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Welcome to How to Retire on Time, a show that answers your questions about all things retirement, including income, taxes, Social Security, healthcare, and more. This show is an extension of the book How to Retire on Time, which you can grab today on Amazon or by going to www.howtoretireontime.com.
This show is intended for those within 10 years of their target retirement date or for those are are currently retired and are concerned about their ability to stay retired.
Welcome to How to Retire on Time, a show that answers your questions about all things retirement, including income taxes, Social Security, health care, and more. This show is an extension of the book, How to Retire on Time, which you can grab today on Amazon or by going to www.how to retire on time.com. My name is Mike Decker. I'm the author of the book, How to Retire on Time, but I'm also a licensed financial adviser, insurance agent, and tax professional, which means when it comes to financial topics, we can pretty much talk about it all. Now that said, please remember this is just a show.
Mike:Everything you hear should be considered informational as in not financial advice. If you want personalized financial advice, then request your wealth analysis from my team today by going to www.yourwealthanalysis.com. With me in this duty today is my esteemed colleague, mister David Fransen. David, thanks for being here today.
David:Yes. Hello, Mike.
Mike:David's gonna be reading your questions, and I'm gonna do my best to answer them. You can send your questions in right now to 913-363-1234. Once again, that's 913-363-1234. Or email them to hey mike@howtoretireontime.com. Let's begin.
David:Hey, Mike. What's the Monte Carlo probability of success with your reservoir strategy?
Mike:Fair question. Fair question because the Monte Carlo is kind of the standard of probability in the financial world, but it's the wrong question to ask.
David:I thought a Monte Carlo was some old car from the seventies. Are we talking about something different here?
Mike:Yeah. So the Monte Carlo simulation is a mathematical simulation that's built on probability. So the idea is you can put in the standard deviation. So standard deviation for the uninitiated math nerds or those who just forgot the math class they took years ago. Yeah.
Mike:You're putting in basically the average return, and then you're putting in a range of the highs and lows within what you would expect into an equation. And then it puts out a bunch of randomized outcomes in a series of events. So in finance, you could say, if this is the expected returns of a portfolio, here's the range of the portfolio, and you were to run it for 30 years. Here's what you would expect. And that's kind of how the Monte Carlo was used in finance.
Mike:Here's the problem though. The Monte Carlo was never built for financial planners or financial advisors.
David:Oh.
Mike:So the Monte Carlo was originally built by 2 mathematicians or at least the it was developed by 2 mathematicians in the 19 forties while working on the atomic bomb.
David:Okay.
Mike:Do you know what the atomic bomb is based on? Let me let me give you a hint. Physics. Okay. Can you defy physics?
David:I've tried. I don't know. I I can't.
Mike:Not even David Blaine can defy physics. He might push the limits of physics, but it's you can't really manipulate physics. Physics just are. We have elements. Gravity exists.
Mike:Right? There are certain things that just are. Yes. K. You you don't break physics.
Mike:Physics doesn't care about your feelings. So here's how it was used, and I'm gonna kind of nerd out a little bit on this. I think it's fascinating. But, basically, they had the atomic bomb, this theory that they're trying to build. And if you saw the Manhattan Project or what what Oppenheimer?
Mike:Oppenheimer.
David:Yeah.
Mike:You probably already already know this. But for those who didn't see it, they had this bomb they're trying to create. And they don't know really what's gonna happen, like, when they when they explode the first atomic bomb. So they had to figure out, okay. Well, in theory, we're splitting the atom.
Mike:What would happen if we split an atom that's never been done before? Would there be a chain reaction that blows up the entire world? Would it blow up the entire continent? Would it blow up just the state? So they had to try and figure out kind of what would expect.
Mike:And so the process was basically neutron scattering, which is where neutrons collide with nuclei changing the direction and possibly losing energy but not guaranteeing losing energy. Okay. That's kind of what was going on there. Then you had either elastic scattering or inelastic scattering. Basically, neutrons bouncing off without losing much energy or neutrons transfer, some of its energy to the nucleus.
Mike:And, you know, is is there a chain reaction? I'm trying to make this as simple as possible for for
David:Yes. For me. Thank you.
Mike:Thank you. And then you have neutron absorption, which is the neutron is captured by the nucleus, which at that point may lead to either fission, splitting the nucleus into smaller fragments, releasing energy and more neutrons. That's that chain reaction Or non fission absorption. So the nucleus becoming heavier without splitting. Or neutron moderation, which is slowing down the fast neutrons and and and thermal speeds and blah blah blah.
Mike:Okay. So here here's what you got. A situation to where some will either speed up or slow down. We don't know exactly which. So let's randomize the different scenarios of what we think would happen based on physics.
Mike:Based on matter. Because we know they're not all gonna do one or the other. They theorize that it's gonna kind of happen and slowly dissipate. And so what would that look like? So they built this simulation to randomize trials to predict probability of what would happen.
Mike:Do you think any of those neutrons or any of the atom and any of that cared about emotions?
David:Probably not.
Mike:It's physics. Yeah. So the Monte Carlo works great when it comes to science.
David:Alright.
Mike:The Monte Carlo is, in my opinion, not great when you consider how the markets work, which is human emotion, the hope of growth, greed, and fear. Why did the market crash in 1987? Because people put all these new things called stop loss and then the market went down and they got scared and they it was triggered and just cascaded down. Why did the market crash in 2020 with the corona crash? Because they were scared it was the end of times or, you know, whatever was happening.
