As we discussed in the “What is a Monte Carlo Analysis” article, Monte Carlo analysis does not give precise results - it gives probabilities, and rough ones at that. Always take the results of a Monte Carlo Analysis with a grain of salt, and if something looks “off” you need to look at it more closely to understand just what the numbers are telling you. (We’re always happy to help you understand just what’s happening behind the scenes.)
There are four sets of numbers to look at:
- The Probability of Success
- The Cumulative Wealth
- The Wealth Over Time
- The Cash Flow Analysis
Let’s take them in turn.
The Probability of Success
This is the main number that comes out of the analysis. Simply put, it is the percent of the simulated paths that were able to meet all of the goals in the plan. In other words, if 100 out of the 1,000 paths ran out of money before the end of the simulation, the plan would have a 90% probability of success.
This is a good starting point, but it doesn’t tell you how extreme the outcomes are going to be. It’s one thing if your retirement plan is running out of money at the age of 105. It’s a very different thing if that plan is running out of money at the age of 75.
The probability of success is the starting point. If a plan doesn’t have a high enough probability of success, then a deeper dive might be necessary to ensure that you have a solid plan.
The Cumulative Wealth
The plan’s cumulative wealth shows you just how big the range of return is in your plan, adjusted back at a constant 3% inflation rate. We show you three outcomes - the 90th percentile (an optimistic outcome), the median (50th percentile), and the 10th percentile (a pessimistic outcome).
The way to read these numbers is that 90% of the time you will have less money than the 90th percentile, half the time you will have less than the 50th percentile, and 10% of the time you will have less than the 10th percentile. 80% of the simulations had between the 90th and 10th percentiles. It’s important to remember the other side of that point - 20% of the time the ending value was outside of those numbers.
The cumulative wealth will give you an idea of what the spread of results are, but only at the terminal point. To get a better picture of the dispersion within your plan take a look at the Wealth Over Time report.
Wealth Over Time
The Wealth Over Time report is basically an expanded Cumulative Wealth chart. We use the same 90th, 50th, and 10th percentiles, but we show them throughout the plan. This should give you an idea of just what path the plan is taking, in aggregate.
The Cash Flow Report
This is the nitty gritty section of the analysis. Using the path with the median ending value, we break down the cash flow for each year. There are twelve data points for each year:
- Beginning Portfolio Value - The value of all of the investment portfolios included in the plan at the start of the year.
- Total Net Income - The sum of all of the income streams included in the plan for that year.
- Total Net Goals - The sum of all of the goals included in the plan for that year.
- Excess Income + Contributions - The sum of all the incomes and contributions to the investment accounts that weren’t directed towards goals. Note: If income/or an RMD is in excess of the total goals for a year, then the excess will display in this column as a taxable bucket contribution.
- Gross Taxable Distributions - The amount of money taken out of the Taxable accounts to meet that year’s goals. This is a pretax number, so it may be higher than the Net Goals number.
- Gross Tax Deferred Distributions - The amount of money taken out of the Tax Deferred accounts to meet that year’s goals. This is a pretax number, so it may be higher than the Net Goals number.
- Tax Exempt Distributions - The amount of money taken out of the Tax Exempt accounts to meet that year’s goals. Since taxes have already been paid on this money, this number will always be either equal to, or less than the Net Goals.
- Total Gross Distributions - The total amount of money taken out of the investment accounts to meet the Net Goals. This number can be higher (taxes on distributions), equal to (all distributions came from the Tax Exempt accounts), or lower (some goals were met with income) than the Net Goals.
- Total Capital Gains Taxes - The amount of capital gains taxes paid in that year. This is estimated based on historical turnover, the Simulated Net Return, and the Capital Gains Tax Rate you have entered for that year.
- Total Income Taxes - The amount of Income Taxes paid in that year. This is based on the distributions made from the investment accounts, as well as actual income streams, to meet the Net Goals.
- Simulated Net Return - This is the investment return used in this year for this run. Based on the model used in this year the program constructs a normal (bell) curve of the possible returns (based on the average return and standard deviation) then the program randomly plucks a return from that curve.
- Ending Portfolio Value - The value of all of the investment portfolios included in the plan at the end of the year.