The problem with most financial planning
software is they accept a return rate on each of your
investments and project your financial future on those
rates. The argument is that over a span of years your
investments will return that rate "on average."
Unfortunately this is an invalid and risky assumption.
Investment rates vary from year to year. Sometimes they
vary greatly. We cannot accurately predict the return
rate on your investments or the inflation rate. Consider
the following simple example You have $1000.00 invested and you
expect a 10.0% average yearly return on your
investment. In two years your investment will be
worth $1210.00. Now lets assume your same $1000.00
returns -10.00% the first year and +30.00% the
second. Your investments after those two years is
worth only $1170.00 even though your investment
returned "on average" 10.0%. The above example demonstrates the need
for a mechanism to account for the volatility of
investment return rates and the variability of inflation.
The J&L Financial Planner has chosen to include two
alternatives, a Historical Return
Analysis and a Monte Carlo Analysis, as that
mechanism. The following paragraphs outline how the
Monte Carlo Analysis is implemented by the J&L
Financial Planner. The J&L Financial Planner allows you
to create simple or complex financial planning scenarios
(financial plans) revolving around your existing
accounts, consisting of investment, retirement, asset,
and equity accounts. You assign a nominal return rate to
each account, the traditional expected average yearly
rate of return, as well as a minimum expected rate, a
maximum expected rate and an optional Standard
Deviation. This minimum rate to maximum rate defines
a range for each account which is used by one the Monte
Carlo Analysis options. As another option the Monte Carlo
Analysis uses the supplied Standard Deviation. The J&L Financial Planner also gives you the option
to collect accounts into groups of accounts. Each
group of accounts is assigned a minimum expected rate and
a maximum expected rate. This minimum rate to maximum
rate defines a range for each group of accounts which is
used by the Monte Carlo Analysis as its third option. The J&L Financial Planner allows you
to assign a range of inflation rates used by the Monte
Carlo Analysis. As shown in Figure 1.0 the Monte Carlo
Analysis allows you to execute your financial plan up to
30000 times. Each gray graph is a separate execution of
your scenario. Each time it is executed the analysis
generates a random rate for each of your accounts or
group of accounts each year of your plan. The rates are
generated within the range of rates or the Standard
Deviation you specify. You have control over the extremes
to which the analysis performs. The J&L Financial
Planner also gives you the option of choosing uniformly
distributed random rates or Gaussian (normal) distributed
random rates, as well as the option to use account rate
ranges or group rate ranges. There is also a distribution
factor setting that permits you to adjust the Gaussian
Distribution. SUMMARY In summary, the Monte Carlo Analysis is
able to estimate the probability of achieving the success
of your financial plan by accounting for the yearly
variability in the two main factors contributing to it's
outcome, the return rate on your investments and the
inflation rate. You can execute up to a thousand trials
of your financial plan. Each trial is a fully independent
execution of your financial plan, where each year the
return rate on your investments and the inflation rate
can take on a range of possible random values. The large number of trials allows the
analysis to compute the statistical probability your
financial plan will be successful. For example, if after
1000 trials, 750 of those trials achieved your financial
goals, your financial plan success rate is 75.0%. If your financial plan rate is below your
expectations the J&L Financial Planner allows you to
make easy scenario changes to play "what-if"
with your financial future. Purchase our financial planning software from this secure site.
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