Monday, November 10, 2014

MonteCarlo Calculation

8:12 PM



Question:

I have a dilemma. Hopefully you can help. My investment advisor recently provided me with a retirement plan using Naviplan. Income, future assets etc were comparable to what I calculate using RetireWare.

However, for same scenario Retireware is indicating 100% prob of success. He is indicating 14% failures. - He targets 10% max as acceptable.

I am not sure what he is using for Retirement Goal Tolerance - rest of the variables look comparable.
 Based on what it has taken to get to this point, I don't have a lot of confidence in his results and I would not bet my life on my results.

I assume that both Naviplan and RetireWare should yield generally comparable Monte Carlo results?

Answer:

Please note that there is a setting in the Options page that counts small shortfalls as a success, so by setting the threshold to $0, the probability may go down.

Also note that Naviplan probably uses a different approach for their simulations. For example, they may use only one expected return and volatility, or maybe only fixed income and equities for the asset classes. In any case, with such calculations resting heavily on assumptions and methodologies, one may view a 14% failure as equivalent to a 10% failure. Also, an advisor will tend to err on the conservative side since your success is at stake, so he may be extra careful to recommend higher spending.

One way to assess your plan is to look at the various results produced by the software. You have the odds of success, a deterministic projection based on your selected expected returns (or RetireWare's standard, which is fairly conservative). You also have a projection assuming you earn poor investment returns in the future. Then there is the risk analysis that "stress tests" the plan against the main risks under various economic conditions.

Our idea in making decisions when facing an uncertain future is to take a "holistic" approach. If you see that most indicators are favorable, then you probably are OK.

One last thought. If you find you experience lower than expected returns or higher expenses after a year or two, you are able to correct the course by monitoring your plan and adapting your
spending going forward to set you back on solid footing to meet your expenses throughout retirement.


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