How to interpret Monte Carlo results

Explanation of how Monte Carlo scenario analysis should be used in retirement planning, how to interpret its result and why a Monte Carlo result of 80% is NOT a similar scenario as a pilot telling you there is only an 80% chance of making it to your destination...
To listen to the Monte Carlo episode of my podcast, "Retirement Planning Education" - retirementplan...
To join my Facebook group, "Taxes in Retirement" - / taxesinretirement
To subscribe to my newsletter, "Retirement Planning Insights" - tenonfinancial...
#RetirementPlanning #MonteCarlo #Investing
DISCLAIMER: This video is only helpful hints and education. It is not specific tax, legal or investment advice. Before considering acting on anything you see in this video, first consult with your tax, legal or investment advisor. While the information expressed in this video is believed to be accurate, neither Andy Panko, CFP®, RICP®, EA nor Tenon Financial LLC make any guarantees to its accuracy.

[@discoverglobeliving]

Understanding Monte Carlo results is crucial for retirement planning education. This video simplifies complex concepts effectively. Great resource

[@huib1965]

Great video! Exactly my view. Between 65 and say 95 there are 30 years. A lot can happen in that time. One remedy to be sure that you never run out of money is to withdraw a certain percentage (say 7%) of your portfolio plus the average return of your portfolio over the last 3 years. In good time you withdraw more and bad times you withdraw less. Run the simulation and you never run out of money.

[@KJFC388]

I always get great insight from this channel. Thanks so much!

[@RetirementPlanningEducation]

Thank you!

[@gregc3288]

The video was very educational and easy to understand. Before the video I had an understanding that MC took into account all data points of retirement income, investments and savings. You made it clear that MC only takes into account investment income and excludes income, such as SS and/or Pension. This video helped clear that up. Thanks Andy.

[@RetirementPlanningEducation]

Yeah, that’s a biggie…even if/when investable assets deplete (which is what the Monte Carlo percentage is in reference to), income from non-investable assets like Social Security and pensions would still be there. As would the ability to monetize or get cash flows from other non-investment assets like home equity or cash value life insurance, if any. Which is why striving to try to get a Monte Carlo result of 100% is almost certainly overdoing it in most cases. And why it’s a completely bogus and misleading comparison for someone to say a Monte Carlo result of 80% is as bad or severe a scenario as getting on a plane that only has an 80% chance of making it to its destination safely.

[@ALittleBitOfEverything-wd9ee]

Aren't there Monte Carlo based calculators that take your other sources of income into consideration? If not, why? Because these income sources are generally more predictable than investment growth, and should actually be easier to simulate.

[@davidfolts5893]

Great video,Andy! Thanks for pointing out the false analogy between the use of a retirement planning tool and a plane crash. In fact, you have a much higher probability of getting in an automobile accident on your way to the airport than the one in eleven million chance of being involved in an airline disaster.

[@01punkin89]

Thank you. Your explanation of the Monte Carlo tool was very helpful.

[@RetirementPlanningEducation]

I’m glad you liked it, thanks!

[@jessefletcher9116]

useful video, and you are so very right about that final part, there's a lot of so-called advisors out there that try to sell products & services based on uncertainty. They give an information overload presentation that fosters fear of how you might run out of money in retirement which paves the way for their sales pitch. Videos like this help a common guy like me see what they're really selling is fear, after which they present a solution via their overpriced products and services.

[@RetirementPlanningEducation]

Selling on fear is unfortunately a very powerful and effective tool

[@ralphparker]

It is good to look at the 99% point. If you have 1 million and spend $1/year, you will will have 100%, and also if you spend 40K/Year, you may still have 100%. Find that point where you break away from the 100% "surface". This is a great point for those extremely safety minded. A MC can model about anything it is programmed to model to include real estate investments, stocks, bonds, etc. Now about safety, It seems to me that a safety minded person can live with a lower POS if there are checks to know when corrective action is required. If in a down market you'll have to quit spending money, at least as much money. Good Vid!

