Why Monte Carlo Is ‘Pretty Terrible’ for Analyzing Annuities
October 23, 2024 by John Manganaro
Financial planners who rely solely on Monte Carlo analyses to weigh the potential role of annuities in retirement income planning are doing their clients a disservice, according to Derek Tharp, the retirement researcher and financial planning expert.
Tharp offered this perspective in a new video assessing the retirement income modeling process posted to his YouTube channel. While noting the power of Monte Carlo simulations in other aspects of the planning process, Tharp cautions that the statistical method is “pretty terrible” at demonstrating annuities’ protective value.
Wink’s Moore on the Market: Ever use Monte Carlo analysis with annuities?
Well, Derek Tharp, Ph.D., CFP®, CLU®, RICP® with Income Lab says “that the statistical method is ‘pretty terrible’ at demonstrating annuities’ protective value.”
“Monte Carlo analyses, he maintains, do a poor job of providing clients with context beyond binary success and failure metrics. As a result, two plans (one with an annuity factored in and one without) could look nearly identical in terms of the probability of success with a certain assumed spending rate and longevity assumption.”
“Yet, the actual experience of the client across the two scenarios could be vastly different, with one providing a stable ride and the other leaving the client subject to an emotional rollercoaster in retirement. Unless clients are themselves well-versed in statistics, Tharp says, it’s not likely that any given client will be able to appreciate this nuance.”
No surprise…this is all a great segue to introduce advisors to Income Lab.
-sjm
