My 2017 Monte Carlo Simulation

How much I’ll have in the future for retirement depends on how my investments perform over time. To get my best estimate I used Financial Engines, a tool provided by my employer for retirement planning. This tool explores thousands of possible economic scenarios using a technique known as “Monte Carlo” simulation. The animation below is a visual representation of this process.

The “Monte Carlo” retirement simulation gives my wife and me a “very like” 83% chance of meeting our desired retirement income goal of $80,000 by the age of 55.

Note: the Monte Carlo simulation includes both of us receiving social security retirement benefits at age 65. Those are purely 30 year out projections done on the Social Security Administrations Website. 

Based off our current finances, we feel we could retire early at age 55 and successfully live off $80,000 annually, or approximately $6,500/month. This is based off the fact that our house will be paid for well before age 55, which currently accounts for roughly 25% of income, and the fact that we will no longer be contributing to Roth IRA’s and/or 401(k)’s once retired, which currently accounts for 15% of our income.

40% of our expenses are currently going to the mortgage and retirement. So once the house is paid for and we’re retired, we should easily be able to live on approximately 60% of what we were making. This is what may allow us to successfully retire at age 55 with an annual retirement income of $80,000.

Monte Carlo Simulation

My 2017 Monte Carlo Retirement Simulation
My 2017 Monte Carlo Retirement Simulation

Each economic scenario explored by the Monte Carlo simulation makes different, realistic assumptions about inflation, interest rates, and returns on asset classes (stocks, bonds, and so forth) for each year of possible growth.

To make sense out of the thousands of estimated portfolio values, each is carefully sorted and counted. Then three very important numbers are shown. My median estimate is the most likely of the three, but I should be prepared for the downside just in case:

  • Upside: if your investments perform well, you may end up with a portfolio in the best 5% of the scenarios (95th percentile)
  • Median: if your investments perform average, you may end up with a portfolio near the middle of the scenarios (50th percentile)
  • Downside: if your investments perform poorly, you may end up with a portfolio in the worst 5% of the scenarios (5th percentile)

For example, suppose 100 scenarios are evaluated. If we sort these 100 retirement income estimates with the lowest estimate assigned the number 1 and the highest estimate assigned the number 100, then the retirement income estimate when your investments perform well would correspond to the income calculated in estimate number 95. If your investments performed poorly they would correspond to the number 5. And the media is 50.

Monte Carlo Simulation: Economic Assumptions

The Monte Carlo simulation doesn’t pick a single average number for inflation or interest rates. Instead, it looks at many different economic scenarios. To begin, every year of each scenario is based on different numbers for inflation, interest rates, and returns on asset classes (small cap stocks, large cap stocks, international stocks, bonds, and so forth).

But that’s not all. Estimating a realistic range of inflation, interest rates, and asset class returns (and their relationship to each other) requires special care. To be consistent, each number takes into account what has happened in prior years. Changes in one part of the economy (such as inflation) affect certain other parts (such as interest rates) during any given year. Estimates for any year should be consistent with estimates from prior years; for example, an inflation rate of 15% should not be expected for a year following one with 1%.

My 2017 Monte Carlo Economic Assumptions Simulation
My 2017 Monte Carlo Economic Assumptions Simulation

Monte Carlo Simulation: Retirement Income Sources

The Monte Carlo simulation estimates that if my investment performance is average/median (50th percentile), then my estimated income would be $116,000 per year at age 55. Of that retirement income, 81% will come from my retirement accounts (Roth IRAs and 401(k)). If my investments perform well (95th percentile), then my estimated retirement income would jump to $240,000. On the contrary, if my investment performance is poor (5th percentile), my retirement income would only be $61,200 per year.

Monte Carlo Simulation: My Forecast

Each economic scenario applied to my portfolio involves different rates of future interest, dividend, inflation, and portfolio growth. Some of those possible paths might end with my financial goals being realized – but others might not. My forecast is the percentage of scenarios where my portfolio reaches or exceeds my retirement income goal.

In my case, 83% of the scenarios ran by the Monte Carlo simulation equaled or exceeded my annual retirement income goal of $80,000.

2 Comments for “My 2017 Monte Carlo Simulation”



No link to the calculator??


Hi Ralph, this Monte Carlo Simulation was done via my Vanguard account and Financial Engines. It is a great tool, but it is a private calculator that I only have access to because of my work 401(k) plan. So there is no public calculator link that I can share. If I find a public Monte Carlo Simulation calculator, I will certainly share with all my Millennial reads.

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