That gets us back to Monte Carlo Simulations. If we are going to use estimates of future returns that are less favorable than the historic record, what do we use? The most popular method on the board was to simply reduce the mean by a couple of percent or so. This method was likely the top choice because it was a choice that could be made given the software’s limitation.

I have read a few studies that use different approaches. In one (Blanchett), low yields were used for the first part of simulated retirements to reflect today’s low yield environment. Instead of assuming that would persist, latter portions of the retirement horizons used yields more in line with historic yield levels.

But these are issues of how. The question that sparked the online debate was, “Should we use historic returns or our estimates of future returns when running a simulation?” Maybe we should do both. Run one with history-based parameters and one with a reasonably thought out good faith estimate. The whole point of MCS is to show a range of outcomes, not serve as some sort of crystal ball.

One knock on using historic returns is it can give clients a false sense of security. Well, regardless of whether you use one of the methods I just mentioned or some other approach that uses below historic average returns, the simulations will show more failures. This can lead clients into a false sense of dread. Use both and clients may get the idea that the future is full of uncertainty. That’s a good thing for them to believe because it’s true.

MCS results only offer the odds of failure if the assumption that the client makes no adjustments to what is modeled holds true. The assumption that people will just keep going along in the face of a growling bear is dubious. Instead, present MCS results as offering the odds that clients should do something different than what is illustrated.

You can then lead them to the discussion that can make the most impact on their lives, identifying what these different actions are. This focuses them on what they can and cannot control. Markets are uncontrollable but their behavior is not. They have choices that can improve outcomes. What are the behaviors that can make them successful?

When portfolios don’t grow or shrink, clients might choose to work longer, save more or, if already retired, spend a little less. The studies on sustainable portfolio withdrawals show that such adjustments can be powerful. Altering an asset allocation is not likely to be a big help, at least from what my business partner, Mike Salmon, and I can tell from our recent study (Journal of Financial Planning Jan 2020).

The asset allocation alteration that can have a big impact is panicking and selling after a large decline. Clients can reduce the risk of this behavior by recognizing that one thing they can control is their intake of news. How do they ingest information and how do they react to it? If they admit watching cable news gets them wound up, they may be able to choose to get their information elsewhere or work on changing their reaction to what they ingest.

Instead of filling them with anxiety over the unpredictability of financial markets, talking with them about what they can and should do when the inevitable volatility arises may better prepare them. I heard football coach Lou Holtz once say, “Pressure is what you feel when you are not prepared.” Financial planning is about preparation, not prognostication.   

Dan Moisand, CFP, has been featured as one of America’s top independent financial advisors by Financial AdvisorFinancial Planning, Investment Advisor, Investment News, Journal of Financial Planning, Accounting Today, Research, Wealth Manager, and Worth magazines. He practices in Melbourne, Fla.  You can reach him at [email protected].

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