[@RetirementPlanningEducation]

Great comments and insight, thanks Ralph!

[@pm9531]

Had to look how to spell Calculus to say this. Somehow my browser went off into the great void and I needed to used History to find this again, even though I did subscribe to channel. Now to the point. Did you learn this max min from calculus or was it something you figured out on your own? Good idea regardless.

[@ralphparker]

@@pm9531 Who knows. I've had calculus plus a lot of other math, I wish I could remember it all.

[@ALittleBitOfEverything-wd9ee]

​@@ralphparker My suggestion is to go to a large physical used book store and look through the math books that fit your learning style

[@keithwalters318]

A 50% result shouldn’t be interpreted as a coin flip as to whether or not you’ll be successful. Rather, should be interpreted as there is a 50% chance you’ll need to make some changes along the way ( perhaps large , perhaps modest) in order to be successful. And those changes might be rather modest such that success is easily obtainable provided you make changes. As this individual indicates, this is largely within our control.

[@RetirementPlanningEducation]

Precisely. But those who sell products or strategies based on fear, will distort how to interpret Monte Carlo to scare people into buying what they're selling. Such as saying a 50% Monte Carlo is synonymous with having a coin flip of a chance of getting on a plane and having it crash (and everyone dies) en route.

[@brucebuckeye]

Excellent! Thanks

[@donaldlee6760]

"Probability of Success" was an unfortunate term to use. "Probability of Adjustment" is a more descriptive term, i.e. - 80% Probability of Success = 20% Probability of Adjustment (downward).

[@RetirementPlanningEducation]

I think that’s definitely a much better way to frame it: “probability of adjustment”

[@scoobedoo5243]

One big limitation of traditional Monte Carlo sims is that each year is treated as a separate and distinct entity - meaning there is no linkage between years. While that seems like a good thing, it ignores the observed linkage year-to-year, otherwise known as momentum of markets. That is, good markets tend to continue year to year until something happens to upset the momentum. Then bad years are not well linked, so bad years don't tend to carry the same momentum to the next year. If someone could figure out a way to incorporate the market momentum confounder, MC results could really become excellent predictors of the future.

[@ralphparker]

There is also this concept of "Reversion to the Mean" that markets seem to demonstrate. For instance. If you use an annual Standard deviation growth rate for each years variation you will predict a much larger variation over a longer timeframe, say 20 year timeframe, than the markets have actually performed.

[@HeritageWealthPlanning]

Could not agree more, Andy . Don’t hear many people say “take corrective action” were you in military at some point?

[@pm9531]

Like your video, but one caveat on anything with humans deciding what numbers to use as estimates, is the inability we, I perhaps more so, have to make these numbers accurately represent current and future money spending. Since I'm not the bill payer, it may be my problem more than a rule. Everyone else may have good estimates of their spending but my confidence level is low in this regard.

[@RetirementPlanningEducation]

That's exactly right; projecting decades worth of expenses is a huge variable that will inevitably be incorrect. Life circumstances will change, as will inflation rates. So we know our estimates will be wrong. But we have to at least try to come up with a good guess, otherwise we'd be flying completely blind.

[@pm9531]

@@RetirementPlanningEducation Yes, comforting to know a lot of brainpower goes into these prediction models, even though in the long run we don't know anything for sure.

[@ALittleBitOfEverything-wd9ee]

You can probably get a transaction record from your bank listing all money in and out going back several years. Perhaps free, if you are signed up for online banking and can find where to look. But even if not, they will probably print it out for you for a fee. I would make a suggestion that I consider important. If you are in the United States, when you try to figure out future inflation, use EXPENSE values for the consumer price index prior to the Clinton Administration, and inflation based increase figures for the years since if you can when you construct your model. This is because instead of just falsifying inflation figures like some governments elsewhere do, ours got clever and has been recalculating the figures by excluding categories that actually increase in price (but people still need to buy) since then, to keep government expenses down.

