When I first heard the term, “Monte Carlo,” early in my financial advisory career, I was wondering what a Chevy sports car had to do with financial planning.
If your mind didn’t go there, maybe it goes to the Monte Carlo district of Monaco, known for its Formula One races, supercars, fashion, and casinos.
The short history of the Monte Carlo analysis involves two scientists trying to solve complex mathematical problems related to the Manhattan Project. The name, Monte Carlo, was actually a nod to the Monte Carlo Casino in Monaco, to reflect its primary goal of forecasting randomness and probability. Since its development, it has been used in a variety of industries and applications in attempts to forecast or estimate risk.1Changes in needs: The Monte Carlo analysis will not factor in changes in spending needs. If you are concerned about planning for unexpected future expenses such as long-term care, disability, premature death, etc., those would all need to be factored in as separate scenarios.
Retirement Income: The Monte Carlo specifically looks at remaining portfolio assets. If you have Social Security benefits, pension, etc., those income sources would continue even if your portfolio assets were depleted.
Likelihood of failure: If the Monte Carlo analysis shows an 80% probability of success, it’s easy to shift the focus to a 20% chance of failure. The INCORRECT analogy would be if you knew, getting on a bus, there was a 20% likelihood of a fatal crash, most people would certainly not board that bus. This is inaccurate because you’re the one in the driver’s seat. If you are approaching traffic congestion or dangerous road conditions, you can adjust your route to reach your destination. Similarly with the Monte Carlo analysis, if we’re experiencing broad economic hardships or significant market volatility, we can make adjustments to realize “success”. So, if you have a Monte Carlo score of 70%, rather than talking about the 30% as failure, it would be better to say that there’s a 30% chance something about your plan may have to change.
What the Monte Carlo analysis is NOT showing
Changes in needs: The Monte Carlo analysis will not factor in changes in spending needs. If you are concerned about planning for unexpected future expenses such as long-term care, disability, premature death, etc., those would all need to be factored in as separate scenarios.
Retirement Income: The Monte Carlo specifically looks at remaining portfolio assets. If you have Social Security benefits, pension, etc., those income sources would continue even if your portfolio assets were depleted.
Likelihood of failure: If the Monte Carlo analysis shows an 80% probability of success, it’s easy to shift the focus to a 20% chance of failure. The INCORRECT analogy would be if you knew, getting on a bus, there was a 20% likelihood of a fatal crash, most people would certainly not board that bus. This is inaccurate because you’re the one in the driver’s seat. If you are approaching traffic congestion or dangerous road conditions, you can adjust your route to reach your destination. Similarly with the Monte Carlo analysis, if we’re experiencing broad economic hardships or significant market volatility, we can make adjustments to realize “success”. So, if you have a Monte Carlo score of 70%, rather than talking about the 30% as failure, it would be better to say that there’s a 30% chance something about your plan may have to change.
What “probability of success” should I aim for before I retire?
Unsurprisingly to most, the answer to this question depends on your specific situation.
Example 1: A couple in their early 60s wanting to retire. They’ve looked at their spending and realized there is little discretionary spending and a relatively small percentage of it is covered by guaranteed income, such as Social Security. These individuals would likely want to aim for a relatively high probability of success before making the decision to retire, because they will need their portfolio to cover most of their living expenses throughout retirement.
Example 2: Another couple in their 60s looking to retire. This couple will have enough Social Security income to cover their day-to-day living expenses, which will remain modest. They look at their portfolio purely as savings and discretionary funds and have no specific goals to leave to heirs. These clients would likely not need as high of a probability of success since their reliance on their portfolio will be minimal.
There is no “one-size-fits-all” strategy but if you’re looking for a rule of thumb, a lot of advisors like to aim for 80%+ as a starting point when having the retirement conversation. Obviously, that number may need to be adjusted based on your risk tolerance as an investor, your future goals, and the fact set of your finances.
In summary, the Monte Carlo analysis is a great tool to illustrate market risk applied to your specific financial plan. However, it is just one tool and one measurement that changes over time as your plan and market conditions change. This is why it is important to meet with your advisor, at least annually, to review, update, and make adjustments to your financial plan as time passes. At Foster Group, truly caring for our clients means taking the time to understand your aspirations and providing personalized guidance to help you achieve your financial goals.
There are many ways to translate a desire to give into positive action!
Most charities would tell you there simply aren’t enough hands to do everything they’d like to accomplish. Volunteering your time can be a precious gift in bridging that capacity gap. Whether it’s serving meals, mentoring youth, or helping at fundraising events, your presence is not only transformative, it can be priceless.
