Posted by Kyle Rolek,
CERTIFIED FINANCIAL PLANNER™
President,
Rolek Retirement Strategies
Many people use
an average rate of return to calculate how much they will need for retirement.
This method fails to account for market ups and downs that will occur
throughout retirement, causes inaccurate planning results, and can create a
false sense of confidence.
The Monte Carlo
Probability of Success indicates the likelihood of funding all of your goals
based on portfolio volatility. This accounts for inevitable market swings and
paints a far more accurate picture of what retirement will really look vs.
using an average rate of return.
The Monte Carlo result calculates
a probability of success by simulating thousands of possible return sequences.
This probability of success accounts for portfolio volatility based on the
return and standard deviation of your portfolio. An 82% Probability of Success
tells us that if we ran the plan 10,000 times, varying the portfolio return
every year, the plan would successfully fund 100% of the goals 8,200 times. In
the remaining 1,800 scenarios, there would be some sort of shortfall in funding
the goals. The graph below displays 1,000 Monte Carlo trials that help
illustrate to the client the concept of Monte Carlo and the impact of
volatility on their portfolio value.
The probability
of success is displayed using a Monte Carlo meter that is divided into three
segments -- Below Confidence Zone, In Confidence Zone, and Above Confidence
Zone. The Confidence Zone can be used as a guide to manage retirement
expectations.*
Credible retirement planning
institutions use Monte Carlo simulations to help clients create accurate
retirement plans. Money Guide Pro is an industry leader in Monte Carlo
Simulations for retirement and is used by Rolek Retirement Strategies and many
other excellent retirement planning firms.
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