No guarantees in life, a quick lesson in probabilities

Posted on January 12, 2019 by wiseguide

cube-1655118_640 Don’t panic, I’m not going to get into too much math here. But it is very important to understand that all of personal finance is about making projections, which are far from certain. I will repeatedly emphasize that no one has a good crystal ball on exactly what the future holds, but we can use the past and a little probability to help us determine our chances. For example, would you retire if you had a 80% chance of outliving your assets? 50% chance? 10% chance? near zero? That answer is different for everyone, but no one can make that decision without getting an estimate of those probabilities, here is an approach you can use.

Although I don’t believe anyone can precisely tell you what will happen tomorrow or next month or next year, it is reasonable to look at stock and bond price histories for any given time period, going back 100 years if you want, to make estimates of the general trend of those assets. Let’s look at the past 10 years, the longer term numbers actually aren’t too different. The average return of the S&P 500 (which we’ll use as our metric for stocks) is 10.4%, with a standard deviation of 18.3. For the Vanguard Total Bond fund (which we’ll use as the metric for bonds) the average is 4.0% with a standard deviation of 2.8. Don’t worry if you skipped that lesson on standard deviation in math class, just understand that a big number relative to the average means that the return fluctuates a lot year to year, and a small number less so. We can then use something called Monte Carlo analysis which is a complicated term for a simple concept, run a whole bunch of sample “futures” and see how they all turn out. Think of it like throwing dice 1000s of times and recording what numbers you get. You can make some inferences on those future possibilities based on the results.

Using a little magic in Excel with random number generation for the return on a given year, and the means and standard deviations above, we can see what is the probability of getting to our retirement goal. Recall in an earlier post we showed we would get to our retirement savings goal of $1.2M. Hurray! Guaranteed? Uh, no. Crud. Going back to our 30 year old with $50k in her 401k, using our asset allocation, adjusting each year, and diligently saving, the chances of having at least $1.2M in the account at retirement? 78%. Good, but maybe you don’t want to bet your whole livelihood on it. Before getting completely bummed, the chance of at least $2.0M? 38%. Not bad, probability works both ways! Also, remember you aren’t doing this in the dark! If things happen to not be working out the way you planned, you can adjust. Maybe your house is a little smaller, or you work another year, or find cheaper hobbies; you have the ability to live to your means, no matter what the future holds.

If you are a weirdo like me and interested in the gory details of the excel calculations, here is a link. It’s really not that bad!

The Upside of Down

Posted on January 5, 2019 by wiseguide

natural-2728146_1920 No, not about Stranger Things. Sorry for the false advertising. What I want to talk about is why you should be happy about drops in the stock market. I know, stick with me here. Just a short time ago the stock market experienced a sharp downturn, and many people “lost” tons of money (I’ll have another post on this fallacy). People are understandably sad when their portfolio loses value, I don’t like to see those numbers go down either, but we shouldn’t be. Let’s think about the alternative. Stocks always go up. Everyday. Nearly guaranteed. No need to worry, right? Great! But remember my discussion on the investment “flea market”. If stocks had a near guarantee of going up every day, they wouldn’t need to pay you nearly the same return. People (correctly) are willing to take less money on their investments in exchange for lower probability that they will decrease in value. This is why stocks have a greater return than corporate bonds, which have a greater return than US Gov bonds, which have a greater return than CD’s. Return follows risk in an open market. So if stocks went up every day without a worry, they’d yield much less! That’s bad! We already have lower-yielding safer investments available to us, the beauty of stocks is for those of us with long time horizons to invest, they offer a great return in exchange for riding those ups and downs. The downs are not an unfortunate part of investing in stocks, they’re necessary. And, if that day, week, month or even year downturn hurts you financially because you were planning on selling right away, you shouldn’t be in stocks in the first place. So, go ahead and cheer those hits to your portfolio. Maybe privately so everyone else doesn’t think you’re crazy.

