Does Monte Carlo-Based Financial Planning Really Work?

A few days ago after wrapping up a productive planning meeting, my client asked me a question in total earnest. He had come to our meeting with concerns that new information he brought would wreck his plan. We made the changes he needed to make and we reviewed all his other goals and priorities. After some adjustments that were easily acceptable to him, I showed how he could still confidently meet or exceed his goals. In fact, during our discussion he added another goal. He had been thinking of increasing his annual giving in place of leaving a larger final estate. When he saw that his changes did not wreck his plan, in fact it was significantly better as a result of having shared more of the things he really wanted in life, he asked his question:

Does this stuff really work?

At first my head filled with a flurry of elegantly logical arguments used over the years to defend our philosophy from countless critics and skeptics who were comfortable with the status quo. But the sincerity of his question begged for a real answer, not an abstract one. His question was from heart, not the head. He had just learned it was possible to meaningfully impact the lives of people during his life in ways that an hour earlier was no more than a fantasy. He was asking me, ‘can I really TRUST what this thing is telling us; that I will be able to accomplish the things I hope, without worry?’

After some reflection, I began my response, speaking from my heart, in kind with his question. I shared that over the past eight years that we have offered the Wealthcare process to our clients we have seen remarkable changes in their lives, for the better. First and foremost, they worried less, far less. When together, we no longer talked so much about the market and where it might go. Rather we talked about families, hobbies, business plans, vacations and mission trips. We talked about their lives.

For most investors, the crash of 2008 brought significant loss, worry, sleepless nights, and behavioral mistakes born of panic or frustration. During the relentless two-and-a-half year market rout, our clients did not worry like they said their friends did. While they were truly concerned for their country, very few expressed concern about their money or their future plans. The reason quite simply was that our clients’ portfolios were not down as much as they were hearing their friends’ were down. In fact, as a result of our process, none of our clients were exposed to more risk than was required to confidently meet their plan’s goals.

In the past eight years we have watched our clients learn to think about their futures in new ways, to stretch their imaginations, to turn dreams that had long been chained by logic into exciting goals that we are working together to confidently meet. Our clients have learned that they are the pilots of their future, better futures, not the markets nor their financial advisors. They set the course and we ensure they get there with as little worry and sacrifice as possible.

Then there’s what goes on behind the scenes in our daily management of portfolios. Here we have a very simple motto: Market returns are uncertain, but expenses are certain. Why should we ask our clients to seek higher returns just to cover expenses and taxes that are not necessary? You don’t have to make back money you don’t lose. That’s why we are passionate about managing our clients’ portfolios as efficiently as possible, by protecting them from the myriad of snares of the financial services industry, and taxing authorities.

Then there’s the Monte Carlo, or the statistical stress-testing we do at least 12 times a year to ensure that every one of our clients’ plans has sufficient confidence to meet or exceed every important goal their plans represent. In this part of the process, the computer system ‘lives’ a thousand times each of our clients’ lives, virtually, through all kinds of markets including Great Depressions. The result is a measure of confidence that falls into one of three statuses; comfort, over-funded, and under-funded. The reasoning behind a properly funded (comfort) and under-funded plan is obvious, but what about the over-funded one? What is wrong with pushing for 100% confidence?

The problem with exceedingly high confidence is that it leaves so much ‘life’ unlived – on the table so to speak. The over confident planner dies with a bigger pile of money than he or she said they wanted in their plans. Financial advisors who push higher confidence are asking their clients to take more breitling replica risk, save more, spend less in retirement, delay goals longer, or reduce them unnecessarily. The cost of overconfidence or piling up money beyond need is measured in lifestyle sacrifice and Monte Carlo used properly can manage that wonderful balance between ensuring confidence of meeting long term goals without unnecessary lifestyle sacrifice today.

Another reason to trust Monte Carlo based planning is that it better informs your financial advisor’s advice for adjustments to the curves and surprises that life throws your way. Those of us with a few years into the journey understand that straight line planning which does not allow for unexpected events is doomed to failure. Monte Carlo addresses uncertainty better than anything going today.

Consider an airplane in flight to a destination. Before our modern GPS, pilots depended primarily on the compass for direction with other means such as radio beacons to validate. In this example let’s assume the pilot takes off on a compass heading for his destination with no other navigational references (akin to straight-line planning). If our pilot does nothing else until his alarm tells him it’s time to land, he will never make his destination. Why? Wind. As soon as an airplane’s wheels leave the ground it’s course is impacted by forces beyond the lift of its wings and thrust of its engines. It is continually being blown off course.

In flight, a pilot makes a series of adjustments to re-aim his plane toward his destination. In so doing he is continually analyzing new information to refresh, to a level of ‘comfort,’ his odds of making his destination before running out of fuel. That’s what Monte Carlo does for our clients.

But it does so much more. We are less about destinations than we are about can be’s. By understanding the important things our clients hold dear, we help them steer through buffeting winds of uncertainty toward futures they themselves create – futures far better than those they would have if they chose to remain at the mercy of the wind.

Next week we’ll address the question, in friendly terms, from the technical perspective.

Author Sam Bass Jr.

Sam founded Beacon Wealthcare in 1998. He has thirty five years' experience investing money for his clients. In 2006 he changed the focus of his firm from asset/return to a client/goal-centered and adopted state-of-the-art planning and management systems to deliver the best fully integrated planning service available. Sam holds a BA in English Literature from Hampden-Sydney College, 1975 and an MBA from Wake Forest University, 1981. He concentrated in International Finance, and did research for an International Finance textbook which included a summer at the London School of Economics. He is married to Sharon, a talented pleinAir oil painter, They enjoy being with their three children, their spouses, and five beautiful grandchildren as often as they can. Sam loves Jesus, sailing, cycling, and writing.

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