You’ve probably heard of a SWOT analysis before. It is the process of identifying the Strengths, Weaknesses, Opportunities, and Threats likely to result from different choices and actions.
Maybe you use this in your work or with major life decisions. Have you ever thought about running a SWOT Analysis on your retirement plan? Today we are going to learn about the Monte Carlo Analysis which will allow you to do just that!
When it comes to your future there’s millions of different ways that everything could play out. We all hope things will turn out in our favor and the Monte Carlo Analysis is one way to stress test your plans to ensure you are on the right track.
Given your current financial status and goals, Financial Advisors and CPAs can run through a multitude of different scenarios; some years the stock market performs extremely well, some years it completely tanks. The analysis will be able to show you the most likely scenarios for your future with different levels of certainly.
For example, they might be able to tell you with 90% certainty that you will have between $1 million and $5 million at retirement age. With 70% certainly they could predict you might have between $2 million and $4 million. And they might be 50% positive that you will have $3 million when you retire. The more specific the prediction is, the less confident the analysis will be. However, given the results you will be able to determine if you are on the right track. If your advisor shows that you have a 0% chance of success if you keep doing what you’re doing, it’s time for some drastic changes!
In addition to your retirement goals, it’s important to stress test for issues that might come up along the way.
One of the most important things to think about is health scenarios. What if in 10 or 15 years you are completely unable to work. Do you have enough savings and insurance to cover medical expenses and potentially your living expenses for life? If insurance premiums increase drastically in 5 years will you be able to pay for them? Your advisor will be able to include this in the analysis to ensure you are properly covered!
Inflation is another issue that your plan should take into consideration. We’ve previously discussed the Rule of 72 where we can divide 72 by an interest rate to see how many years it will take for items to double in cost. Inflation typically rises around 3% every year, so dividing 72 by 3 means that we can expect an item to double in cost in about 24 years. We’ve all heard our grandparents talk about buying gas for a nickel and candy bars for a quarter, but we pay much more today!
This is due to inflation and you’ll want to be prepared for higher costs in your own future as well. If you had $1 million saved today, that might be enough for you to retire on. But if you plan to retire 20 years from now, you might want to plan for twice as much or more.
We also want to take longevity into consideration. Advancements in healthcare mean that you might live to 100 – that’s amazing! Will your retirement portfolio live that long? You want to make sure it can!
Financial advisors and CPAs can run the Monte Carlo Analysis through a thousand scenarios to give you very strong predictions about your likelihood of success in the future. The sooner you learn about the changes you need to make, the better off you’ll be, so now is the perfect time to work with your advisor to learn about your future and craft a plan!