Monte Carlo Simulations During Uncertainty

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In times of financial uncertainty, Monte Carlo simulations provide insight into portfolio performance. Whether it’s high inflation or greater market volatility, Monte Carlo analysis will reveal how those uncertainties impact a client and provide peace of mind about their plans.

Understand capital market assumptions in Monte Carlo simulations

Calibrating your capital market assumptions (CMAs) is the first step to understanding how your Monte Carlo results compare to the real-world behavior of a financial plan during a period of uncertainty. Most Monte Carlo analyses use CMA data based on either the past performance of asset classes or via a projected performance based on analysis from an investment committee. Both approaches are valid, with each one offering the advisor something to consider when using Monte Carlo analysis for retirement planning.

For example, CMAs based on projected performance often use 10-year market outlooks, even though financial plans often span 25-40-year horizons. Is the advisor comfortable using market assumptions deemed reasonable for the next 10-15 years for a client with a 40-year life expectancy? Many investment committees are conservatively expecting 10-year returns to be lower than historical averages. Are these lower return assumptions still useful for 40-year projections where economic cycles should even out, resulting in market returns closer to historical norms?