Key takeaways
- Read the assumptions before the results. The assumptions decide the results.
- Find out whether figures are in today's dollars or future dollars before you react to any of them.
- A probability of success is a count of simulated paths, not a guarantee and not a grade.
- Look for the worst case in the report. If there is not one, the report is selling rather than informing.
Start at the back
Most people read a plan top to bottom and stop at the headline balance. Read the assumptions first. Return, inflation, contributions, retirement age, life expectancy. Everything above them is downstream.
If a report will not show you its assumptions, you are not holding a plan.
Which dollars is this in
A projection can be stated in future dollars or in today's purchasing power, and the two can differ by more than half over thirty years at 3 percent inflation.
Neither is dishonest. Quoting the larger one without saying which it is, is. Check the label before you feel good or bad about the number.
What a success rate means
A Monte Carlo report gives a probability, usually something like 85 percent. That is the share of simulated paths in which the money lasted. It is not a promise that you have an 85 percent chance in the real world, because the simulation only knows the return distribution it was handed.
Treat it as a comparative measure. Moving from 70 to 85 percent by changing one input is meaningful. The 85 itself is soft.
Look for the bad path
A useful report shows the range, not just the median. You want the tenth percentile as much as the fiftieth, because the tenth is the one you have to survive.
The historical record is the reason. Real portfolios have fallen a long way and taken years to recover. A plan that never shows you a bad path has not prepared you for the only part of the journey that requires preparation.
Sources
- Peak to trough declines and recovery periods are drawn from the standard bear market record for the S&P 500 and, for 1929, the Dow Jones Industrial Average.
- The 1929 figure of roughly 25 years to recovery is on a price basis. Including reinvested dividends and deflation, the breakeven arrived considerably earlier.
- Monte Carlo success rates on this site are counts of simulated paths under the assumptions you set.
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