If you’ve ever met with a financial advisor, you’ve probably heard something like, “Your plan has an 85% chance of success.” That sounds pretty reassuring—but what does it actually mean?
The answer usually comes from a Monte Carlo simulation. Monte Carlo software is a way to test thousands of possible futures instead of pretending anyone knows exactly what will happen.
For example, if your planner uses a 6% rate of return on your retirement investments, that doesn’t mean that your assets will really grow 6% each year. Don’t you wish! There will be much higher years and also years when your portfolio loses money.
A Monte Carlo simulation shows the thousands of potential outcomes based on real market returns from many slices of time in the past.
If your report says you have an 85% probability of success, it means that about 85 out of every 100 simulated futures reached the goal. The other 15 did not.
It isn’t a prediction of what will happen. It’s a summary of what could happen under thousands of different conditions.
It’s a cool tool, but…
There is a big concept that is not clear in Monte Carlo results: Behavioral changes happen when markets are down.
Most Monte Carlo simulations assume you keep spending the same amount (plus inflation) year after year—even if the market drops for several years in a row.
Real people rarely do that.
If your investments lose value for an extended period, you might delay buying a new car, skip a big vacation, eat out less often, or hold off on a home project. Small adjustments like these can make a meaningful difference, especially during long market downturns.
The simulation assumes you’re on cruise control when real life usually includes course corrections. The computer doesn’t know you’re willing to tighten your belt for a while.
Another surprise is that younger people receive lower probabilities of success than retirees or people who are close to retirement.
That doesn’t mean they’re in worse shape. It’s because they have a much longer time horizon.
Here’s an example.
Cooper, at 35 years old, may have another 50 or 60 years of saving and spending ahead of him. That’s a lot of time for unexpected events, market swings, inflation, and life changes to appear in thousands of simulations.
Linda, at age 70, has a much shorter (ahem) time horizon, so there are fewer years where things can go off track. It’s simply easier for the computer to produce a higher success percentage over a shorter period.
Ironically, younger investors often have something the simulation can’t fully appreciate: time. They have decades to save more, adjust their plans, change jobs, or simply wait for markets to recover.
Why, with all these drawbacks, do advisors use Monte Carlo simulations at all?
First, it’s way better than the yellow legal pad we used in the Fidelity branch offices in the 1990s to create retirement income plans.
Monte Carlo accounts for a future that is unpredictable. Instead of relying on a single guess, it explores thousands of possibilities and helps people compare different choices.
Keep in mind that the percentage isn’t a grade or a guarantee. A 95% success rate doesn’t mean nothing can go wrong. In fact, it could leave a ton of money on the table during your passing, when you could have been kicking up your heels more during retirement.
To me, that seems like just as much of a risk as running out of money.