Oooh, that’s a good price for stocks!

Posted on December 29, 2018 by wiseguide

athens-2476281_1280 What’s a good price to buy stocks? By itself this is an impossible question to answer but it is useful to understand what can cause prices to go up and down when considering where to put your money.

Picture yourself at flea market. At each booth someone is trying to sell you something. There’s the Certificate of Deposit booth, a guy selling government bonds, a guy selling corporate bonds, a woman selling real estate, and a woman selling stocks. You’re trying to decide what to buy, and they’re all competing for your business. Let’s say at today’s interest rates CDs are offering 2%, guaranteed. The government bond guy is offering 3%, with low risk of default, corporate bond lady is offering 4% at a bit more default risk, real estate people can show rents on her properties that give a return on investment of 5% and the stock woman is offering stocks that have average earnings of 8 cents for every dollar invested (In other words, earnings vs price of 0.08. You will usually see company valuations given as the inverse of this, price over earnings–PE ratio. With earnings of 0.08 per dollar, this would be a PE ratio of 12.5, and only one way of valuing stocks, but a useful on for this exercise). Today you decide to buy the stocks because even though they are the most risky—the corporate earnings vary a lot and certainly no guarantee—you feel the risk is worth the return compared to everything else. This is the key. You aren’t judging the price of the stocks all by themselves, you’re judging them in comparison to all other possible investments. Let’s say when you go back, the fed has raised interest rates, driving up yields on CDs and other bonds to double what they were before. Let’s also pretend the companies that you have invested in have done exactly as expected. Now, the stock prices have plummeted. Why? The companies are doing fine! At least in part, it’s because of the competing options available to investors. If I can now get a corporate bond at an 8% yield, I’m probably going to need the stock to yield more. It’s now expensive by comparison. If the earnings are the same, the only way to get the yield higher (e.g. PE lower) is the price has to drop: the same earnings for a lower price. This is a simplified example and bond prices moving higher also hurts earnings themselves by making borrowing costs higher, but the important thing to remember is always evaluate the return and risk of an investment to every other alternative. There isn’t a magic PE ratio for “cheap” vs “expensive”, it’s always relative to the times.

Asset Allocation

Posted on December 22, 2018 by wiseguide

chicken-1686641_640 Where you put your money to attempt to maximize your returns while protecting your money is the subject of countless studies and makes up the primary job of many financial professionals. My suggestion for asset allocation is far simpler than what many of these professionals would recommend, and due to ultra low fees, the returns are likely better.

The first questions that need to be answered for asset allocation is a) What is the money for? and b) How long until you need it? For definitive expenses (like your emergency fund or saving for a major purchase in the next year or two), the money should be in something safe, like a CD or a money market fund. For something like retirement or other longer-term investing, it’s more interesting. Here is a starting example:

Age 25, Planned Retirement Age 65: Years to Goal: 40 years

For anything 25+ years to the goal, my recommendation is a 90%/10% stock/bond ratio. This isn’t magic, but certainly with a long time horizon, history has shown the vast majority of your money should be in stocks. I prefer a diversified group of index funds of all sizes, both domestic and international. You could go a long way to achieving this with just two funds: 60% in Vanguard Total Stock Market Fund (VTSMX) and 30% in Vanguard Total International Fund (VGTSX), The other 10% of the money can go into bond funds, such as Vanguard Total Bond Fund (VBMFX) and Vanguard Total International Bond Fund (VTIBX). I’m a big fan of Vanguard for their low fees, but if your 401k does not offer these funds hopefully you can find some similar funds that have very low fees—less than 0.2% should be standard for an index fund. For God sakes hopefully the funds they offer have no loads (sales commission). Aside—this is completely wasted money. “Sales Loads” are money paid to the salesperson for “selling” you the fund. They are so worthless you likely didn’t even know they sold you anything. This is different from the higher fees that actively managed funds (vs index funds) charge, that money is actually for the person picking stocks for you, but isn’t worth it either.

