Don't Gamble When It Comes to Your Retirement

Most people associate Monte Carlo with gambling and the lifestyles of the rich and famous. As investors, however, you should be familiar with another meaning.

A "Monte Carlo analysis" can be used to determine if you are on track to retire with dignity or more likely to run out of money and spend your "golden years" destitute and dependent on family or the government for your monthly expenses.

In a Monte Carlo analysis, the computer generates a large number of future return scenarios and computes the statistical likelihood of your portfolio surviving to the end of a designated period. The results of the analysis are heavily dependent on the assumptions, so great care must be taken to make the assumptions as accurate as possible.

The assumptions I use in the Monte Carlo analysis include:
  • The beginning portfolio value;
  • The number of years (according to actuarial tables) of life remaining for my client;
  • Future deposits and withdrawals in retirement;
  • Inflation rate; and
  • The distribution of returns for the portfolio selected based on past returns. I use either 83 years of data (which includes the Great Depression) or 50 years of data.
10,000 Retirement Scenarios

The computer generates 10,000 different scenarios of year-by-year returns and calculates the value of the portfolio at the end of each year. The end product is the "portfolio survival rate," which computes the odds of the portfolio surviving. For example, if the portfolio is in negative territory for 1,000 of 10,000 trials, the portfolio survival rate would be 90%. I regard a portfolio survival rate of less than 95% as unacceptable.

You can input your assumptions and obtain a Monte Carlo analysis for your portfolio here. (Full disclosure: The input form was designed, and the reports are generated, by Index Funds Advisors, with whom I am affiliated.)

It's not surprising that most investors have no clearly defined goal for their investments. The financial media and "market- beating" brokers and advisors focus on trying to predict the direction of the markets, picking stock winners, and selecting the next "hot" mutual fund manager. Few investors understand no one has the expertise to engage successfully in any of these activities.

Here's the question I ask every investor: Would you find it helpful to understand how to structure a portfolio that will maximize the possibility of your money lasting longer than you and your surviving spouse or partner, for a given level of risk? I have never had a negative response to that question, but I have also never posed it to an investor who had a clue whether he or she was on the right or wrong path towards achieving that goal.

Running a Monte Carlo analysis is not perfect. It is not predictive since it is based solely on long-term historical data. Nevertheless, it is a lot better than the "wing and prayer" that passes for investing "advice" at the office of your retail broker.

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May 29 2011 at 12:20 AM Report abuse rate up rate down Reply

bush misunderestimated the bubble

April 04 2011 at 10:28 AM Report abuse +1 rate up rate down Reply

and what's with the barefoot contessa. as far as I can tell, she's neither.

April 04 2011 at 10:25 AM Report abuse rate up rate down Reply

I agree with the others. This is advertising trying to pass as analysis.

April 04 2011 at 10:24 AM Report abuse +1 rate up rate down Reply

What a crock of yada-yada.... just pick up a copy of Parsons I-Vision and figure your own situation... stay the hell away from "financial advisors".

April 04 2011 at 8:20 AM Report abuse +2 rate up rate down Reply

This article should be labeled "Advertisement." Input data and someone will call and try to sell you a mutual fund.

The gist of Solin's flawed analysis is that since the average person gets average returns, no one can expect to get above average returns. And if they do, they should open a mutual fund so that we can all get above-average returns. The fact is that the bell shaped curve has tails, and small numbers of individuals are on the upper tail of that curve. Players in the market are not just passive transactors -- in large numbers they ARE the market. But it is possible for small numbers of players to do better than the average without moving the market. Providing feedback on that success would itself be information that moves, or has the potential to move, the market. Stated in terms consistent with the "Monte Carlo" theme here, Solin would argue that casinos should allow card counters to play because the average person loses money at the casino. That nonsensical result comes from the statistical error of comparing individuals and populations in the same way.

A final word about the foibles of market timing: Even most academic researchers who look at market-timing assume an investor who has a peculiar cognitive defect: the investor is able to predict rises and falls in the market, but for some reason is only able to take advantage of rising markets. The fact is that with the ability to time markets, a good investor can make money by going long on the way up AND ALSO by selling short on the way down, in effect making the same profit twice.

April 04 2011 at 2:25 AM Report abuse +2 rate up rate down Reply

you liberal tools act like pelosi and company wasnt running things for the last 2 years of the bush term. The country was under liberal control for the melt down. Do you even know what the president job is? Comander and chief of the military with the power to veto that can be over turned by a 2/3 majority.Thats it morons its not policy!!!!!! That is the job of congress.Hello Mc Fly. You know congress like when newt made clinton sign a bill to reform welfare that he vetoed 2 times then finally signed know u liberals love to say Clinton left a surplus.........Morons it was the gop bill that did it just like it was pelosi and friends that were running the country for the melt down!!!! You liberals are idiots figure out how it works. Google it and find out that between Mc Cain and Bush they went to liberal congress 16 yes 16 times with concerns of the bubbble that they said wasnt there....You morons have a opinion but you cant make ur own facts

April 03 2011 at 11:39 PM Report abuse rate up rate down Reply
1 reply to expresselectric0's comment

What a republitard !

April 04 2011 at 11:11 AM Report abuse +1 rate up rate down Reply

Yeah, like MC theory sure worked for your portfolio in the latest Great Recession, right? What a joke.

We face massive unresolved financial headwinds into the domestic and international future.

You either have exposure of debt and equity risk with your capital, or you have absolute guarantees.

Anything not guaranteed is simply a crap-shoot.

April 03 2011 at 11:09 PM Report abuse +3 rate up rate down Reply

Retire - hell no!! I still don't know what I want to be when I grow up!!!

April 03 2011 at 8:24 AM Report abuse +8 rate up rate down Reply

Hey imalibnow...isn't it about time for you to eat your gov't cheese?

April 03 2011 at 1:07 AM Report abuse -2 rate up rate down Reply