Cameron Passmore CIM, FMA, FCSI

Portfolio Manager

Benjamin Felix MBA, CFA, CFP

Associate Portfolio Manager
  • T613.237.5544 x 313
  • 1.800.230.5544
  • F613.237.5949
  • 265 Carling Avenue,
    8th Floor,
  • Ottawa, Ontario K1S 2E1

What are the odds?

June 11, 2014 - 0 comments

Achieving your financial goals doesn’t happen by chance, it happens through disciplined savings plans, long term goals and a well thought out financial strategy. With an infinite number of future possibilities, it’s important to understand the likelihood of scenarios and have reasonable scale as to what to expect over a portfolio’s lifetime. Thankfully there is a tool that runs thousands of simulations using a proxy for market volatility to give scope as to what is practical for long term financial planning. This tool is called the Monte Carlo analysis.

The Monte Carlo analysis is an easy to understand tool that is used to effectively explore the relationship between risk, return, cash flows, and portfolio longevity. The analysis uses the cash flow requirements of the portfolio, the expected returns of the market along with the market volatility to simulate a high volume of possible scenarios. The simulations are not predictive, but large numbers of simulations can reveal a realistic estimate of a range of possible outcomes for the portfolio’s lifetime.

The Monte Carlo analysis simulations use pseudorandom numbers constrained to the volatility characteristics of a probability distribution (usually a normal distribution) to help model potential outcomes of the stock and bond market. Using this simulation engine along with market expected return data, explained in this white paper from our own Raymond Kerzerho and Dan Bortolotti, the simulation can be paired with cash flows to give a realistic probability of portfolio longevity. The resulting data can then be used to evaluate the probability of best/worst case scenarios and the probability of achieving a financial goal. For example, if you have a monthly withdrawal plan of X dollars and you want to know the probability of an equity portfolio having Y amount of dollars on date Z, then the Monte Carlo analysis is perfect for you!

The Monte Carlo analysis is an effective tool that can be used to contrast the different risks/rewards of various asset mixes and the consequences of withdrawal rates/cash flows on the portfolio’s lifetime. 

Please ask your advisor about this tool and how it can be used in your own financial plan.

By: Max Lane with 0 comments.
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