• Create BookmarkCreate Bookmark
  • Create Note or TagCreate Note or Tag
  • PrintPrint

Monte Carlo Simulation

One way to make certain that you have the proper distribution of assets and you are using reasonable assumptions for growth is to use a Monte Carlo simulator. This is a computer-modeled analytical tool that evaluates risk using a random series of returns. Its name comes from the infamous casinos of Monte Carlo where games of chance have spawned a tool that can help reduce risk. The Monte Carlo simulator is used to paint a more realistic picture of how long-term investment cycles impact long-term investments. Most projections use an assumed investment, an assumed period of time, and an assumed rate of return.

As an example, we invest using an assumed investment of $25,000, an assumed period of 20 years, and an assumed interest rate of 6 percent. Monte Carlo simulators keep the investment ($25,000) and the number of years constant (20), but they vary the investment return to show the impact of good and bad years. This is a much better long-term indicator than a straight 6 percent a year for calculating future value. The assumption is that in a dice game, you don't roll a four each and every time—sometimes you roll a five, sometimes a one. The same should apply in investing, and you should be able to see the impact of various scenarios to be able to effectively manage risk. You'll read more on Monte Carlo simulators in Chapter 12.


PREVIEW

                                                                          

Not a subscriber?

Start A Free Trial


  
  • Creative Edge
  • Create BookmarkCreate Bookmark
  • Create Note or TagCreate Note or Tag
  • PrintPrint