Monte Carlo Simulation

Hi, this is Dave Zaegel.

Let’s talk about Monte Carlo Simulations.

You may be wondering what in the world is a Monte Carlo Simulation?

What does it have to do with anything business or finance related?

Well, Monte Carlo Simulations sounds fancy, and in some ways it is, but really when you break it down into layman’s terms, it’s a probability analysis.

And it uses random variables to figure out the probability of various events happening.

Again, that’s a very layman’s terms explanation, but it’s all you really need to know for Monte Carlo Simulation unless you’re really getting into the details and you’re going into a scientific field, where this is often used.

So Monte Carlo Simulation is heavily, heavily used in science and engineering because they really need to know the probability of a random set of variables and how that impacts their calculations.

It’s also crept into the use and the field of finance, and specifically financial planning.

You’ll especially hear this a lot when talking about retirement planning, because if you are nearing retirement especially, and you want to look at the probability of a successful retirement, well there’s a lot of random variables that will go into that.

You could look at different tax rates, you could look at different outcomes in the Stock Market and Bond Market and just a lot of different inputs that are variable and that will impact the future of your investments over time.

What happens often times is this word Monte Carlo Simulations or Monte Carlo Analysis gets thrown around and it sounds fancy and everybody goes, “Oh, Monte Carlo Simulation.”

When really if you just break it down for what it is, it’s a probability analysis.

This used to be done a lot using Excel and it might have taken awhile to build out Monte Carlo models.

Now there’s add-ins in Excel that make it a lot easier, but really a lot of the financial planning software has this built in already.

So oftentimes, I hear people say, “Oh, we’re running a Monte Carlo Simulation”, and they try to make it sound fancier than it is, when really the software’s developing the simulation.

They don’t necessarily know how to calculate it.

And that’s okay.

They don’t need to know how to calculate it.

But I feel like a lot of people hear Monte Carlo Simulation and they think, wow this must be amazing, whereas really it’s pretty standard in the retirement planning space.

You should be running a Monte Carlo Simulation to figure out the likelihood of your retirement success.

And again, that tends to be built into the financial planning software that a planner would be using.

So I hope that helps at least break down and demystify what a Monte Carlo Simulation is and that’s it not necessarily as fancy as it sounds, especially in the financial planning world.

Let’s try to keep this simple so that way when we use complex terms like this we understand that really we’re talking about retirement dollars, looking at many different simulations with random events happening and in those simulations, how likely are we to accomplish our goal that we want to accomplish in retirement, knowing what we know and knowing the various inputs that we have to plan for.

And I’ll say one more thing: it’s important to note that if in the Monte Carlo Simulation there’s, let’s say, a percent chance of you achieving your retirement goal out of this analysis, that’s not the end of the world.

You’re still going to have something in retirement and you may very well achieve the retirement goal it’s just that you can’t say for sure that you will.

So it’s not the end of the world if you don’t have percent guaranteed Monte Carlo Simulation retirement goal met.

It’s okay to be a little bit under that and to work towards that over time, versus in the science world if something doesn’t come out much closer to percent it might not be so desirable.

Let’s say you’re an engineer trying to build something.

If you’re building a building or a bridge and there’s even a point one percent chance of failure well, that’s completely unacceptable.

In retirement planning, if you a . percent chance of success, that’s phenomenal.

So, we have to keep this in a little bit of perspective and realize that, even if we’re not at percent odds of achieving our retirement goal, that’s still okay.

There are things that we can change along the way.

Different levers to pull and make sure that you get there.

So don’t freak out if you’re not percent on the Monte Carlo Simulation.

It’s just a probability analysis.

It’s a guide for us going forward.

I hope this helps.

If you have any questions on this, please feel free to reach out to me or leave a comment below.

Thank you.

 

Featured

Retirement Planning

In retirement, we will likely encounter critical financial challenges: rising interest rates, continued stock market fluctuations, and rising tax rates. All of these are manageable with proper planning, strategies, and tactics. We present answers to these challenges in ways that you won’t often hear from other advisors.   Think investing in bonds is the ultimate

Read More »
Tax Planning

They Gotcha Going Out – Estate Taxes

When you die, your estate may be subject to estate taxes. Want to know how much the federal government receives in estate taxes? Check out this video to learn more. Facebook Twitter LinkedIn Google+ Shares

Read More »
Tax Planning

Federal Tax Explanations – Video 1 – Overview

Want to know how much tax revenue the federal government receives and where it comes from? I’ve made it a goal to help educate people on the big picture of federal taxes. That way, you can have a greater understanding of how much the government receives, where it comes from, what truly makes a difference,

Read More »
Retirement Planning

The Power of Roth Conversions for Retirement

When we plan for retirement, one of the strategies that can be counter-intuitive, but extremely powerful is looking at Roth IRA conversions, especially in the early years of retirement. When I say it can be counter-intuitive, it’s hard to think about paying a lot of taxes now to save on taxes later. A lot of

Read More »
Business Planning

Profit Sharing Bonanza

Profit sharing plans can be a big deal for successful business owners. Many successful business owners will use profit sharing plans because it has a big impact on their financials in multiple different ways, especially among more white collar business owners that have been successful is. Think of doctors, lawyers, dentists, therapists, chiropractors. The list

Read More »
Business Planning

LLC Does Not Matter for Tax

We get a lot of questions about what type of business entity I should use for my business because there are lots of different options. You have C corporation, S corporation, partnership, sole proprietorship, LLC which stands for limited liability company. So people are always asking, what’s the best one to use? How should I

Read More »
Business Planning

Don’t Let Your Business Die

Let’s talk about a topic that is not necessarily fun to talk about, but it is important to talk about. If you’re owning a business, what happens if you die? And the reason we’re discussing this is because most people are familiar with life insurance. If you’re collecting a paycheck, you want life insurance for

Read More »

Pin It on Pinterest