Why Monte Carlo Isn’t Just a Place in the Mediterranean



We have all seen the allure. All of those yachts and mega yachts docked in the cove, the Indy car races in the street and especially the James Bond-esque scenes at the casino tables. Who wouldn’t want to spend any amount of time in Monte Carlo?! I thankfully get to spend an exceptional amount of time in Monte Carlo. However, mine is a financial planning analysis tool, not the elegant hillside oasis, on the coast of the Mediterranean in Monaco. If I am being honest, Monaco sounds like a great reprieve from all that 2020 has brought us thus far and may still yet bring. Yet my goal here is to show you how the financial planning tool is more relevant and encouraging to you than the coastal resort could ever be.

Investopedia provides a rather academic definition of the Monte Carlo Simulation, “Monte Carlo simulations are used to model the probability of different outcomes in a process that cannot easily be predicted due to the intervention of random variables. It is a technique used to understand the impact of risk and uncertainty in prediction and forecasting models.” Before the thought is solicited to your mind that this is far too academic, allow me to simplify: Monte Carlo analysis is used to analyze different investment returns, over time, to estimate confidence in maintaining a given amount of cash flow. The stock market is highly unpredictable. Nobody knows what direction the market, or individual stock prices, will run over time. We may certainly make educated evaluations and perform calculated analyses, but we don’t definitively know. That is why when we create a given asset allocation, based upon your risk tolerance, we run the Monte Carlo analysis to see what happens when, not if, investment returns vary over time.

So, this brings us to 2020 where COVID-19 wreaked havoc upon the investment markets, brought uncertainty to employers and employees, multiple hurricanes, forest fires, and to top it off is the political turmoil of it being an election year. This much uncertainty without question impacts investment markets. Yet our use of Monte Carlo analysis should provide some confidence in the decisions we make about our financial lives.

This is where the value of Monte Carlo analysis should bring confidence to your financial life as you encounter the uncertainty regardless of the year or form. The higher the confidence, the smaller the impact a market correction should have on your financial life. This is why it is important to continually update your financial plan, as opposed to simply creating one financial plan and leaving it alone. Our lives change and it is possible for them to change in an instant. The value in any financial plan is in continually updating it year over year so that we are increasing our confidence in being able to live the life we want to live, as we live it, regardless of what happens in the world around us. This isn’t to say that we won’t ever pivot or make adjustments to the plan. Certainly, we will. We may want to make these adjustments, or they may be necessary. We may need to delay retirement. We may need, or be able, to accelerate retirement. These are decisions that I believe we need more data to filter through rather than relying on our emotions. The data is probably less likely to change as quickly as my emotions will. So, while I clearly need to understand how I feel when processing certain decisions, I definitively need to seek more information by which to process what pivots and adjustments are needed.

While no model can perfectly forecast the market, the Monte Carlo analysis is one key aspect of our financial plan that enables us to sleep well at night knowing that we have a plan that is working for us. Not only is it working for us but it gives us the flexibility to react and adjust to whatever 2020, or any other year, throws our way. We want you to be confident not just in how your money is invested but in how your financial life is situated. We would much rather be vaguely right than exactly wrong. The higher our confidence the more right we will eventually be. So while it would be enjoyable to eventually end up on the coast of Monaco at some point, it is more enjoyable to live our lives with the peace of mind the Monte Carlo analysis provides.

About the Author

JT Trimble, Candidate for CFP® certification, joined YHB in August of 2018 and serves as a Client Account Manager. He is a regular contributor to Let’s Talk Investing and speaker at numerous events throughout the region. JT is a member of the Loudoun County Chamber of Commerce and the Financial Planning Association.