The suggested allocation looks something like this

60% Vanguard Total Stock Market Index Fund
30% Vanguard Total International Index Fund
8% Vanguard Total Bond Market Index Fund
2% Vanguard Total International Bond Market Index Fund

The above can be substituted for other equivalent index funds, you are looking for funds with fees of <0.2%. This gives you a broadly diversified portfolio in just four funds.

Once you get within 25 years or so from your retirement age, you want your portfolio to start to get more conservative, meaning a shift from stocks to bonds, such that at retirement you have something close to 50%/50% split of stock and bonds. I’ll have a future post on the logic of this allocation in retirement. This can be achieved by shifting your allocation by 1.5% from stocks to bonds with each year. For the ratio of the above funds at years until retirement, for example,

25 years to go (60%/30%/8%/2%)
15 years to go (50%/25%/20%/5%)
5 years to go (40%/20%/32%/8%)
At retirement (35%/18%/38%/9%)

Target retirement funds attempt to do this adjustment for you and there are some of these that invest in low-cost index funds, but I usually like to have this control myself.

That’s it, not complicated.

Retirement: When will I get there?

Posted on December 16, 2018 by wiseguide

My previous post discussed determining needs for retirement life, and for our example calculated we’d need $2.1M. Ouch. But here’s the thing, remember that’s with dollars way into the future (inflation adjusted), and if you have some discipline you can get there. Here’s our approach. For our financial projections, we’ll look at each group of assets as we did with with our retirement needs, and try to figure out how they will grow with time.

Home. Your home is one of your larger assets, and should grow in price like other assets and as you pay down your mortgage. We should be ale to get a reasonable current value of our home using sites such as zillow. Though not exact, it’s reasonable to assume an increase in value of 2.5% per year. Each year we also subtract off the principal portion of our mortgage, available from your amortization schedule (Microsoft Excel has a template for this if you need it). The equity in your home equates to

Home equity = (Current home value) x 1.025^years-Principal Owed

For example, a person retiring in 35 years with a $300K home today, starting with a $240K mortgage at 4%, the home equity looks like this

2. Retirement savings. Though historical data for stocks is higher, I like to assume an average combined return of 6%, assuming you’ll be allocating assets to a mix of stocks and bonds. Hopefully your return will be higher, but this is reasonably conservative assumption. You’ll probably be able to increase the amount you invest each year, but we’ll assume this is fixed. The easiest way to calculate this is using the Excel formula for future value,

FV = (Current Value, interest rate, years, yearly deposit)

Also, remember money in a 401k or IRA is not available until age 59.5. So, for example, a 30 year old saving $7200 per year with a current account of $50K:

3. Regular Savings. Similar to the above savings, however now we don’t have the benefit of tax deferred savings like the 401k, and also part of this savings is in your emergency fund, which will necessarily have a lower return. I think a reasonable assumed return on investment is 4%, again hopefully you’ll do better. For example, a 30 year old saving $2000 per year with a current account of $10K:

4. College Savings. Assuming you have kids (congrats!) college savings is another bucket for accumulation of assets. Assuming you are using a 529 plan, these earnings are tax free, but also should get more conservative (=lower rate of return) as your child gets closer to college age. Here I recommend assuming a rate of return of 5%. For example, let’s assume you’re putting away $100 per month for your child. This probably won’t be enough to cover the whole bill, but will take out a good chunk:

Finally, we sum up all all the curves and compare it to your needs from our earlier post. For our example:

Whoa. Made it! We didn’t have to assume ridiculous returns and we didn’t have to save $50k a year! Hopefully, this shows you this is achievable. We made some pretty conservative assumptions, but we show making it to your comfortable retirement while not eating Ramen Noodles and sacrificing Netflix during your working years. Notice what it takes is discipline to save every month, and starting early.

