Wouldn’t it be nice if we could get stock tips and investment advice from Marty McFly?
Unfortunately, the Back to the Future method of predicting the future isn’t grounded in any basis of reality or possibility (yet). However, there is a way to look at the results of what might happen in a situation, with a fair degree of certainty: By running a Monte Carlo simulation.
A Monte Carlo simulation is a computerized, mathematical technique that uses probability and data to estimate the possible outcomes of a statistical problem with randomly evolving variables, and it does so quickly and efficiently, even though it is analyzing thousands upon thousands of data points.
Remember probability and statistics from your high school math class? What is the probability that you will draw one red marble and one blue marble from a bag, given there are 11 marbles of all different colors inside?
Well, the Monte Carlo method is a bit like that – a random sampling of data points, but with a side of simulation to make the process go a lot faster than drawing two marbles from the bag, several hundred thousand times. In a Monte Carlo simulation, the computer analyzes information, then provides a representative distribution of results.
These simulations can help tremendously with financial planning, and the team at PAX Financial Group uses them to help clients understand their options and create steps to reaching their financial and retirement planning goals.
The Monte Carlo simulation method was developed in the 1940s by scientists who were working on the Manhattan (atomic bomb) Project, to help analyze extremely complex physics problems with a number of variables. The scientists quickly realized they just couldn’t handle all of the variables, or do so many calculations manually. The simulation was named for Monte Carlo, a city in Monaco known the world over for its casinos and high-stakes gambling – games of chance.
Today, Monte Carlo simulations are often used in risk analysis and decision making, and the technique is used in many very different fields, from engineering and design to finance. Even basketball legend LeBron James has wondered about using a Monte Carlo simulation to make game-winning decisions.
How Does It Work for Financial Planning in San Antonio?
To utilize a Monte Carlo simulation, the financial advisors at PAX Financial Group take random samples of inputs, and then use the results to determine probabilistic behavior of a complex system or process.
A Monte Carlo simulation builds a virtual model of possible results, performs thousands upon thousands of calculations involving random values, and generates a visual, graphical result. The technique is incredibly sensitive, and you can tweak the results by tweaking the inputs.
For example, when it comes to your finances if the model shows your account balance will be $2 million when you retire, but your goal was $2.5 million, you can adjust different factors such as income, contribution amounts, and the retirement age to see how those changes could potentially affect the result. At PAX Financial Group, we use these models to adapt each client’s financial plan accordingly.
Monte Carlo Simulations and Your Finances
The financial advisors and analysts at PAX Financial Group use the Monte Carlo method to estimate portfolio values, analyze risk, predict stock prices, evaluate risk assessments, project cash flow, and ultimately, help clients develop very specific retirement spending and savings plans.
One of the great things about this technique is that the results of a Monte Carlo simulation can help with decision-making, by providing clients with extreme possibilities on either end – what would happen with 100 percent or 0 percent? – as well as the range of possibilities that fall somewhere in the middle. Arming yourself with the knowledge of what the potential outcomes might be for any given situation can help narrow down the best options based on your specific situation. Remember, financial planning is not a one-size-fits-all equation! There are a lot of factors to consider in every situation.
Without considering the possibilities, your retirement plan might be based on rules of thumb or generalities that might not work for your situation. This generalized method doesn’t account for variables like market volatility, longevity, levels of inflation, etc.
While history can tell us a lot, looking at what has in fact happened might not be enough. This is where a lot of DIY investors have trouble. A Monte Carlo simulation allows the financial advisors at PAX Financial Group to take a deeper dive into any statistical problem with a range of inputs and variables, and see a reliable distribution of results.
These specifics can mean the difference between not having enough saved (outliving your money or having to change your retirement lifestyle) and saving too much or not spending enough.
Using Monte Carlo simulations allows the financial advisors at PAX Financial Group to really fine tune your financial and retirement plans, factoring in a whole range of considerations, from how many years you’ll live after you retire to rates of investment returns, and more. Monte Carlo simulations even help us incorporate multiple values for each variable.
A Monte Carlo simulation gives us a spectrum of potential outcomes and a detailed virtual representation of what a client’s finances could look like, far better than what we could consider in our heads, or even with paper, a pen and a calculator!
So, until someone invents a machine for safe time travel, it’s impossible to know exactly what the future holds. The next best thing we can do is use a Monte Carlo simulation to help scientifically consider the outcome of a particular decision – and what changes need to be made if the original path is not successful.
No one has a crystal ball to predict the future, but a Monte Carlo simulation can show you likely outcomes based on hard facts and data.
Retirement planning is a delicate and complex process. Schedule a no-obligation conversation with the financial advisors at PAX Financial Group to see how you can incorporate Monte Carlo simulations into your retirement planning efforts.
This material is provided by PAX Financial Group, LLC. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. The information herein has been derived from sources believed to be accurate. Please note: Investing involves risk, and past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All market indices discussed are unmanaged and are not illustrative of any particular investment. Indices do not incur management fees, costs and expenses, and cannot be invested into directly. All economic and performance data is historical and not indicative of future results.