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Retirement, Monte Carlo style

Updated: May 3, 2013 12:14PM



Originally published: August 29, 2005

For those Americans who are clueless about planning for retirement -- and there are lots of them -- Terry Savage has come to the rescue.

In her new book, The Savage Number: How Much Money Do You Need to Retire? (Wiley, 256 pages, $24.95), the personal finance expert and Sun-Times columnist provides hands-on techniques to plan a successful, satisfying retirement.

This is the second of two excerpts from Savage’s new guide.

You want the answer to that key question: How much money will you need in order to retire?

The answer is simple. All you have to do is factor in your current assets, how much they will grow in value over your life expectancy, and how much they will be deval-ued by inflation.

Then decide how much income you’ll need to maintain your lifestyle over the rest of your life. The sophisticated computer program that deals with all these variables is called Monte Carlo modeling.

Despite the name, Monte Carlo modeling has nothing to do with gambling. It’s simply the statistical science of modeling multiple alternatives to come up with a likely range of probable results.

Monte Carlo offers the answers to your retirement questions.

If you’re seeking advice on planning for life in retirement, you’re the leading edge of the 76 million baby boomers. You’ve looked at those 10 retirement-planning questions printed near-by, and you know you need help.

But where should you go for help, and whom can you trust to give you the straight answers?

The entire financial industry is gearing up to offer you retirement-planning services, and soon you’ll be seeing all sorts of advertisements for Monte Carlo modeling from firms such as T. Rowe Price, Fidelity, Vanguard and many others. There will be slight differences in the scenarios and recommendations provided by the various firms. What’s really important is that you’re doing something statistically significant about planning for your investments and withdrawals during retirement.

For sure, your odds of coming out ahead are much greater.

But first, get some perspective on two key aspects of the planning process -- accumulation and distribution.

During the accumulation phase, you’re concerned about whether you’re saving enough money and whether you’re investing appropriately to reach your goals. You might even need help prioritizing those goals.

Then, during the withdrawal phase, you need to know not only how much money you can take out every month or year, but how the remainder should be invested. Once again, you need to set priorities, either for lifetime income or for an estate.

The two phases are complementary parts of the same project: your retirement.

And there is no fixed moment in time when you make the switch from one to the other. You’ll always have investments -- assets accumulating -- even as you start to withdraw your money for living expenses.

Whether you’ve only saved a few dollars or are well invested in a retirement plan at work, you’re in the accumulation phase if you are still contributing.

The accumulation phase won’t stop until you stop making contributions to your IRA, Keogh or 401(k), and that may be longer than you think -- even past your official retirement date.

That’s the first half of the challenge. Withdrawal is the second.

As the 76 million baby boomers approach retirement, the focus has shifted. Yes, you’ll still be urged to contribute more. But now the industry is ready to target the next great shift for this generation -- the move from accumulation to withdrawal.

If building a pool of retirement assets caused anxiety, it will be nothing compared to the worries (and family fights) that will arise when retired boomers try to decide whether they can afford that vacation, new car or second home.

Monte Carlo simulations can help you develop a strategy for both accumulation and withdrawal.

Now that you have a fixed sum in your retirement account, how should it be invested? How much can you take out every month? Where does Social Security fit in? And how much should you continue to earn by working?

The trick is to make it come out even -- your money and your life.

No one has a crystal ball to know whether inflation or deflation is in your future, so financial modeling is designed to create a balance that will get you through all extremes.

The answer to creating a secure retirement plan is to use a combination of investment vehicles: some for growth, some for income, some for diversification and some for certainty.

It is that mix of investment choices and a realistic assessment of how much you can spend that Monte Carlo modeling is designed to provide.

Excerpted with permission from The Savage Number: How Much Money Do You Need to Retire? by Terry Savage (Wiley, 256 pages, $24.95).



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