Instructions
To run a Monte Carlo simulation, click the Run Monte Carlo button. This will randomize each year’s returns around the value entered for the IRA Retirement Return in the active scenario. The default number of simulations is 500. The default standard deviation is 15%. Both of these can be changed if desired in cells J8 and J9 on the Scenario Sets worksheet. A histogram showing the Monte Carlo results will be generated on the Monte Carlo worksheet.
Blog Posts
- Why Monte Carlo Matters: Bringing Real‑World Uncertainty Into Your Retirement Plan
- “Probability of Success” Added to Monte Carlo
Definitions
- Monte Carlo: When a Monte Carlo simulation is run, every year will get a randomly generated return. The simulation targets a median CAGR equal to the rate of return provided as an input (eg: “IRA Retirement Return” input). To do this, the tool estimates the volatility drag and increases the arithmatic mean, used as the Monte Carlo input, accordingly. As a result, you will see an arithmetic mean that is higher than your input value.
- Arithmetic Mean: This is the average of each annual return across all the years.
- CAGR: This is the geometric mean, which is the compounded annual growth rate across all the years for a single iteration. This represents the actual return and is typically smaller than the arithmetic mean. The geometric mean, or CAGR, is how stock market returns are described.
- Volatility Drag: The difference between the arithmetic mean and the geometric mean (CAGR) is the volatility drag. The more volatile the investment, the more drag there is. The Monte Carlo Standard Deviation setting in cell J8 of the “Scenario Sets” worksheet controls volatility. The default is 15% but can be changed if desired.