When it comes to market performance over a retirement that could last 30 years or more, it is impossible to know exactly what the future will hold. When financial advisors seek answers to these kinds of forward‑looking questions, they often turn to planning tools that use probability modeling, such as a Monte Carlo analysis. This type of analysis is particularly helpful when it comes to individuals, as well, for retirement planning.

What is Monte Carlo analysis?

A Monte Carlo analysis is a technique that simulates a range of possible outcomes for an uncertain event. In the context of financial planning, the analysis helps to test an individual retirement plan’s viability against a range of market environments and investment outcomes. The results of Monte Carlo simulations are then expressed as a percentage of scenarios (from 0 to 99) where there was money remaining at the end of the retirement horizon. For instance, a Monte Carlo score of 80 means that 80% of the test simulations resulted in $1 or more at the end of the period, while 20% of the simulations ran out of money.

“We don’t know how the market may behave in the future, but we do know that it goes up and down and that certain assets perform differently over various time periods.”

By comparison, other types of retirement planning might assume a static annual rate of return (for example, 7%) for the entire duration of the planning period. While an average rate of return is an important assumption, that approach assumes that market returns go up every year and does not consider a period of poor market performance, for example.

The T. Rowe Price Retirement Income Calculator

Our tool helps you gauge whether your retirement plan is currently on track.

A Monte Carlo analysis lies at the heart of the T. Rowe Price Retirement Income Calculator. A user can create a profile and enter retirement planning information such as their birth date, salary, retirement savings, retirement contribution amount, and portfolio allocation. They can also enter their spouse’s information to get a more complete picture. Utilizing proprietary capital market assumptions (asset class returns and volatility, for example), the tool runs 1,000 simulations that result in a Confidence Score illustrating the percent of successful trials. 

Making Adjustments
The tool’s interface allows you to adjust your initial parameters to see how the choices you make could lead to a higher or lower score. Examples of these adjustable parameters include the amount being saved, retirement age, expenses in retirement, and portfolio allocation.

Tool Limitations
There are limits to this flexibility, however. The tool assumes that your expenses will remain constant through retirement, and it assumes that your income will remain relatively constant as well. Despite these assumptions, the Retirement Income Calculator offers users valuable insights on the overall resilience of their retirement plans.

Understanding your score

While investors may assume that the highest success rate from a Monte Carlo analysis is best, that’s not always the case. These investors may be surprised when an advisor suggests that they can spend more in retirement, retire earlier, or both. After decades focused on saving, some investors feel reluctance to spend their own money. However, they may be in a position to enjoy retirement more than they think.

T. Rowe Price retirement advisors typically recommend aiming for a good score, rather than a perfect one. For example, many advisors, including the T. Rowe Price Retirement Advisory Service, counsel investors to aim for a Confidence Zone that ranges from 80% to 95%.

At the same time, a lower score, or seeing a dip in the score, may not mean it’s time to panic, either. The score is a helpful barometer to understand how much attention you may need to give to your retirement plan at a particular point in time.

Moderate adjustments can have a big impact on your score

The power of the Monte Carlo analysis is not just limited to the initial results. Most tools allow you to make adjustments and test how the changes could affect your long‑term financial success. For instance, minor adjustments in the following factors can lead to large changes in your score:

• Your retirement spending
• How much you save
• When you expect to retire
• Your asset allocation

What’s more, a Monte Carlo analysis as part of an advisor‑led planning service can help you craft your vision of retirement, personalizing your plan for your unique situation. An advisor can guide you through the process and help you prioritize what adjustments or actions will benefit your plan the most. (See “The benefit of our Retirement Advisory Service.”)

A Monte Carlo analysis is not a prediction of the future. It is merely a way to test various assumptions against an unpredictable future. The results of the analysis are heavily influenced by the quality and accuracy of those assumptions and inputs. Keep in mind, if you’re planning for retirement with a spouse or partner, you should also include their information for a more complete picture.

The benefit of our Retirement Advisory Service

Working with an advisor can give you access to more complex analyses and help you better understand what adjustments might be available or necessary.

The advisors with T. Rowe Price Retirement Advisory Service use Monte Carlo simulations as part of their process to guide investors on how to best plan for a dynamic retirement. Advisors walk clients through the different scenarios and review with them what changes might be necessary or available to improve their confidence in achieving their long‑term retirement goals as a household.

We find that our clients tend to focus on the extreme scenarios in an analysis, namely when the money runs out too early or when there is plenty left over at the end. We guide them to aim for a Confidence Zone of 80% to 95% to help keep the focus on the more likely scenarios and avoid making unnecessary sacrifices or aggressive adjustments to the plan.

After receiving a complimentary Monte Carlo analysis and resulting retirement plan, investors who opt to enroll in the ongoing Retirement Advisory Service gain the benefit of a dedicated advisor and a diversified portfolio monitored and actively managed by a team of experienced investment professionals at T. Rowe Price. The dedicated advisors touch base with their clients at least twice a year to review their situation and discuss any changes that might need to occur to keep their retirement plan on track.