David:Yeah.
Mike:Right? And then it recovered quickly. But those are human reactions that you can't quantify. We don't know what's gonna happen in the future. So the Monte Carlo is an unfair and biased, in my opinion, way to try and predict your probability of success in retirement.
Mike:Now here's the truth. K. Yeah. Pull up a seat. Don't don't turn the dial.
Mike:Don't pause this. This is a very important fact that you need to understand. And you can go home and go on Excel and have a blast with this. Just Google and ask chat GPT or whatever. Google, YouTube video how to do a Monte Carlo.
Mike:It's not terribly difficult to do. But if you put in a Monte Carlo simulation, let's say you have a $1,000,000 portfolio and you're gonna take out 4% each year. So $40,000 from your portfolio. Okay? And you're gonna increase that $40,000 by 3% because inflation.
Mike:It's real. K? And you're gonna go for 30 years. If you put in, let's say, the S and P 5 100 standard deviations, their average return, and then the range of which you would expect, you're gonna get probably around a 99% probability of success. And you could do some variations of this, but it should be fine.
Mike:When I built it, I thought, well, this is easy. My job is simple. I just have to quote unquote sell a stock bond fund portfolio and things will just work out. But something was eating me up inside. Because I just I know the principles.
Mike:I know the rules. I know the risks. And so I actually had my Monte Carlo output all of the simulations, all the samples, the thousands of iterations, and I read them. And I noticed that the Monte Carlo's randomization was not actually simulating market patterns that have happened for the last 120 years. And I say 120 years because that's as far as back as I could find with doctor Schiller's research.
Mike:Doctor Schiller being an economic professor from Yale. Okay. His research is fascinating. And so I said, this doesn't feel right. So what I did was I kept the Monte Carlo in there.
Mike:I had the same 30 year average return, but I put in a 30% market crash in year 7, 14, and 21. K. Every 7 years. Yeah. Just that.
Mike:Same 30 year average, but I'm replicating a market pattern that's happened. That's emotion based. I rebrand the simulation, and I got around a 64% chance of success. That's very different. You can manipulate the Monte Carlo to sell a product.
Mike:You can manipulate all sorts of things with this, because the reality is our market is based on human interpretation of value. It's based on emotions. There's a chain reaction that happens when fear hits the market. There's a chain reaction when greed hits the market. And it's unfair to say that it's gonna follow laws of physics, because it doesn't.
Mike:Yet so many people have built their plan around Monte Carlo projections. And have no idea the risk they're taking. And by the way, when I put the crash in the 1st year of retirement, still 3 crashes. That's it. It went down to like a 46% probability of success.
Mike:Oh. And people have no idea. This is it's just math. Yeah. It's just math.
Mike:I share this at financial conferences when I'm a keynote speaker. And the financial professionals jaws drop and they say, oh no.
David:Boy.
Mike:So, yeah. To say that, okay, the Monte Carlo is great. Okay. Again, an oversimplified idea using a mathematical tool out of context, in my opinion, it's just it's riskier than people realize. Oversimplified plans are risky.
Mike:Here's how you combat that. If you want to maintain your growth, you wanna maintain the lifestyle flexibility in the future, if you want to sail through these market crashes that no one knows when they're gonna happen, you do what I talk about in my book, how to retire on time. You you implement the reservoir strategy. For some people that might be a 60% of your portfolio reservoir. For some people it might be 20.
Mike:Everyone's gonna take different amounts of risks associated with what their goals are. Whether it's lifestyle goals, whether it's legacy goals. But the day you retire is the day you should have the least amount of risk according to your lifestyle goals. The day you retire, you need to ladder up that liquidity. You need to implement your strategies to offset an up market, a down market, or a flat market.
Mike:You gotta put the plan in there and then stress test it, and then explore efficiencies and strategies that can help increase your probability of success. Because the guy who sells guaranteed income for life, can't guarantee comfortable income for life. They're just gonna guarantee based on the crediting of that insurance company, that the money should keep coming in for life. Then the a rated companies are probably in good hands. It's probably fine.
Mike:But you're getting up a lot of control, which I think that's where people struggle with that lifetime income from insurance companies is giving up that control. Or you can do the reservoir strategy. You have options. You can blend these strategies together. There's 10 ways that you can take income from retirement.
Mike:Blend them together. But the idea you plan first, you then explore the efficiency second specifically to your your situation and your goals. Then you design your portfolio so that you can support all these different outcomes. That's often not being done in my opinion based on what I've seen. Based on everything that's on a Monte Carlo and a set it forget it strategy, I think is dangerous.
Mike:And I don't think people fully understand the magnitude of what we just discussed. That's all the time we've got for the show today. If you enjoyed the show, consider subscribing to it wherever you get your podcast. Just search for how to retire on time. Discover if your portfolio is built to weather flat market cycles or if you're missing tax minimization opportunities that you may not even know exist.
Mike:Explore strategies that may be able to help you lower your overall risk while potentially increasing your overall growth and lifestyle flexibility. This is not your ordinary financial analysis. Learn more about Your Wealth Analysis and what it could do for you regardless of your age, asset, or target retirement date. Go to www.yourwealthanalysis.com today to learn more and get started.