How do I figure out whether I’m saving enough for retirement? What’s the impact of one bad year in the stock market? How much can inflation erode my nest egg?
These are the types of questions that can be addressed by financial modeling. I’ve written a program that lets you enter data for two people (presumably you and your significant other), and it calculates the probability that you will have enough money to last both of you.
You can use Quicken or other retirement calculators, but they usually do not include a Monte Carlo simulation. Monte Carlo does not mean you take your life’s savings to Monaco and let it ride on roulette red. A Monte Carlo simulation is used to model systems that have some random elements and for which the outcome can’t be expressed by a simple formula. The return on your investments fluctuates from year to year. Low investment returns are worse if you are close to retirement than if you are just starting out. So the timing of the market highs-and-lows relative to your time-to-retirement is an important factor. A Monte Carlo simulation calculates a lifetime of savings and expenses, letting the investment returns vary. Then it repeats that calculation many times, simulating many possible lifetimes. Read the rest of this entry »
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