Nestegg Cycle © HELP Set Crash Cushioning (Crash Points)
Posting Date: Jan.28, 2025Rev.A: May.22, 2025
For more background about Crash-Points, including derivation of the equations,
and our special definition of a Crash, the special case of the Crash to 100%,
and our DISCLAIMERS, please see THIS ARTICLE
Links to new Crash-Point (CP) "SOLVER" tools:
SOLVE_target_CP1_payout
SOLVE_target_CP2_reserve
* * * * * * * *
Crash Cushioning Parameters, on the Retirement Contribution Calculator screen:
Target CP1: First layer of protection, to be achieved with extra invested principal
Can be bypassed by clicking on the "skip" checkbox to its right.
Target CP2: Second layer of protection, to be achieved with extra money in a separate cash reserve
Can be bypassed by providing a number equal to or greater than the Target CP1.
The "Feel" of the Crash-Point
Based on a newly devised metric, the Crash-Point, conceived and researched by the author throughout the year 2024 and early 2025,
any given payout scheme responds to sustained periods of market under-performance along a scale ranging from
"harsh, brittle and unstable" at one end (high crash-point),
to "well cushioned, resilient and stable" at the other end (low crash-point).
A "neutral" Crash-Point value is 1.00, the upper limit of order and control. You want to be well below this number.
Crash-Point values less than 1.00, such as 0.80 or 0.50 or 0.20, are increasingly stable, requiring less and less attention or intervention during a sustained period of market under-performance.
A crash-point, when less than or equal to 1.00, is "the outer edge of OK".
A small step beyond will cause small long term damage; a larger step beyond will cause more damage.
The technical meaning of the crash-point, is a survivable drop-to percentage for your portfolio for the duration of the crash length specified,
while maintaining full payouts.
Thus, protection to a target 3-yr CP of 0.25 means you would survive a 3 year sustained drop to 25% of your portfolio's original value, still take full payouts, and come out "whole" at the end of the crash.
So for example, if you started retirement with 1 million dollars, the implication here is that
your portfolio could drop to 250,000 for 3 years, and you'd still be fine.
Note that the word "whole" is in quotes because, while you will survive retirement, all the cushioning you started with, is now gone.
There will be no money left over at the end.
A second period of market under-performance would leave you with a retirement shortfall.
And of course, Crash-Point values greater than 1.000, such as 1.01, 2.00, 4.00, or 8.00, are increasingly UN-stable, requiring more and more attention or intervention during a sustained period of market under-performance.
The implication of Crash-Point values greater than 1.000, is that at a "Crash to 100%" (a sustained period of stagnation), you would need to get some or most of your payout from elsewhere:
at CP = 1.10, your portfolio can only support 1/1.10 or 90.909% of your payout;
at CP = 2, your portfolio can only support 1/2 or 50% of your payout;
at CP = 10, your portfolio can only support 1/10 or 10% of your payout;
Cost-Benefit Considerations:
The Original CP, for the maximal possible payout per unit of principal, is now displayed as well.
This is the rating, on the same CP scale, but for the initial output of the annuity calculation.
Usually well over 1.0, this can fail easily if there is any market underperformance during early years of retirement.
The default settings
If desired, you can make the entire protection adjustment as CP2 only,
or as CP1 only.
CP1 only is the most worry-free, but also the most expensive.
CP2 only is the cheapest, but requires the most ongoing attention during retirement payouts.
If CP2 is to be used at all, it is strongly recommended that the CP1 target be set to 1.000 or less.
The crash length of 3 years seems intuitively to the author, to be a good amount of time for a very severe crash.
You can specify any decimal value for the crash length, as you see fit:
Smaller values will be cheaper but the protection will be less strong, and the opposite for larger values.
You may also want to consider the risk of a "lost decade", a much longer period of say 10-15 years of stagnation, where your investment fails to grow at all.
An example of parameter values to protect for this:
Crash Length = 12.5 years, Target CP1 = 1.000, Target CP2 = 0.999
How much protection do you actually NEED?
We have only one real life data point thus far, but it is a very good one:
Bill Bengen's study of 30 year retirements beginning in each year from 1926 to 1976,
assuming a portfolio with this specific investment investment mix: 50% US Stock Market / 50% US Intermediate length Treasuries,
at a NET Yield (above inflation) of 4.5631%
This is the same study that produced the famous "4% Rule" and it corresponds to protection to a 3-year crash-point of 0.34283,
or about 34.3% when the payout was limited to 4.0% (revised to 4.15%).
This same scenario will alternately survive a "lost decade" of up to 12 years.
This means we could survive EITHER the 3 year deep crash, OR the "lost decade", but NOT BOTH!
So a first cut answer is that your payout plan needs protection to the level of a 3 year crash to 34.3% --
PROVIDED THAT
your payout and investment conditions are at or very close to those used for the "4% Rule"!
Thus we have the reality check of 80 years of history in the 20-th century;
there can be NO GUARANTEE that the world will behave similarly and not worse, in the coming decades!
But it is the best information we have.
For any OTHER conditions (NOT 30 years; NOT that same 50/50 investment mix) this is really unknown territory.
