When you sit down with a financial advisor, they can give you a good sense of how your investments are doing plus a realistic forecast of how they are likely to grow over time. They create this forecast using a number of different tools, both financial and mathematical, to simulate the growth of your investments. Today we will talk about a few different investment simulation tools so you can understand where your advisor’s predictions come from and what they can be used for.

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Linear Projections

This very basic financial simulation models the growth of your investments under a single set of assumptions. You can easily calculate one using an online tool. Just put in your current wealth, the amount you hope to save per month, and the expected rate of return, and it will chart a straight line showing your progress.

Of course, real investment growth is rarely a straight line. You can’t guarantee your rate of return, and you don’t know for certain you will continue to save at your current rate. That’s why a linear projection is only a very general estimate. However, if you put in conservative numbers and don’t assume perfect market conditions, it can give you a good idea of how you’re doing.

If the projection falls far short of where you need to be in your retirement, you’ll need to make changes. That might mean saving more each paycheck or shifting your investments to products with a better annual return.

Of course, products with bigger gains often come with bigger risks. How do you know your investment plan is safe? Your advisor can help you determine this by using a more advanced investment tool.

The Monte Carlo Simulation

One of the most popular investment prediction tools is called the Monte Carlo simulation. Named after the famous casino, this simulation was invented by Polish-American mathematician Stanislaw Ulam. While in the hospital, he played so much solitaire that he started wondering how he could predict the outcomes of his games using math. It turned out his method was useful for more than just cards, and today experts use the Monte Carlo method to analyze everything from investments to wireless networks.

The core concept is very simple. It involves simulating the scenario on question over and over, with different variables each time. For instance, your advisor might want to simulate your retirement situation if you live to 90, and then again if you live to 100. Then they can create simulations based on each potential market factor that could arise as well. This can take tens of thousands of individual simulations, called iterations. Luckily, your advisor doesn’t have to crunch those numbers by hand—computers do most of the work.

After that, they can average all the iterations together to show the most likely outcome. This method also allows an advisor to see the odds that something goes wrong—you run out of money before retirement, for instance. If these odds are unacceptably high, they’ll advise you to make some changes, like saving more or investing more aggressively.

No Crystal Ball

Unfortunately, the tidy charts your advisor shows you are not a guarantee. No advisor is a prophet. They can tell you whether you’re taking the best steps to be secure in a variety of conditions. However, the unexpected happens all the time. For over 100 years, the Cubs never won the World Series. Predictors gave them an 85% chance of losing in 2016. However, the stars happened to align for Chicago that year, and they finally got their victory.

Likewise, when you have a Monte Carlo simulation showing success in 90% of situations, it’s still possible the market collapses at just the wrong time for your investments. Investing is largely about risk tolerance: how much risk are you willing to undertake for how much reward? Along with that question, it’s wise to ask what your safety nets are if things do go badly.

Your advisor can show you just how secure your investments are as well as steps to reduce your risk. If you’re not comfortable with the risk of failure in your retirement plan, the surest way to make it more secure is to save more of each paycheck. You can also talk to your advisor about when to shift your investments into more secure vehicles as you get closer to retirement.

See Your Investment Simulations

If you have only a back-of-the-envelope sense of how your investments are doing, you need a professional to run a more accurate simulation. With the help of modern technology, a financial professional can run a linear or Monte Carlo simulation for you in very little time. These charts can help you visualize your current situation and predict your future success. Your first step is finding the right advisor for you. We can connect you to a qualified professional when you contact us.

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