Waaayyyy back in the day, when I worked for a large discount brokerage that shall remain unnamed, but was headquartered in Boston, and still shall remain unnamed, management introduced a groundbreaking new software called the Retirement Income Planner.
The irony that our new offering for those transitioning to retirement was called R.I.P. was not lost on us. We had lots of giggles at the marketing misstep. Don’t act so surprised; financial people do have a sense of humor.
Despite the unfortunate acronym, we were very excited to have a more professional output to help clients with all important question, “Can I afford to retire?” Not only that, but this amazing tool included the fancy new Monte Carlo simulation which could help answer the second most common question, “What if there is a recession during my retirement?”
The problem? No matter what the age of the client, we were supposed to only deliver results that put them in the 90% or higher Probability of Success. This meant that we had to tell people they needed perhaps an unreachable amount of assets or could only spend a tiny fraction of their savings to have a “successful” retirement.
Here are some things to know about a Monte Carlo simulation:
- It assumes that the income you put in plus the inflation percentage will NEVER change through the course of a 30 year retirement. In other words, if your accounts went down two years in a row, you as a human being would not change your spending behavior at all in response. From experience, I can tell you people do adjust their discretionary spending in response to temporary investment losses.
- The possibility of getting a 90% + result for someone in their 50s is almost impossible. The time horizon (life expectancy of 95 – age 55 = 40 years) is so long that the variables of market returns are incredibly high and low. So, solving for the same probability of success for a 55 year old as a 65 year old or a 75 year old is almost financial malpractice.
- Yes, there is a risk of running out of money if you spend too excessively in early retirement. But there is also a risk of running out of good health and energy, and frankly dying unexpectedly young and not having enjoyed your retirement as much as you could.
For these reasons considering hiring an experienced financial advisor help interpret the online calculators you may be using, or even give a second opinion on a plan you have had done in the past.
There is an interesting article below from the Michael Kitces website about interpretation of the probability of success in a Monte Carlo simulation. The author makes the argument that in some cases even a 50% chance of success is enough, if the retiree is willing to make spending adjustments along the way.
