I'm currently using PRC Gold2020 and am struggling a bit with figuring out how to model assets with a fixed rate of return. As an example, suppose a significant chunk of assets are locked up in something like a 10 year CD. A ladder constructed of individual bonds with varying maturities is another example that would seem to fall into this situation. I can create an asset class for the specific instrument, eg an asset called CD, but this seems to introduce a couple of dilemmas.
1) What do I assign as the ROR? I understand the relationship between Nominal ROR, Real ROR and Inflation Rate. And it seems that PRC takes the approach that Real ROR is fixed, while Nominal ROR can float as inflation changes. That makes sense to me for asset classes, such as stocks, where there are long-term projections as well as a lengthy history on which to base the Real ROR. But in the case of something like a specific CD or bond, the Nominal ROR is fixed while the Real ROR fluctuates with inflation. Evaluating different inflation scenarios would seem to require changing the ROR for each scenario.
2) To model this as an asset class requires assigning an allocation % on the Asset Allocation Table. The problem here is that the % allocation is used for annually rebalancing the PRC accounts (Regular, Roth, etc). That doesn't really apply to this type of asset.
Is this situation outside the scope of what PRC is currently designed to handle? Is there a different way of approaching this? I've thought about using income streams to model this but haven't investigated very far. Any suggestions or insights are appreciated!
Eric,
You could theoretically use one or more of the Other Income streams on the Income page to model this as an alternative approach; however, I think the capabilities within the Financial Assets page probably work well enough.
1) In the big picture view of things, it's my opinion that defining the ROR of most asset classes is best done via Real ROR but I understand that this might not be totally correct in all short term views such as being locked into a fixed interest rate for many years on a CD. Bonds may or may not be the same because the interest rate is fixed but the face value can change; so, I think it's fair to just assume a fixed real ROR for bonds. In any case, yes, if you wanted to model a fixed nominal ROR you'd have to adjust the real ROR for the corresponding asset classes whenever you wanted to evaluate different inflation scenarios. There are no alternatives other than to eliminate this from the ROR being modeled via the Financial Assets pages and put the growth due to the CD's (and maybe bonds) as a separate income stream on the Income page.
2) The Financial Assets > Asset Allocation page provides you with the ability to specify different asset allocations for each of five time periods, so that will go a long way to avoiding the problem you're describing here.
Stuart Matthews
Stuart,
Thanks for the quick reply. At a minimum, it helps verify my understanding of how PRC operates which is my primary concern as I get up to speed on this awesome tool!
That said, I'm not sure I fully understand your reply to 2). Suppose I have an IRA with a current allocation of 80% stocks and 20% in a CD that matures in 5 years. As I understand it, PRC will recalculate the balance of the account each year factoring in withdrawals, contributions and growth and then rebalance the account based on the allocations specified. In reality, there's no rebalancing that will happen until the CD matures. So, over time, it seems that the amount PRC thinks is allocated to stocks in that account will drift from what's actually happening. It's not clear to me how utilizing different time periods with different asset allocations would address this without a lot of effort on my part to figure out when and how much of a course correction to introduce.
However, I may be getting into the weeds here. It may very well be that in the scheme of things, across a 30 year retirement, approximating fixed income instruments as more generic asset classes gets close enough. But that's part of what I'm trying to figure out... ?
@danas467 Eric, it sounds like you've got a good understanding of the process. In your 80/20 example, if the stocks appreciated faster than the CD's PRC's annual rebalancing scheme would effectively be contributing more dollars to CD's each year (which would diverge from your actual case). The only way to counter that would be for you to do manual calculations at a few points (as you've surmised) to determine different allocations for future time periods. I don't know of a better way to do this. Whether you're getting into the weeds, I'd say maybe. The good news, from my perspective anyway, is that just leaving it alone at 80/20 and not sweating this detail will result in a more conservative long-term projection than would be the case if the rebalancing wasn't done.