One other big caveat. All my calculations and assumptions above show nice smooth curves as your assets grow. This is far from reality, but a reasonable estimate for projections. No one can tell you if you will definitely make your financial goal. In a future post, we’ll get into how this is really just a best guess, and calculate the probabilities of getting there.

When Do I Have Enough?

Posted on December 8, 2018 by wiseguide

money-2724235_640 “Enough” is a tough concept to answer for each person, but extremely important to define for an person’s financial goals. Remember the role of money is only to give you a happy, satisfying life. For some people “enough” means a yacht with two helicopter pads (because with just one they’d be unhappy), though I’d suggest they may have lost their perspective on what it takes to make them happy. This concept is so critical that John Bogle, the founder of Vanguard and the father of index investing, used it as the name of his book.

There is a classic bit of financial wisdom, that totally misses this point. It states you figure out your needed retirement income as a percentage of your current income, typically about 75%. This is overly simplified, foolish, and sends the wrong message. Think if you get a big raise late in your career, would you think, “Oh no, my retirement account is suddenly way underfunded!” Of course not. Further, your expenses in retirement are completely different from those pre-retirement. Instead, you want to calculate what you need for enough. This is obviously different for each person, but I suggest determining your happiness needs in three categories.

1. Lifetime income. Hopefully you’ve gone through the budgeting exercise for your current expenses. For your retirement income needs, you should go through this again, except for retirement life. Your categories will undoubtedly change quite a bit. If you’re retiring before Medicare age (65), or if you think the Government will screw this up before you get there, your medical insurance will be a significant expense. This is going up considerably every year, I’d budget at least $2000 per month for medical insurance and expenses. Also, perhaps you’re looking to travel more, golf more, eat out more, whatever, but you should have less expenses for that house mortgage (paid off!) and for kids. Again, you’re trying to define “enough” for you. Lets assume your monthly budget adds up to $5000 in today’s dollars. If you’re 30 and retiring at 65, with a 2.5% rate of inflation, this is

$5000 x 1.025³⁵= ~$12,000 per month

Once you’ve built this retirement monthly budget subtract your expected social security payment (also adjusted for inflation and if you are retiring after social security age AND you think it will actually still exist when you retire!) as well as any expected retirement pensions you might have. Multiply that number by 12 to get your yearly income need, it will look something like this:

12 x (Monthly budget -Social Security-Pensions) =Income need

e.g. 12 x ($12,000-$6000-$2000)= $48,000

Multiply this number by 25 and that is the rough amount you need to save to support the budget you developed, in this case $1,200,000, or roughly a little more than a million bucks. Multiplying by 25 follows the “4%” rule meaning you should be able to invest your money reasonably conservatively and withdraw 4% per year. This isn’t magic, and has a ton of assumptions, but is a decent best guess.

2. Home. I’m a believer that your retirement home should be mortgage free. If you are carrying a mortgage, that needs to go into the budget above, but let’s assume you are not continuing to carry debt in retirement. If you’re a homeowner now, generally your retirement home will be no more expensive, and possibly much less if you downsize. What I suggest is start dreaming about where you want to live, and what kind of house will make you happy. Use sites like Zillow to see what that house costs. Once again, adjust for inflation as we did for the budget above, and there is your number. If you really, really want another big purchase (like that second helicopter) include this cost also. But please, try not to believe you need a helicopter. Or two.

3. College. If you have kids not yet in college, and you believe it is your obligation to pay for it, this is the third big expense. I’ll have a separate post on saving for college, but in summary a good place to start is the current in-state tuition, room, and board where you live and multiply this by 1.5 for a teenager, 2.0 for a grade-schooler, and 3.0 for a baby. College inflation is pretty ridiculous. Thank your parents if they paid your way. Then multiply this by 4, for 4 years of college, and encourage your young one to finish in 4 years. Again, this could change a bunch if he/she really wants to go to that expensive private school, or grows into a world class volleyball player, but again, it’s a good guess. For example, where I live in Virginia, current tuition, room and board at UVa is $28,000. For a grade schooler, I’d plan on

