Menu
Business and Personal Finance
Are You Mature Enough To Buy A Home?
Should Sports Teams Receive Tax Breaks?
Is A Retirement Career Right For You?
Who Benefits From ETFs In 529 Plans?
Why You Shouldn't Die In 2013
How To Determine Your Business' Target Market
Who Does The Current Tax Code Benefit?
Savings Plans That Can Make Good Christmas Gifts For Kids
Varieties Of Brokers And How To Pick The Best One
Why Credit Card Debt Levels Are Rising
Benefits Of Paying Off Your Mortgage
How To Recommend A Stock
Are Distressed Homes Worth Buying?
How To Get A Relocation Allowance
How To Start A Charity
4 Business Partnership Mistakes To Avoid
How To Spot Knockoff Labels And Fake Products
8 Qualities That Make A Good Insurance Agent
Using Social Media To Reach Customer Service Departments
How To Make Money Busking
The Difference Between Being Fired And Resigning
3 Banking Moves You Should Make Before Traveling
What To Do If Your Company Cuts Your 401(k)
Money Saving Tips From Your Grandparents
Planning Your Retirement Using The Monte Carlo Simulation
The city of Monte Carlo in the country of Monaco has long served as a playground for the jet set, where rich gamblers who can afford to lose huge sums of money come to play for big stakes in games of random chance where strategy and experience can provide little or no benefit. But those who are trying to plan for a secure retirement and can't afford to lose their savings don't want to take big chances with their money.

How It Works
Although naming this type of calculation after a gambling mecca may seem a bit ironic, it has come to be used in the financial arena to signify a planning technique used to calculate the percentage probability of specific scenarios that are based upon a set group of assumptions and standard deviations. This method of calculation has often been used in investment and retirement planning to project the likelihood of achieving one's financial or retirement goals and whether or not a retiree will have enough income to live on for life, given a wide range of possible outcomes in the markets. While there are no absolute parameters for this type of projection, the underlying assumptions for these calculations typically include such factors as interest rates, the client's age and projected time to retirement, the amount of the investment portfolio that is spent or withdrawn each year and the portfolio allocation. The computer model then runs hundreds or thousands of possible outcomes using actual historical financial data. The results of this analysis usually come in the form of a bell curve, where the middle part of the curve delineates the scenarios that are statistically and historically the most likely to happen while the ends, or tails measure the diminishing likelihood of the more extreme scenarios that could also occur.

Limitations
Despite its apparently thorough mathematical breakdown of possible future outcomes, recent market turbulence has served to expose a major weakness that seems to afflict this method of financial projections. While its supporters are quick to point out that Monte Carlo simulations generally provide much more realistic scenarios than simple projections that assume a given rate of return on capital, critics contend that Monte Carlo analysis cannot accurately factor infrequent but radical events, such as market crashes, into its probability analysis. Many investors and professionals who used this methodology were not shown a real possibility of market performance such as we have had over the past few years.

In his paper, The Retirement Calculator from Hell, William Bernstein clearly illustrates this shortcoming. He uses an example of a series of coin tosses to prove his point, where heads equals a market gain of 30% and tails represents a loss of 10%. If you start with a $1,000,000 portfolio and toss the coin once a year for 30 years, you will end up with an average annual total return of 8.17% over that time. That means that you could withdraw $81,700 per year for 30 years before exhausting your principal. If you were to flip tails every year for the first 15 years, however, you would only be able to withdraw $18,600 per year, while if you were lucky enough to flip heads the first 15 times you could take out a whopping $248,600. And while the odds of flipping either heads or tails 15 times in a row seems statistically remote, Bernstein further proves his point using a hypothetical illustration based on a portfolio of one million dollars that was invested in five different combinations of large and small cap stocks and five-year treasuries back in 1966. That year marked the beginning of a 17-year stretch of zero market gains when you factor in inflation. History shows that the money would have been exhausted in less than 15 years at the mathematically-based average withdrawal rate of $81,700. In fact, withdrawals had to be cut in half before the money lasted for the full 30 years.

How Can I Plan Realistically Instead?
There are a few basic adjustments that experts suggest can help remedy the shortcomings of the Monte Carlo projections. The first is to simply add on a flat increase to the possibility of financial failure that the numbers show, such as 10 or 20 percent. Another is to plot out projections that use a percentage of assets each year instead of a set dollar amount, which will greatly reduce the possibility of running out of principal.

The Bottom Line
There is no absolutely foolproof way to predict what will happen in the future. But running a Monte Carlo analysis that allows for the real possibility of disaster can give you a clearer picture of how much money you can safely withdraw from your retirement savings.

Print
How Inflation Affects Your Net Worth
Ways To Destroy Your Net Worth
Rebalancing Your Portfolio For The Fiscal Cliff
Why Santa Is The Shrewdest Businessman
Gift-Giving Etiquette
How To Financially Prepare For A Doomsday Scenario
What People Spend On Christmas Around The World
5 Most Financially-Lucrative Toy Fads
Is Free Shipping Worth It?
How Much Your New Year's Partying Could Cost You
The Fiscal Cliff And Your 401(k)
Fiscal Cliff Implications For Year-End Tax Planning
5 Viable Career Options In 2013
Save Early For Retirement If You're A High Earner
Languages That Give You The Best Chance To Broaden Your Career
Top-Paying Contract Positions
A Look Into Proposition 30
The Real Risks Of Entrepreneurship
What New Student Loan Repayment Options Mean
3 Famous People With MBAs
How To Play Dividends During The Fiscal Cliff
The Highest Paying Jobs In 2013
Top Employment Skills For 2013
Don't Judge Your Partner Based On Credit Score
Most Affordable Cups of Coffee
Planning Your Retirement Using The Monte Carlo Simulation
How To Dine Out Without Breaking The Bank
The Real Cost Of Volunteer Tourism
Top 5 Business Alternatives To Facebook
Plethora Of 401(K) And IRA Changes Coming
How To Improve Net Worth By Decreasing Liabilities
6 Top-Paying Freelance Jobs
Should You Poach Clients From Other Advisors?
Gifts For People You Aren't That Close To
How The Fiscal Cliff Could Affect Your Net Worth
Why You Should Know Your Net Worth In Retirement
How Credit Cards Will Change In 2013
Why You Should Know Your Net Worth In Your 20s
Students: Don't Be Afraid Of Your Net Worth
Average Net Worth Of The 1%
6 Tips For Increasing Your Net Worth
Share 0 Disqus Net Worth Of Citizens Around The World
The Cost Of Santa's Trip On Christmas Eve
Why You Should Embrace Online Shopping
How To Advise A Couple Starting A Family
7 Tips For Outlet Mall Shopping
All I Want for Christmas Is A Santa Claus Rally
Social Faux Pas Made By Frugal People
The True Cost Of Pharmaceutical Scandals
Will Your Net Worth Be Affected By A Recession?
Are You On Track To Hit Your Desired Net Worth By Retirement?
Net Worth Throughout Your Life