While Monte Carlo simulations are valuable tools in financial planning, they are appropriately named. When a planner tells a client that he has a 90% chance of achieving his goals and states that with certainty, that planner may be unknowingly deceiving his client. When one projects 30, 40 or more years into the future, it is impossible to make accurate predictions about what may happen. There are so many variables, such as the return on the portfolio, the timing of returns, spending patterns, income, unexpected expenses and many other things, that relying on a favorable percentage can create a false sense of security for some of our clients and may lead to behavior that sabotages the attainment of their goals. We need to communicate the uncertainty of these Monte Carlo simulations.
Those of us who use them regularly will attest to the fact that the odds of success can change substantially from year to year. If one plays poker or blackjack, we all know that the odds of winning or losing changes each time a new card is dealt. I know that the simulations we did in early 2009 looked significantly different than the projections we did in 2007. While we may all know this, it is extremely important that we communicate the uncertainty of these simulations to our clients so that they don't see them as accurate predictions of their future finances.
The list is not meant to be all-inclusive, and there may be other rules and shortcuts advisors choose to use in their practices, but nothing can replace a thorough discovery process, advice that is unique to each client and periodic reviews and updates. Financial planners are smart, and they don't need to be guilty of using rules of dumb.
Roy Diliberto is chairman and founder of RTD Financial Advisors Inc. in Philadelphia.