$28,000 x 2.0 x 4.0 = $224,000

So now, just add them all up. For example, let’s say you figured out the $1.2 Million you need to generate the income you want, and figure you would like a $300k house, adjusted for inflation is ~$700k, and figure it will take a little over $200k to send your kid to college. The total then is ~$2.1 Million. This is your targeted net worth. That’s the minimum you will need, assuming all the assumptions above, and is a reasonable target for what you’ve determined as “enough”. Scary? It doesn’t have to be, and I’ll show you how to get there. If that’s too big a goal, you can make some adjustments to your future lifestyle, or decide to work a little in retirement or junior’s college choice. Also, if your goal is to retire prior to social security age, I’ll have a separate post on retiring early and how to define this need. The point is to have a definitive goal to shoot for that has some relationship back to what you feel you need.

Happy Holidays! Buy Me!

Posted on December 1, 2018 by wiseguide

gift-2096990_640 I have to vent a little here on the holiday ads. It’s relentless, but the worst of them has to be the car commercials. The worst. The ad goes like this

Serene winter scene. Beautiful husband/wife comes running out to the driveway with a look of joy and complete love for his/her beautiful husband/wife and exclaims “Oh my God! You Bought Me a Car!” and all is right in the world with their new car (or two!) They even put a bow on it so everybody can see it’s a new car for Christmas! We’re the best people in the world!

Here’s the reality

“Oh my God, You Bought Me a Car!” with a look of terror, anger, and what-the-hell-is-the-matter-with-you. “You know we share expenses right? What happened to our previous (perfectly fine) car? What did this cost us and our children? You financed it? Great! So we get to pay interest as well on this thing we didn’t need and can’t afford? Did you even think this over? No, because you don’t think, ever. I should have listened to my father and never married you. Loser.”

OK, maybe that’s a bit harsh, but for the love of all that is holy, don’t fall for this ridiculous ploy. Reasons to purchase a new automobile are primarily

Your current car has become unsafe
Your current car has become unreliable
Your current car requires repairs/maintenance that are very high compared to the value of the car

Cars are terrible investments. They lose value with time. Further a financed car is a double-whammy, you are paying interest on that thing that is losing value with time. They are necessary in our lives in general, and can bring joy for some, but are huge cost sinks. You buy a car when you need it, not as some gesture of romance or whatever.

And news flash, saddling your spouse with a huge financial obligation is not romantic! As a general rule, never make a major purchase without your spouse’s consent! Maybe you like fighting? If you share finances (and married people usually do) you are spending some of your spouse’s money! It’s not a gift, it’s not even a kind gesture.

Advertising in general likes to try to convince us that it takes buying their product to achieve happiness. I mean look at these happy, beautiful people! You could be happy and beautiful too, in a new Chevy! It’s like they expect us to forget they’re paid actors, reading scripted lines, and all of what they presented is make believe. Don’t fall for it, you’ll be much happier in the long run.

Getting (and Sticking to) a Budget

Posted on November 23, 2018 by wiseguide

savings-2789112_640 Developing a budget is a crucial first step on your road to financial wealth. The goal is not only to figure out where you’re money is going, but maybe even more importantly what you can afford to save. If I ask you today, without a budget, can you put away $1000 a month? More? Less? You really don’t have a good idea. At the same time, a budget enforces that your money should be allocated in a way you consciously decide, not just spent until the wallet is empty. There are a number of personal finance software packages out there to get you started, but I’ve generally found them more of an obstacle than a help. Personally, a spreadsheet has always done the trick for me.