We believe the logic and formulas make sense, but do be aware that this is new theory, in need of real world research!
Some Examples, Compared and Contrasted
Consider three runs of the NesteggCycle calculator, all using these same basic parameters:
Goal salary replacement: 50% of final; No prior savings; Inflation 2.5%; Raises 3.0%. Work and save for 42 years, ages 25-67; Retire and collect payouts for 38 years, ages 67-105.
But we'll vary the Crash-Point parameters for each run, and discuss the differences.
For brevity and clarity of this illustration, we have removed the solution rows for original contributions of 2.5%, 5.0%, and 40%.
Most people will tend toward solutions in the 10% and 20% contribution range.
The 80% contribution rows are included because they illustrate a special situation.
EX01: Crash Length(yr): 3.00 / Target CP1: 0.85 / Target CP2: 0.20 ORIG Nominal Net ORIG tgt-CP1 tgt-CP2 tgt-CP2 contrib Yield sav/sal withdrw Yield CP1 contrib contrib reserve ... 10.00% 1 6.554% 9.748X 5.130% 3.955% 4.198 11.444 12.621 9.325% 20.00% 1 4.772% 12.753X 3.921% 2.216% 2.250 21.722 23.521 7.648% ... 80.00% 1 1.239% 24.412X 2.048% -1.230% 0.633 78.011 81.770 4.597% ---------------------------------------------------------------------------------------- EX02: Crash Length(yr): 3.00 / Target CP1: 0.85 (skipped) / Target CP2: 0.20 ORIG Nominal Net ORIG tgt-CP1 tgt-CP2 tgt-CP2 contrib Yield sav/sal withdrw Yield CP1 contrib contrib reserve ... 10.00% 1 6.554% 9.748X 5.130% 3.955% 4.198 10.000 11.466 12.783% 20.00% 1 4.772% 12.753X 3.921% 2.216% 2.250 20.000 22.143 9.680% ... 80.00% 1 1.239% 24.412X 2.048% -1.230% 0.633 80.000 83.361 4.032% ---------------------------------------------------------------------------------------- EX03: Crash Length(yr): 3.00 / Target CP1: 0.20 / Target CP2: 0.20 (skipped) ORIG Nominal Net ORIG tgt-CP1 tgt-CP2 tgt-CP2 contrib Yield sav/sal withdrw Yield CP1 contrib contrib reserve ... 10.00% 1 6.554% 9.748X 5.130% 3.955% 4.198 17.328 17.328 0.000% 20.00% 1 4.772% 12.753X 3.921% 2.216% 2.250 30.717 30.717 0.000% ... 80.00% 1 1.239% 24.412X 2.048% -1.230% 0.633 96.807 96.807 0.000% ---------------------------------------------------------------------------------------- In the explanation that follows, we look at EX01, the row starting with "10.00%", in greater detail. The left-most columns are the same as in the previous version, though slightly re-named, ORIG contrib, Nominal Yield, sav/sal, and withdrw. These are NOT affected by the crash-point parameter values. 10.00% 1 6.554% 9.748X 5.130% The columns to the right of those, are new to the Crash-Point version: 3.955% 4.198 11.444 12.621 9.325% The Net Yield (here, 3.955%) is based on the Nominal Yield (just above, 6.554%) This too is NOT affected by the crash-point parameter values, but was not displayed in the previous version. The next column rightward (here, 4.198) is the Original CP. This depends on the choice of Crash Length entered (here, 3.00 years) but is the unmodified crash-point, directly out of the annuity calculator. This value, 4.198, is much too high for comfort in a market downturn. Each new processing step has an extra column to the right. The remaining three columns (here, 11.444, 12.621, 9.325%) show: 11.444 - the salary contribution, adjusted upward from the initial 10%, needed to fund the same payout but crash-protected down to the target CP1 (here 0.85) 12.621 - the salary contribution, adjusted farther upward, needed to fund the same payout but additionally crash-protected down to the target CP2 (here 0.20) 9.325% - the separate CASH RESERVE created by the extra contribution, to support the target CP2. Other Observations: When the Target CP1 calculation is skipped, as in EX02, the Target CP1 column repeats the original contribution, as no adjustment has been made. When the Target CP2 calculation is skipped, as in EX03, the Target CP2 column repeats the Target CP1 column, as no adjustment has been made; and the Target CP2 reserve amount is zero -- we have NOT provided for a cash reserve. Solutions with the smallest original contributions and thus highest required yields, also require the largest adjustments to satisfy the target CPs, and the largest cash reserves. Protecting against more severe crashes (smaller target CP1 or CP2) raises the cost, so there is the practical trade-off of providing good enough protection without breaking the bank. For an original contribution amount of 80% (not usually a realistic possibility) the Original CP is only 0.633; but in EX01, we want to calculate a target CP1 of 0.85. This "breaks the model" of what we are trying to do, causes an adjustment in the wrong direction, and needs to be discarded. It is not a meaningful result. If there were serious interest in pursuing this, one could handle it individually, using the SOLVER links provided at the top of this posting.