Monte-Carlo sim­u­la­tions are a math­e­mat­i­cal tool often used for retire­ment plan­ning. They are more real­is­tic com­pared than sim­pler meth­ods. The sim­plest approach – a ‘straight-line’ fore­cast – makes the assump­tions that returns are con­stant. Obvi­ously such a triv­ial pro­jec­tion is fatally flawed: as we all know too well, real world returns aren’t at all con­stant from year to year.

In con­trast to, MSCs (MSC) explic­itly allows for volatil­ity and vari­abil­ity of mar­ket returns and other vari­ables. A MSC gen­er­ates a mul­ti­tude of ‘runs’ where each run is a sequence of ran­dom ‘flips of a coin’ of these vari­ables. But even this more sophis­ti­cated approach has its own prob­lem; as we all know, past results do not fore­tell the future: the behav­ior of equity and bond mar­kets are sim­ply impos­si­ble to pre­dict. Even if thou­sands of Monte-Carlo runs sug­gest that an investor’s prospects for a secure retire­ment are sound, given the sta­tis­ti­cal nature of the beast one always has to take MCS results with a gigan­tic grain of salt. One has to con­sider worst-case sce­nar­ios, not just median cases. But hav­ing said that, spend­ing a bit of time run­ning some Monte-Carlo sce­nar­ios can be quite help­ful for most peo­ple… and it can often help them sleep better!

For exam­ple, con­sider a 10 year MCS for an investor with a $1M. It might find a best-case (say the aver­age of the top 5% of the sim­u­la­tion runs) where the port­fo­lio grew by 10.8% to $2.7M while in a most-likely sce­nario (the mean) the investor ended up with $2.0M (a 7.4% return). Finally, it might find that in the worse case –the lower 5% of all runs– the investor’s end­ing port­fo­lio value was only $1.4M — a mere 3.8% return. By pro­vid­ing such var­ied sce­nar­ios, MCSs can give a bet­ter idea of the range of pos­si­bil­i­ties; no par­tic­u­lar out­come should be under­stood to being par­tic­u­larly ‘likely’.

Unfor­tu­nately most of MSC tools are very com­plex to use and costly – they are typ­i­cally mar­keted to finan­cial plan­ners. Even to answer the most basic ques­tions, these ‘pro­fes­sional’ tools require a plan­ner to spend huge amounts of time enter­ing gobs of infor­ma­tion about a client and to make pre­dic­tions of future mar­ket returns, volatil­ity, and tax rates. Here is the flaw: of course all finan­cial prog­nos­ti­ca­tions are fraught with peril. Garbage-in, garbage out. While these reports typ­i­cally pro­duce reports in excess of 50 pages much of their volu­mi­nous out­put is of lit­tle use. From our expe­ri­ence, most clients find these reports inac­ces­si­ble and over­whelm­ing. More­over, we have found that most peo­ple are sim­ply try­ing to assess how secure might their retire­ment might be:

  • Will their cur­rent invest­ment and sav­ings plan power their retirement?
  • How much might they have at, say, age 75?
  • How much might they leave to their children?
  • What is the most, least, and the median amount of their estate when they die?

Luck­ily, there are a few easy to use – and free – tools out there. By far our favorite is ‘The Flex­i­ble Retire­ment Plan­ner’. In a few min­utes this free web based tool can help answer the above ques­tions …and more. We have tried sev­eral costly pro­fes­sional tools and found them cum­ber­some to use while pro­vid­ing no clearer answers to the ques­tions we seek.

Flexible Retirement Planner

3 factor Indexing is in no way asso­ci­ated with The Flex­i­ble Retire­ment Planner.

Better Returns Through Research

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(1) Analy­sis com­par­ing after tax per­for­mance of other advi­sors (or a self-managed, sophis­ti­cated investor) to 3 factor Indexing based on a glob­ally diver­si­fied port­fo­lio with a 60% equity, 40% fixed income allo­ca­tion. Ini­tial port­fo­lio val­ues assume the fol­low­ing: (a) $750 tax­able and $250k IRA with yearly addi­tions of $20k to tax­able account and $5k to IRA. (b)Taxes deducted via shares each April, assum­ing the high­est tax bracket for a Cal­i­for­nia investor. 

Past per­for­mance is not a pre­dic­tor of future performance.

3 factor has con­ducted exten­sive analy­sis con­cern­ing port­fo­lio per­for­mance. See “impor­tant dis­clo­sure” for details and dis­claimers regard­ing our state­ments con­cern­ing per­for­mance, and the var­i­ous assump­tions we have made in our analy­sis.