| After posting, we received the following comment on this post from David Blanchett: “While it's true some financial planning tools don't do the things you list, I wouldn't ascribe the problem to Monte Carlo models... since there are few, if any, limitations for Monte Carlo simulations. Therefore, you might want to change the header to something like "Common Financial Planning Problems" to reflect the fact it's not the model itself (Monte Carlo), rather the tools that have been built using the model that aren't as good as they could be (or likely will be as they evolve)!” We thank Mr. Blanchett for his constructive feedback and agree with him, but we point out that these problems are much more easily fixed in our deterministic actuarial models than in the Monte Carlo models typically used today by financial advisors. |
In her July 21 Think Advisor article, What’s Wrong With Advisors’ Retirement Planning Models, and How to Fix It, Bernice Napach highlights some of the problems with the Monte Carlo planning models used by most financial advisors today. These problems were discussed by three distinguished financial planning experts participating on a panel discussion at the recent Engage 2020 virtual conference: Michael Kitces, David Blanchett and Michael Finke. And while Ms. Napach’s article is reasonably good at detailing the problems raised by these gentlemen, it falls a little short at discussing the fixes. This post will discuss what we believe to be a pretty obvious fix to these problems: financial advisors need to incorporate our Recommended Financial Planning Process (or components of it) into their planning tools and processes.
Problems with current Monte Carlo modeling tools and processes
Some of the problems noted by the panel experts include:
| Kitces: | Current industry tools for retirement planning “are not very good.” |
| Kitces: | Tools don’t provide an adequate framework to adjust from two people in a couple to one (after first death within a couple). |
| Blanchett: | Retirement plans need to quantify the value of non-financial assets. Advisors view assets as income but not income (like Social Security or pensions) as assets. |
| Finke: | Plans should reflect flexibility to adjust spending |
| Finke: | Retirees also need to understand how much of their budget is fixed and how much is variable. |
Fix: Incorporate Recommended Financial Planning Process
The chart below compares the functionality of our recommended process (utilizing basic actuarial principles) with that of Monte Carlo models, with respect to the problems discussed above, as well as several not discussed.
Functionality Comparison
| Item | Monte Carlo Modeling | Recommended Financial Planning Process |
| Different rates of future expected increases for different future expenses? | No | Yes |
| Expenses reduced by X% when first in a couple is expected to die? | No | Yes |
| Different lifetime planning periods for different members of a couple? | No | Yes |
| Automatically adjusts plan spending for actual experience? | No | Yes |
| Reflects all assets (including home equity) and spending liabilities in model? | No | Yes |
| Distinguishes between non-recurring and recurring expenses? | No | Yes |
| Distinguishes between essential and discretionary expenses? | No | Yes |
| Quantifies value of non-financial assets? | No | Yes |
| Quantifies size of Floor Portfolio necessary to fund essential expenses? | No | Yes |
The above chart shows that certain aspects of retirement planning can be improved by incorporating the basic actuarial principles and processes built into our recommended approach into the tools currently used by financial advisors. And while we wouldn’t necessarily go so far as to say that the current industry tools used for financial planning “are not very good,” we do agree with Messrs. Kitces, Finke and Blanchett that they certainly can be improved.
Summary
We thank Ms. Napach and the three gentlemen who participated in the recent Engage 2020 conference for teeing up our Recommended Financial Planning Process. We believe that adding this process and tools (or components of it) to financial advisor toolkits will help advisors better serve their clients.