The first thing you need to do is come up with your spending categories. Many of these are easy: food, housing, etc but some may be particular for you. There’s a funny Office episode where Michael is questioned for his money spent on magic sets. Hey, no judgement. If it’s important to you and within your budget, go for it. Magic aside, here an example monthly budget for a person with a yearly salary of $72,000

Let’s look at a few of these. Some expenses can be tricky. I know you probably aren’t going on $300 vacations every month, the idea is to set aside money in your budget so when you want to take that vacation, the money has been saved. Other expenses like things for your home might have occasional big purchases and some months where you need to spend nothing. Again, this is just an average so you are ready to replace that washing machine when it craps out. For the car, I know loans are common, but I really can’t stand borrowing money for a depreciating asset. It’s a double whammy. I understand you usually need a car to work and sometimes a car loan is unavoidable, but try to avoid it if you can. Instead, think of some of this money as saving for the car you pay for with cash. I also have a category here called mad money and I that needs some explaining. My wife and I set up three bank accounts. One joint, one that’s hers, one that’s mine. Most bills are paid from the joint account and each month our “mad money” is transferred from the joint account into our personal accounts. Our rule is we aren’t allowed to question each other on what we spend from our personal accounts. It has really protected me from being ridiculous and headed off at least 1000 potential disagreements.

Estimating your after tax income is not very difficult especially if you are using the standard deduction. See here for an example.

Once you have your food, car, magic, and whatever other categories for your situation you need to estimate your monthly expenses in each category. You can do this by tracking your actual expenses for a while, bu don’t be afraid to challenge yourself. If your spend $500 at the bar every month you’re reaction shouldn’t be “well I guess that’s my bar budget”. It should be…”holy crap, I’m literally drinking away my future!” The example budget I show above leaves room for fun, in addition to saving almost 15% of the pretax income.

Hopefully when you figure out your budget the monthly income exceeds the total monthly expenses and you can plug in a significant amount for savings. If not, you have to make some cuts. I know it’s painful, but saving for your future is just as important as food and shelter. It’s literally your future food, shelter, and medical care. If that means a few less nights out, that seems like a small thing to ask. Future You says thanks, by the way.

Let’s Get Started

Posted on November 17, 2018 by wiseguide

rocket-launch-67723_1280 I starting writing this blog mostly as an advice column for my kids. I’ve taken what opportunities I’ve had with them to sit down and explain the importance of budgeting, investing for the long run, and making smart decisions, but those conversations are not as thrilling as they sound. It’s really, really tough for a teenager to look away from a YouTube compilation of people doing crazy things to hurt themselves so you can explain the beauty of index funds. And I get it–I don’t think my YouTube channel called “Successes” would get nearly the number of hits. They indulge me and they are great listeners, but this blog will always be sitting patiently, here when they need it.

Always a lover of math puzzles, I’ve made personal finance a bit of an obsession. As I’ve gotten older I’m constantly amazed at the amount of bad advice out there, and how financial salespeople feed people’s fear of math and investing know-how into making decisions that really only makes the sales person rich. I’d like to try to fix that. The math isn’t scary–I’ve worked through all of what you’ll need that I’ll readily share–and the knowledge required is amazingly simple.

Often what people are looking for is what are those “magic” investments that pay insanely high returns with almost no risk. Somehow there is a belief that there are people out there in the know, working their way through the system, hopefully legally, to get richer. I still hear infomercials on the radio using lots of words like ‘smarter strategy’ basically implying they have found that low risk/high return investment to get you rich with almost no capital. I’ll write a separate blog post on the ridiculousness of this argument, if there are loopholes of return without risk, they are quickly closed. But people hear this and think, man, I need to be part of that action if I ever want to be financially secure. Thankfully, cheaters and scammers aside, there really isn’t a shortcut, and furthermore, you can get there without a shortcut.

So what to do? First of all, the mega return on investment is not that necessary, boring and average is just fine. What is really important is DISCIPLINE. The discipline to automatically and consistently save money, month after month, year after year. The discipline to not keep up with the Jones’ and not satisfy every wish and desire at the expense of your financial freedom. You need to save as much as your budget can stomach. Very few young people (or old people) get this. If you get it, you will grow your nest egg. Yes, hopefully you are investing smartly, and I do have some advice for this, but the most important thing is to invest consistently. Don’t sweat too much trying to find that ultimate return year after year. Even professionals can’t do it, though many claim they can.

