Comment by stevenhubertron
1 day ago
I use a Monte-Carlo for my retirement planning. This did a good job of telling me not to trust it but didn't really give me a better option. Anyone have one?
1 day ago
I use a Monte-Carlo for my retirement planning. This did a good job of telling me not to trust it but didn't really give me a better option. Anyone have one?
> This did a good job of telling me not to trust it
What do you mean? The retirement planning with Monte-Carlo gave a better result than the base assumption of 4% returns and 2% inflation. The information MC provides let's you, when taking into account your risk threshold, whether you're satisfied with your savings or not by giving you more realistic odds of how long the money will last.
There's no sure fire option for making sure you don't run out of money, as nothing can 100% predict the future. The best we have is the assumption that the future will look kinda like the past over long periods of time.
If you acknowledge that assumption, then you have to choose what model of the historical market you want to use a predictor for the future.
You can use exact market data, test retiring out at every single possible year at every possible asset allocation and see what happens. This is the basis of the 4% rule from Bill Bingham.
You can pull random years out of history and string them together a bunch of times and see what happens with a given asset allocation. This is a naive Monte Carlo simulation.
You can pull blocks of years and string them together, to acknowledge that there are repeating trends in years (what happens in one years influences the next) and do a Monte Carlo simulation which is a bit less naive.
There are more esoteric models overly smart people have constructed, each of which will give you slightly different answers for a safe withdraw rate.
At the end of the day though we are all just crossing our fingers, and hoping for a black swan catastrophe to not happen.
I don’t think a pure Monte Carlo is as helpful as “replaying” past actual scenarios (or a hybrid of the two).
I don’t have reason to believe that 40 years in a row would all have randomly and independently chosen results from a distribution (pure Monte Carlo) as a better model than past actual results.
None of these things are oracles. The Monte Carlo helps you visualize the universe of outcomes. Simulating past events helps you specifically apply your knowledge of the past to your portfolio.
Think of it as a tool to understand and explore risk. I’ve found all of these tools more useful as a I get older and the day I need to use the cash is closer.
I agree that it’s a tool to explore risk. I just think it’s more useful if you pull the likely universe of outcomes from the sequences of the past (sliding your retirement across multiple starting dates) more than worry about what happens if we get multiple -43% years in a row. There’s no realistic portfolio that will survive that, but also no realistic underlying economic model where that happens (or if it does, where what you have saved really matters).
Why wouldn’t you trust it?
Usually critics of these estimates say stuff like “the simulation includes scenarios like the Great Depression”.
They give you a range of results that illustrate things like sequence of return risk, which most people have difficulty understanding and incorporating into plans. Many people have an underlying “stonks go up” assumption that may not serve them well.