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For many Americans their greatest fear is living beyond their nest egg. What happens if you retire and are faced with bad luck—and your entry into retirement begins with successive years of portfolio losses? How likely is the probability that your money will outlast you? There is a science in the financial planning industry that focuses on such a problem and it’s called Monte Carlo. Monte Carlo is a complex mathematical calculation that can generate the probability of you not having to outlive your money during retirement. We here at Ortner, O’Brien & Ortner incorporate a Monte Carlo analysis into every wealth management plan for clients. Think of it as a balancing act between a reservoir (your assets) and flow of fresh water into a creek (need for cash flow). However, a challenge occurs when retirees face a lack of rainfall and summer heat simultaneously (recession/stock market crash). This puts stress on the demands for water (withdrawals). You may find it interesting to look at a simple before and after example for a retired couple who had done a Monte Carlo analysis in 2007 before the stock market crash of 2008. How does bad luck—and portfolio losses early in retirement—affect the probability your assets outlive you?
In the year 2007, a Monte Carlo analysis shows our retired couple a 99% probability their money would last. Let’s take a look at what a new analysis showed in 2008 after their portfolio has gone down in value.
At the end of the year 2008, following the big stock market drop, another Monte Carlo analysis shows our retired couple with an 83% probability their money will last. Generally, you would like to see a 90% probability factor. Does luck play a factor? Surely it does. If you are faced with a bad market early in retirement it could affect your ability to spend over the long run. However, what a Monte Carlo analysis won’t tell you is how to make adjustments. A bull stock market is ideal for
retirees who want to continue to make withdrawals from their portfolios
during their golden years. However, after the devastating losses
in the 2008 financial markets, many retirees are concerned about
making withdrawals. In our second example, if the retired couple
makes a small reduction to their monthly spending then there is
a 90% probability their money will last. |
The feature article in our next E-Newsletter will be titled "Expected Value and Your Retirement Funds". This article will address how people deal with risk, how this relates to the 17th-century French mathematician Blaise Pascal's analysis of dealing with risk, and how we at Ortner, O'Brien and Ortner are constantly seeking to accurately determine the expected value.
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