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Why Monte Carlo Simulations Don't Tell the Whole Story

It took the Greek Freak for me to finally articulate a problem that’s bothered me for some time. If you don’t know who the Greek Freak is, he is NBA MVP Giannis Antetokounmpo who beautifully answered a question from a reporter following a tough first round playoff loss last week. In keeping with his Greek heritage, he channeled the Stoics when he was asked if the top seed Bucks series loss to the Miami Heat was a “failure.”

Here's why Giannis’ thought-provoking reply got me thinking about Monte Carlo results. A quick sidebar for those who might not be familiar with what a Monte Carlo simulation is. To oversimplify, it’s a mathematical modeling technique that factors one’s spending patterns, investment portfolio and life expectancy to determine the probability that someone (or couple) will outlive their money.

The major shortcoming of Monte Carlo simulations is that clients too often view the results as a false binary - you either die with money or you die penniless. For a couple entering retirement there’s already a certain anxiety about giving up the predictability of a regular paycheck, so they look for reassurance in a Monte Carlo result with a highly favorable probability.

The bad news is that despite our best efforts our Monte Carlo simulation will undoubtedly be “wrong.” It’s a model, not real life. The future is fundamentally unknowable. But a financial plan that is “wrong” doesn’t mean that it is worthless. It serves as a valuable guide to let us know that we are on the right track, or conversely that we aren’t.

Where models come up short is that they do a poor job of capturing adaptability. And we humans are all about adapting (see Darwin, Charles). If some unexpected financial hardship occurs, we adjust. If stock market returns are a little less than historical returns, we adjust. If it takes a little longer than planned to sell a vacation home, we adjust. If long-term care insurance premiums turn out to have higher increases than we expected, we adjust.   

The shortcomings of Monte Carlo are a key reason why we don’t offer “one off” financial plans. As I often tell our clients: “our true value isn’t completing a financial plan, it’s helping you navigate it.” Financial planning, like sports, is often about reframing perspective.