Retirement planning has become an uncertain exercise in recent years. As a result, many investors now engage the services of a financial advisor when making critical retirement planning decisions. Those nearing retirement need to begin addressing some important questions well in advance of their actual retirement date.
An advisor can help guide the decision process and provide “dollars-and-cents” calculations using sophisticated computer forecasting models. When used in investment applications, tools such as the Monte Carlo simulation are gaining popularity as a retirement planning resource. This article describes how such tools work and sets parameters for their proper application in the overall retirement planning process.
Retirement planning has become more challenging in recent years. Stock markets remain volatile and unpredictable, yet “safe” investments such as money market accounts and CDs have continued to offer relatively low short-term interest rates.
Aside from current market uncertainties, there are other more constant issues to consider, such as inflation and taxes. Investors planning for retirement have questions about how these factors will affect their retirement funding issues. Have I saved enough? What is a reasonable and sustainable withdrawal amount?
Can I plan for retirement while also meeting other intermediate financial goals, such as educating children and paying off debt? These and other questions weigh heavily on the minds of most retirement investors.
While it may be necessary to adjust your financial expectations for retirement or even postpone your retirement date, you can still pursue retirement security. But to do so, you may want to consider engaging the services of a financial planning expert.
Once retained only by the wealthy, financial advisors now assist all types of investors in making decisions about retirement. In fact, perhaps one of the most common reasons for people to begin financial planning is to build a retirement fund.
In the past, calculating annual withdrawal amounts was done by means of simple spreadsheet analysis. A planner would use historical performance averages to project future portfolio values and automatic calculations for variables such as inflation and life expectancy. The problem with such an approach is that the lack of flexibility in the calculations makes it difficult to account for year-by-year variations in outcomes or changes in an individual's life or lifestyle that can affect underlying assumptions.
Fast forward to the present where sophisticated computer forecasting models such as the Monte Carlo simulation have become the preferred tools for dealing with the uncertainty surrounding retirement planning. When used in investment decision making, the Monte Carlo simulation forecasts how a portfolio is likely to perform under thousands of possible scenarios based on a combination of parameters–such as life expectancy, interest rates, equity returns, and inflation–and modeled around a specific problem (e.g., How much can I accumulate for retirement?). Results are recorded and ordered according to which scenario is most likely to match the investor's retirement goals.
With more attention being paid to retirement planning, forecasting tools based on the Monte Carlo simulation have enjoyed a renewed popularity in investment analysis. But remember, any forecasting tool, no matter how sophisticated, cannot predict the future. What’s more, forecasts are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future performance. For this reason, you should think of forecasts as a starting point for discussion with your advisor–not as your ultimate planning solution.
Planning for retirement and charting your course through retirement can be very complex. A financial advisor can help you through the planning process, so that your golden years are truly golden.
The tax information contained herein is provided for informational purposes only. AMG Funds does not provide legal or tax advice. Always consult an attorney or tax professional regarding your specific financial or tax situation.
Investing involves risk, including possible loss of principal. Diversification does not guarantee a profit or protect against a loss in declining markets.
AMG Distributors, Inc., a member of FINRA/SIPC.
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