For many people, a key concern is to keep from running out of money as they grow older. How likely is this to happen? One way to find out is to consult a financial advisor and request a “Monte Carlo simulation.” Using sophisticated software, assumptions are changed randomly and the model is run many times. This shows the range of potential outcomes and the probability of achieving certain results.
For example, 1,000 different scenarios might be run, with various investment returns, withdrawal patterns, and inflation rates each year. The results might show that you’ll live prosperously in 36 percent of the projected outcomes but run out of money 64 percent of the time, given certain projected results.
That is, if you have $1 million and take out $100,000 (10 percent) per year for your retirement, you may feel fairly safe, given that stocks have returned around 11 percent per year, long-term. However, if the stock market drops and your $1 million shrinks to $700,000, your $100,000 withdrawal would be 15 percent–and you’d probably be broke within eight years. A Monte Carlo simulation can show you the positive effects of building in a cushion, perhaps by withdrawing, say, 6 percent per year from your retirement fund.
