Weekend Reading: Adjusting Monte Carlo Success Thresholds by Tolerance for Spending Volatility
This article appears as part of Casey Weade's Weekend Reading for Retirees series. Every Friday, Casey highlights four hand-picked articles on trending retirement topics and delivers them straight to your email inbox. Get on the list here.
If you had a crystal ball, retirement planning would be much less complicated. Unfortunately, no such thing exists, but there is one thing you can do, which is stress test your portfolio.READ THE ARTICLE
If you had a crystal ball, retirement planning would be much less complicated. Unfortunately, no such thing exists, but there is one thing you can do, which is stress test your portfolio. From a psychological perspective, by focusing on what you can control, you gain more confidence in your ability to handle what you can’t.
Running the numbers (carefully): One way advisors can “forecast” the stability of a portfolio is by running Monte Carlo simulations, but as this article states, it’s important to tread carefully when doing so. Running an analysis such as this allows you to view how a wide range of potential market returns (based on probability they occur) would impact your lifelong savings over time. In this instance, a 100 percent success rate might seem ideal, however, it can also assume the portfolio offers zero opportunity for flexibility.
Adaptation is key: Maybe you’re actually able to increase your spending ten years down the road, or maybe an unexpected event occurs, requiring you to make a change to your plan. The bottom line is, a solid retirement strategy requires the ability to evolve. As such, this article introduces the concept of creating a customized target success threshold; one which addresses your willingness and ability to modify spending, as well as mirrors your comfort with risk. For some, that might be a 90 percent success rate, while for others, it could be 50 percent.
The more you know: Whether you leverage a traditional income strategy alongside a Monte Carlo simulation or not, understanding the degree of flexibility you have with your budget, in preparation for the unexpected, is never a bad idea.