I thought the 2007 crash was even worse than that and yet you say your formula survived that crash without negative returns
Hi Duke. The difference between the real world 2007 and the simulated Year 5 is that the historic 2007 smoothed value was below market value. This served as a cushion in the subsequent market fall. The same isn't true in the simulated Year 5 experience.
But you have to pick a starting point!
Yes, Coyote, you have to pick a starting point. It's the market value at the start. You don't speculate whether the smoothed value at the start should be lower or higher than the market value. I worried a bit about that too when I started down this road, but it's actually not that important in reality. In particular you don't "start your fund in 2019 using the benefit of positive returns since 1999". And yes, you do start in 2019. If you look at the formula, there is an inbuilt assumption that, in the long-term, equities will outperform bonds. The assumed outperformance in the formula is less than has been achieved in reality. You asked about people who will only have the benefit of 10 years' paid-in contributions when they begin drawdown. In that 10 years they will be given the benefit of a 3% (3.5% less 0.5% management charge) excess performance over bonds from day 1. That will be modified slightly as actual results unfold. In particular, if equities and property have a bad run, they won't suffer negative returns. Remember also that there is cross-generational solidarity, so if, for example, markets fall sharply in year 1 and recover from year 2 onwards, the people who joined in year 1 will share the benefits of the uplift in year 2 which, in a unit-linked fund, would be enjoyed exclusively by the year 2 joiners.
The simplest way to understand the points I'm trying to get across is to work through the example in Appendix 2 of my submission of 4 November 2018 to government (
here). Appendix 2 is on pages 12 and 13. The example chosen to illustrate the formula in action is not dissimilar to the question you're asking. Market values fall by 2% in each of months 1 to 5, then rise by 4% in month 6. The monthly smoothed interest rate is 0.380% in month 1, then falls gradually in months 2 to 5, reaching 0.319% in month 5, then rises to 0.391% in month 6.
In summary, I have addressed what you think is a flaw. (I'm not saying the proposal is f lawless, though!!!).