Monte Carlo? Or Sensitivity Analysis?

Retirees need to face the dilemma of having to project 20 or 30 or more years ahead. How does someone assess the future with all of its unknowns, including inflation, taxes, health, longevity and, of course, the uncertainty of the financial markets themselves? 

The starting point is always the same: How much are you spending now? How much non-portfolio income are you taking in? How much will you need to withdraw from your portfolio to maintain your lifestyle over a lifetime that could last 30 or more years after retirement? And are you an expert investor?

In the real world, investment counsel, such as my firm, starts with a cash-flow analysis that looks at how the portfolio will be impacted given different withdrawal and return scenarios. We do that with a sensitivity analysis that is driven by different assumptions for longevity, inflation, taxes, returns and so on.

An alternative approach is a Monte Carlo simulation, which gives you a probability of success (or ruin) of a total-return portfolio.  You can search for Monte Carlo simulations online to give them a try.  If you go that route, be careful to review the underlying assumptions for inflation, spending, returns, and so on.   Be especially alert to whether the program accounts for withdrawals from your portfolio to cover your spending.    

This blog is an excerpt from Julie Jason's weekly column (Nov. 10, 2016).  Email for a full version.   

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