[@brendapace5115]

Touché! Wow

[@SecretInventor]

Great Video as always. We want you to put these videos bit frequently :). I have a quick question: I put $6K earlier this year in my ROTH for the first time. I realized that I may not be eligible due to excess income. My $6K turned to $4K after losses in investing. I withdrew due to excess income for 2022. How can I offset this loss? If I close my ROTH account, can I report losses? If I close my ROTH today, can I open ROTH in the future? Appreciated your help in advance :). Thank You.

[@RetirementPlanningEducation]

I don't think there is currently anyway you can deduct the $2k loss. Prior to 2018, when miscellaneous itemized deductions were still allowed, then it would have potentially been possible. But it's not now.

[@nathanchapel5950]

Was that a Scranton sales process that shared that ability with you?

[@R.and.R.]

Thanks for the great information Andy!! Do you have a favorite Monte Carlo analysis tool available online?

[@RetirementPlanningEducation]

I use the one that’s part of my financial planning software, eMoney. Most financial planning software has a Monte Carlo tool. I’m not sure what other options there are, specifically for consumer use. Sorry! They’re all a bit of a black box though. But they should all give generally comparable results if using the same inputs and assumptions.

[@R.and.R.]

I found one at the T. Rowe Price web site that looks decent.

[@ralphparker]

I use Flexible Retirement Planner, the downloadable version. It's free for personal use and you can save your scenarios. It does require you to become more savy in the deeper levels.

[@dr.athleticz2777]

Is there a Monte Carlo formula taking into account adding to account every year

[@RetirementPlanningEducation]

Yes, but it's not a formula, per se. Monte Carlo is a program that runs iterative scenarios based on whatever inputs you specify. If you specify that you will be contributing to your investment accounts going forward, that will be factored in accordingly (just like whatever projected expenses you enter in will be factored in, as will whatever income sources you enter in such as wages, Social Security, pension, etc.)

[@philipnicholson3216]

What Monte Carlo software are you talking about? The only ones I've ever seen planners use does NOT use historical data. It uses randomized performance of your investments - the planner puts in an average rate of return, the SD size, average inflation rate, etc...

[@RetirementPlanningEducation]

I use eMoney. It uses historical returns, volatilities and covariance across asset classes as the starting point to generate the randomization of future returns & volatilities

[@Scout2462]

Almost everything you say in this video about how a Monte Carlo analysis works is wrong.

[@RetirementPlanningEducation]

Thank you for the feedback

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[@peter-hr1gl]

visually I am not a fan of Monte Carlo simulation scenario's because of the blurring of so many lines and colors. I would prefer another way to represent the data, but have not seen any alternatives. Perhaps some type of percentage bar graph indicator to represent the percentage groupings of results (even perhaps showing in a bell curve type graph). Ultimately it's a tool like any other. It may be useful, it may be correct (for your situation/scenario) or it may not. Could be like using a construction hammer to pound in a brad nail. I like the fact that they named this tool after a city known for gambling ....hmmmm. Statistics to me is nothing more than using fancy math to justify an opinion. Same goes for Monte Carlo simulations. Statistics can be easily manipulated to represent whatever you want it to. The underlying mathematics may be very sound, does not make the representation sound.

[@ALittleBitOfEverything-wd9ee]

So I would suggest taking a statistics course (if you are in the United States, you can probably do so inexpensively at your local junior college) or even just go to a used book store and look through statistics books until you find one that makes sense to you. You will need a highschool level understanding of Algebra first, I should mention just in case. My father (MBA in finance and accounting) used to say that figures don't lie, but liers figure. In my opinion, it is important to understand the math (for really anything you are making a decision about) if you don't want to be mislead. Someone can even be very honest and not trying to mislead you, but have a different concept of what is important than you do. I find statistics useful, if for no other reason, than because nothing is certain in life, and statistics helps you at least have an idea of what you do and don't know, and understand the level of risk. Because there is literally always risk.