We use the concept of “Income at Risk”, which is the size of a drop in the sustainable income from the fund with a 1 in 4 chance after 3 years.
We calculate the initial sustainable income as the median (or 50th percentile) level that can be provided by using all the fund (both income and capital), so that the fund is fully exhausted by the end of the period. This assumes income that doesn’t increase over time.
We then recalculate the same sustainable income after 3 years and compare the levels for each of the 10,000 scenarios. This provides us with a range of outcomes for the client’s potential level of income.
We order these from smallest to largest and look at the value which is the 2,500th outcome, i.e. at the 25th percentile which represents the drop in income with a 1 in 4 chance after 3 years.
This concept is comparable to the already familiar concept of “Value at Risk” which refers to the amount by which a fund may drop in value, but here we are using the level of income per year rather than a lump sum value.
The fund is then categorised according to the size of the potential drop based on this Income at Risk.