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Cash Flow Projection with Fixed Percent Pay Out

What do you do when you have a cash flow projection for a portfolio that pays out a fixed percent of assets? How do you model cash flows at different confidence intervals. For example, I would like to project wealth at a 75% confidence level while maintaining a 5% payout.

Answer
If you are working on a case for a foundation or endowment with a required spending rate, consider the following approach:

Alternative 1:
The endowment has a $1,000,000 portfolio. The first year cash flow is $50,000. Calculate the annual growth rate using the expected return of the portfolio. For example, if the expected return of the portfolio is 8%, and the first year cash flow in this example is 5% of the starting value of the portfolio the distribution should grow annually at 3% (i.e. 8%-5%).

Next, run the simulation and proceed to the “Wealth Potential” screen. Specify the confidence parameter at 0.75 (this is equivalent to 75%). The data and charts will update to present the portfolio(s) values with at a 75% confidence. This will be a conservative estimate of the portfolio value if the spending steps down in lower return years.

Alternative 2:
You could model the portfolio without cash flows to calculate the portfolio expected return with a 75% confidence using “Wealth Potential”. For example,  the portfolio is expected to grow to $2,000,000 at a 75% confidence in 10 years. We can now solve for the annual return which will be lower than 8%. Let’s say it’s 6.5%. You now use $50,000 cash flows with a growth rate of 1.5%. Input these values and then go back to “Wealth Potential”. You will not need to re-run the simulation.


Category:Understanding the Software -> Cash Flows

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