assume that my fixed withdrawal amount is 5% of initial equity. If my initial equity is, say, $1, then my withdrawal rate is 0.05. Since my simulation is real return based, do I need to adjust my fixed withdrawal rate for inflation or do I just keep it fixed at 0.05 and withdrawal this amount each period?

If I do adjust it, I am using the following equation: if inflation is 1% then current withdrawal rate = 0.05 + (0.05 * 0.01) = 0.0505

Which is correct?


Let real wealth at time $t$ be defined as $W_{t}^{R}\equiv\frac{W_{t}^{N}}{P_{t}}$ where $W_{t}^{N}$ is nominal wealth and $P_{t}$ is the price level indexed to one at the initial period. You want to withdraw a $x_{t}$ percent of real wealth. This would give $$x_{t}W_{t}^{R}=x_{t}\frac{W_{t}^{N}}{P_{t}}$$.You could then consider a withdrawal rate in nominal terms $y_{t}\equiv\frac{x_{t}}{P_{t}}$ (ie. that you multiply by the nominal wealth) that would effectively mimic the real withdrawal rate. When wealth grows faster than inflation, the nominal withdrawal rate should decline and vice-versa.


Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.