Details of the simulation
I built a predictive model calculating potential outcomes at various annual DQ rates to help inform the choice. The model simulates random market movements at each DQ rate over one-hundred years.
Assumptions
Investment values can swing wildly with the stock market. Over the one-hundred and twenty-three years of Dow Jones and S&P indices, annual swings have varied between a high of 86% up and a low of 40% down. A composite of these two indices with dividends re-invested averaged an upward move of 12% over the entire period even when the market went down in thirty of those one-hundred and twenty-three years.
To reflect that often stocks go up and down in large swings together, I have used a rolling five-year average to smooth the swings.
Fixed income investments, typically bonds, form about forty percent of typical foundations assets. Bonds provide less return but more stability. I found that over the one-hundred- and twenty-three-year period that annual returns from bonds were about seventy percent that of stock returns.
In this study, I set inflation two percent. An added 1.7% of costs are included for wealth management and internal administration. Thus, these values are in today's dollars as of the beginning of the simulation.
The actual return rate used was a blend of 60% five-year average of stocks, plus 40% of the bond returns less 2% inflation and 1.7% administration costs. From this total, the DQ of interest was subtracted to get the net gain or loss for the year.
By using a return rate with common assumptions for stock and fixed-income returns less assumed costs, including inflation allows the model to permit variations of just the DQ rate. Setting the DQ at a fixed rate the simulator created one hundred results all in current dollars.
Results
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The model calculates two values in each iteration of market conditions:
1) the fund's average annual level and
2) the end value over one-hundred years of random market gyrations.
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By simulating several levels of DQ we can compare the current 3.5% with setting the DQ at 5%, 6% 6.5% or 7%
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The simulation captured the two values one hundred times at each separate DQ rate. The results of one hundred simulations of these values show how often the end value was below the starting value, if ever. Examining this addresses the growth issue – whether the foundation is able to survive and continue.
The median of the average results showed what could be the most likely average outcome each year. This result shows how big the fund is throughout the one-hundred-year period.
The range of outcomes for both the average yearly result and the end value shows the volatility introduced by the market's random results.
Of particular interest is the number of times the end value ends up below the starting value. In that situation, we assess that the fund is not surviving, at least not without additional funds from gifts being added. However, if the decrease in end value is low and the chances of that happening are minor, then overall the likelihood of a reduced fund might be an acceptable risk.
Return here to the main blog to view the results and conclusions.
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Below are the detailed results.
The numbers shown are based on a starting value of $1,000,000
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Note these results are sorted lowest to highest at each DQ level, so are not correlated per instance (correlated Average and End Results are available on request).
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