The next question is, how much do I save every month? That is where a good budget comes in. You need ruthlessly adhere to a budget, and coming up with a budget is not difficult, I’ll show that in my next post. You can’t really know what you can afford to save unless you know what you really need to spend. Hopefully the money budgeted on expenses is less than the money coming in. If not, you need to make some cuts. Painful if need be, but you cannot support a lifestyle by going further into debt or stealing from savings. Lots of young people fight this because they figure they are young, shouldn’t this be the time they are living it up? Well, yes, but that can’t be at the expense of your future, which will only lead to greater stress in your life. So allow some money in your budget for fun, but if you really want to set yourself up for your future, you need to save early and as much as you can.

All of this is really about freedom (this is another rant coming, prepare yourself). As long as we NEED to work, all of us are servants to some degree, we are never truly free. Hopefully you like your job, but few of us would continue coming in if the little pieces of paper that come every two weeks stopped. Having complete financial freedom is about having options, where money does not have to be part of the equation in your decisions. So you can keep doing that job you love if you’d like until you’re 90 and that is your choice. Or, with a big enough pile of cash, you can do what you want, when you want, as much as you want. That is freedom.

I’ll touch on a these topics in more detail in later posts, but this hopefully gets you fired up to save some cash! Well maybe not fired up, that’s just me. Slightly motivated? I’ll take it.

Monte Carlo Analysis

Link

For those interested in how I got the probability numbers for reaching retirement goals, a little fun with excel.

I used the random number generator =RAND() for each possible outcome to simulate the randomness of the return of our investments for both stocks and bonds. My example used a 30 year old in 2018, investing for 35 years until age 65 (year 2053). Stock and bond returns for each year are generated based on our random number and the mean and standard deviation we have chosen to use, using the excel function =NORM.INV(A1, 10.4, 18.3) and NORM.INV(B1, 4.0, 2.8) assuming the random number for stocks and bonds is in cell A1 and B1 respectively, and you are using the 10 year averages for mean and standard deviation I mentioned in an earlier post for stocks and bonds.

I used an allocation following my recommended asset allocation based on age. The overall return for stocks and bonds is calculated by using the randomly assigned returns from above and adding in our deposits made that year. I also rebalanced at the end of the year to get us back into the proper allocation for the upcoming year and use that value when calculating my return for the next year. This is repeated for every year until retirement.

Running this calculation once represents one potential future, or one run of the Monte Carlo simulation. We really want to run 1000’s of simulations, but for this case, I’ve just run 100 for simplicity. Each time I recalculate the sheet (hint, press F9), I record that bottom line number. Note, you want to copy and paste the value of this cell into another cell, not just do a strict copy and paste, otherwise all your numbers will be changing. For 100 runs, I got the following results:

monte carlo runs

For our purposes, these represent the universe of outcomes. The randomness of returns keeps things far from guaranteed, but we can get a sense of how good or bad things can be. I then use this list and the COUNTIF function in excel to determine how many “futures” get above certain thresholds. For example if the data above is in cells M1 to M100 and I’m looking for how many cases were above $1.2M, that is =COUNTIF(M1:M100, “>1200000”). For various thresholds, the results are below

monte carlo summary

There are still a bunch of assumptions here, most notably that the return for stocks and bonds for the next 35 years will look a lot like the past 10, but this philosophy gives some insight for making decisions in a very unsure world. For instance, from the above you can feel good, but not great, about getting to at least $1.2M, but if you’re counting on $4M, you better be a very lucky person. I know, Han Solo said “Never tell me the odds!” I’m guessing Han had a substandard retirement plan. You want to know the odds.

The Wealthy Wise Guide

Find your path.