What will your investment portfolio be worth in 10 years? In 20 years? When will you stop working? The Human Resources Department at Four Corners Corporation was asked to develop a financial planning model that would help employees address these questions.

Tom Gifford was asked to lead this effort and decided to begin by developing a financial plan for himself. Tom has a degree in business, and, at the age of 40, is making $85,000 per year. Through contributions to his companys retirement program and the receipt of a small inheritance, Tom has accumulated a portfolio valued at $50,000. Tom plans to work 20 more years and hopes to accumulate a portfolio valued at $1,000,000. Can he do it?

Tom began with a few assumptions about his future salary, his new investment contributions, and his portfolio growth rate. He assumed a 5% annual salary growth rate and plans to make new investment contributions at 6% of his salary. After some research on historical stock market performance, Tom decided that a 10% annual portfolio growth rate was reasonable. Using these assumptions, Tom created an Excel worksheet (FourCorners.xlsx).

The worksheet provides a financial projection for the next five years. In computing the portfolio earnings for a given year, Tom assumed that his new investment contribution would occur evenly throughout the year, and thus half of the new investment could be included in the calculation of the portfolio earnings for the year. From the worksheet, Tom is projected to have a portfolio valued at $116,321 at age 45.

Toms plan was to use this worksheet as a template to develop financial plans for the companys employees. The data in the spreadsheet would be tailored for each employee, and rows would be added to reflect the employees planning horizon. After adding another 15 rows to the worksheet, Tom found that he could expect to have a portfolio of $772,722 after 20 years. Tom took the results to show his boss, Kate Kelly.

Although Kate was pleased with Toms progress, she voiced several criticisms. One was the assumption of a constant salary growth rate. She noted that most employees experience some variation in the annual salary growth rate from year to year. In addition, she pointed out that the constant annual portfolio growth rate was unrealistic and that the actual growth rate would vary considerably from year to year. She suggested that a simulation model for the portfolio projection might allow Tom to account for the random variability in the salary growth rate and the portfolio growth rate.

After some research, Tom and Kate decided to assume that the annual salary growth rate would vary from 0% to 5% and that a uniform probability distribution would provide a realistic approximation. Four Corners accountants suggested that the annual portfolio growth rate could be approximated by the normal probability distribution with a mean of 10% and a standard deviation of 5%. With this information, Tom set off to re-design his spreadsheet so it could be used by the companys employees for financial planning.

Play the role of Tom Gifford and develop a simulation model for financial planning at Four Corners. Write a report for Toms boss and include the following:

1. Without considering random variability, extend the current worksheet to 20 years. Confirm that by using the constant annual salary growth rate and the constant annual portfolio growth rate Tom can expect to have a 20-year portfolio of $772,722. What would Toms annual investment rate have to be in order for his portfolio to reach a 20-year goal of $1,000,000? (Hint: use Excels Goal Seek)
2. Re-design the spreadsheet model to incorporate the random variability of the annual salary growth rate and the annual portfolio growth rate into a simulation model. Assume that Tom is willing to use the annual investment rate that predicted a 20-year $1,000,000 portfolio from your answer to part a above. Run the simulation model 25 times and determine the mean and standard deviation of the 20-year result.
3. What recommendations do you have for employees with a current profile similar to Toms after seeing the impact of the uncertainty in the annual salary growth rate and the annual portfolio growth rate? What should employees do to give themselves a better chance of reaching the 20-year $1,000,000 goal? Use the results from the simulation model to support your recommendations.
4. Assume that Tom is willing to consider working 25 more years instead of 20 more years. Re-run the model 25 times and determine the mean and standard deviation of the 25-year result. What is your assessment of this strategy if Toms goal is still to have a portfolio worth $1,000,000? Use the results from the simulation model to support your assessment.

A B D E F G 1 Four Corners 2 3 Age 40 4 Current Salary $85,000 5 Current Portfolio $50,000 6 Annual Investment Rate 6.00% 7 Salary Growth Rate 5% 8 Portfolio Growth Rate 10% 9 10 Year Beginning Balance Salary New Investment Earnings Ending Balance Age 11 1 $50,000 $85,000 $5,100 $5,255 $60,355 41 12 2 $60,355 $89,250 $5,355 $6,303 $72,013 42 13 3 $72,013 $93,713 $5,623 $7,482 $85,118 43 14 4 $85,1181 $98,398 $5,904 $8,807 $99,829 44 15 $99,829 $103,318 $6,199 $10,2931 $116,3210 45