Don’t picture your retirement plan like this
BY TERRY SAVAGE Sun-Times Columnist Nov 6, 2006
Updated: May 3, 2013 12:14PM
Originally published: November 6, 2006
The race for your retirement dollars is getting more competitive.
Every financial services firm is advertising the fact that it can provide guidance, advice and investments to help you on the way to a secure retirement. But it’s still your money, and your retirement, so you have to consider these offerings carefully. While the promises are similar, the pathways are not. And the costs can vary substantially.
As I predicted in The Savage Number: How Much Money Do You Need to Retire?, the industry has embraced the concept of Monte Carlo modeling.
I highlighted the irony in the “Monte Carlo,” which brings gambling to mind, while the reality is quite the opposite. Monte Carlo modeling is the name given to a statistical process that models multiple variables to get a range of probable results.
Monte Carlo modeling is done on very sophisticated computer programs, which take into account the extreme ranges of potential results based on interactions with historic data. These results are far better than using historic “averages” to make decisions, because real life is never average.
If, for example, your retirement withdrawals start in a bear market, your early withdrawals could deplete your retirement funds so that you run out of money before later bull market years can grow your portfolio.
To calculate the probabilities of that occurrence, you need to use Monte Carlo modeling -- or more realistically hire a financial services firm to do it for you.
Monte Carlo modeling can be used during the “accumulation” phase of retirement planning, while you’re still working and contributing, to tell you how much money you need to save, and to give advice about how to diversify your investments to meet your goals
At the other end of your retirement planning process, as you start to plan your retirement withdrawals, Monte Carlo simulations are especially useful. You can get specific advice on withdrawal rates, as well as continued investment diversification advice during the withdrawal period.
Monte Carlo matchup It’s fascinating to watch financial services firms jostle for position in this environment. Their first step seems to be finding a way around using the actual term Monte Carlo, which was created back in the 1940s by scientists modeling the creation of the atom bomb. Fearing the name itself would be a bomb, you’ll see financial firms refer to their services by more palatable names.
For example, Wachovia Securities calls its service “Envision,” which is certainly a more encouraging process, but one that uses the most sophisticated Monte Carlo modeling tools.
Financial advisers on a Morgan Stanley team call their process a “Retirement Design Blueprint,” Vanguard calls its modeling process “time pathing,” and Fidelity avoids naming it anything but a “tool” to help you estimate and stay on track.
Only T. Rowe Price, one of the earliest providers, comes right out and says “the analysis we perform to provide you with a recommended retirement strategy relies on sophisticated computer modeling known as a ‘Monte Carlo’ analysis.” Planners explain that their recommendations are based on “a range of possible future outcomes of your chosen strategy under 1,000 different market scenarios” to determine the odds that your money will last at least as long as you do.
If you want the real thing in your retirement planning, the first thing you should ask a financial planner is whether it is indeed Monte Carlo modeling or how their process differs. It’s hard to do serious Monte Carlo modeling and create personalized investment plans just by interacting with a Web site. You’ll get the numbers, but you probably will need personalized advice to implement a strategy.
Major no-load mutual fund companies are moving in that Web-based direction, however. So the accompanying boxes compare the offerings at Fidelity, Vanguard and T. Rowe Price. Each differs slightly in its historic database, its advice about how much current income you need to replace, and how large a portion of your post-retirement assets should be invested in equities -- as well as in the degree of personal interaction they offer, and the sophistication of their planners.
Yet any one of them could provide you with far better advice on retirement planning than you would get by relying on your own guesswork.
Morningstar Inc., the Chicago-based provider of independent research on mutual funds and stocks, is also offering a Web-based financial planning tool that uses Monte Carlo modeling. The service is available to investment advisers and registered representatives.
Called Morningstar Retirement Income Strategist, it is a broad-based planning tool that takes into account Social Security, taxes, inflation, pensions, required minimum distributions and other income streams in planning for retirement goals and withdrawal scenarios.
The Monte Carlo modeling is powered by Ibbotson Assoicates’ “Wealth Forecasting Engine.” While this tool is not directly available to the individual investor, it is readily accessible by financial professionals -- ensuring even wider use of Monte Carlo modeling techniques.
An easy way to learnIf you’d just like to see how the concept of interactive Monte Carlo modeling works at its simplest level, here’s something you can try. Just go to my Web site (www.TerrySavage.com) and click on the blue box that says “Financial Engines,” a link that leads you to a free one-year trial of this service. (To be very clear, I do not receive any remuneration or information about who enters through my portal.)
