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Monte Carlo retirement? Not what you think



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» MonteCarloSimulations
» Using Monte Carlo Simulations to Plan
» T. Rowe Price Retire Income Calculator
» American Express Retirement Success Planner

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Pairing Monte Carlo and retirement sounds nice, doesn't it? But when finance experts talk about "Monte Carlo" modeling -- and these days, they often do -- it has little to do with Monaco or the French Riviera.

Market forecasting is notoriously tricky and unreliable; after all, if it were easy, everyone would do it and no one would lose money. Nevertheless, retirees need to figure out how much they can spend without fear of destroying their portfolios, so they need to know what they can expect from stocks and bonds. One way of forecasting is to create a test bed for investment plans.

So to replicate the random, unpredictable nature of markets, financial gurus borrowed from work originally done by researchers trying to simulate the effects of atomic explosions. Those nuclear scientists named their model "Monte Carlo" because the roulette games of that city's famed casinos represent chance in its most elementary form.

Monte Carlo-type simulations have become popular among financial planners, who enter assumptions about inflation rates and investment returns, along with retirees' personal information into a computer program. The software then sticks those numbers into a model of the markets to produce an expected range of values that can be used to determine an income level for the retiree.

Although Monte Carlo modeling has become more prevalent the past few decades, investment experts are divided on Monte Carlo versus using historical market returns as a basis for planning. Critics of Monte Carlo argue that it doesn't account for the emotions and sentiment of real human beings, and thus doesn't truly replicate the market. And even Monte Carlo's proponents disagree on how many times simulations should be run to be accurate.

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