FinancialEngines.com was created by a Nobel Prize-winning economist, William Sharpe, who wanted to make sophisticated portfolio modeling available to individuals. Many Fortune 100 companies offer this service to their employees.
You’ll create your own secure, password-protected account, so you can receive personalized advice about how much you should be saving, and how you should be diversifying your investments, both inside and outside your company retirement plan.
It would be a fascinating journalistic endeavor to create a model portfolio based on the investment advice given by each company. The big problem is that we wouldn’t know the results for 30 or 40 years.
After all, this is designed to be a long-term process of giving advice for both investments and withdrawals. So we won’t know the winner until it’s way too late to change direction.
Even so, it’s far better to pick one of these providers, develop a plan, and stick to it than to put your head in the sand and just hope you’re saving enough, investing properly, and withdrawing appropriately. And that’s The Savage Truth.
Noted for its low-cost mutual funds, Vanguard can save investors big money over the years in annual fees. But its Vanguard Financial Planning service is more costly than the other two companies.
The service, which uses the “time pathing” variation of Monte Carlo modeling, costs nothing if you have $250,000 in assets with Vanguard, or are willing to move $100,000 in new money to a Vanguard account. Otherwise you’ll pay a steep $1,000 fee.
Vanguard points out, however, that its funds have the lowest expense ratios, and that in the long run its service is quite economical.
Vanguard has partnered with Financial Engines to provide an online tool to help people decide if they’re accumulating enough money -- and get advice in allocating their investments among fund choices.
For the withdrawal phase of retirement, Vanguard suggests that people need a personalized consultation with a Certified Financial Planner to help them through the process and to implement the plan. Almost all Vanguard retirement advisers are CFPs, or on the way to that designation.
Contact: (800) 337-8476 or www.Vanguard.com.
The largest mutual fund company in the world, Fidelity is constantly enhancing its retirement plan offerings. And all its Monte Carlo services are free.
Starting Monday, Fidelity will offer “myPlan Snapshot,” a very short and very graphic tool that requires you to answer just five questions to give you an instant read on whether you’re close to reaching your retirement goals.
You can move “sliders” to visualize the impact on reaching your goal if you save more, work longer before retirement or take more investment risk.
You can access the tool at www.fidelity.com/check, and it’s definitely worth a couple minutes of your time, and far better than hiding your head under the covers when someone asks if you’re planning for retirement.
Then, if you want to develop a better plan of saving and investing, you can go online at Fidelity.com to “myPlan Retirement Quick Check,” a process that takes about half an hour to complete. It uses a simplified version of Monte Carlo modeling to give you an analysis of your current situation, suggest how much more you need to save, and create a model asset-allocation portfolio for you. You can transfer that advice to your own workplace retirement account, or use Fidelity funds in your IRA or self-directed 40l(k).
The third facet of the Fidelity program is geared toward those approaching retirement within a couple of years. The Fidelity Retirement Income Advantage program uses Monte Carlo to guide you to an investment and withdrawal strategy designed to make your money last your lifetime. Then you can pay for the Fidelity Income Management account, designed to keep you on track with withdrawals and investments.
Contact: Fidelity now has more than 100 offices around the country, and meetings with its reps, who are typically not financial planners, are easy to arrange. Or you can call (800) FIDELITY, ask for a retirement specialist, and he will walk you through the computer programs. If you’ve been hesitating about how to start thinking about the subject of retirement planning, the Fidelity.com Web site is a good place to start.
T. Rowe Price is the smallest of these fund companies, but it has long been the leader in Monte Carlo modeling, first offering its service for retirement withdrawal planning in an inexpensive format in 1999.
Now it is extending coverage to provide modeling for diversification during the accumulation period, through the transition period into retirement and throughout the retirement withdrawal period.
T. Rowe’s fee is a flat $250 (which will be waived if you invest $100,000 in assets in T. Rowe funds). But you don’t have to use T. Rowe Price funds to earn its advice on diversification, saving rates or withdrawal rates.
The fee includes an annual planning checkup, to make sure you’re staying on track in future years.
You’ll meet -- over the telephone -- with an individual planner, typically a Certified Financial Planner, who guides you through the extensive question-and-answer process about your situation, your goals and intangibles like your risk tolerance.
A few key facts about the T. Rowe Price service:
? Your plan is modeled to age 95, a good idea since we’re all -- hopefully -- living longer!
? T. Rowe suggests you plan for your retirement income to replace at least 75 percent of current income.
? The company typically suggests a larger portion of your investments be diversified in equities during your retirement years, noting the continued need for growth even as you’re withdrawing. But each recommendation is created individually based on the investor’s personal circumstances.
Contact info: (800) 638-5660 and www.troweprice.com