Ideas, theories and strategies are seemingly infinite when it comes to the choices for managing an investment portfolio. But no matter how you manage your nest egg, there’s a growing number of independent financial advisors who counsel that Monte Carlo analysis should be an integral part of the process.
What is Monte Carlo analysis? A statistical tool for measuring the probability of various outcomes. (For a deeper look at MC, peruse the myriad of information on the web by
clicking here.) Thanks to the computer revolution of the past generation, Monte Carlo analysis is now widely available at affordable prices. Sophisticated investment advisors routinely use Monte Carlo analysis for judging the odds that an asset allocation strategy will live up to expectations. One popular application is using MC to adjust a portfolio in order to improve the odds that an investor won’t run out of money.
But while there’s much to embrace when it comes to applying Monte Carlo to finance, there are no free lunches in the land of statistics. In the February issue of Wealth Manager, your editor penned an article–“A Sure Bet?”–on Monte Carlo and its applications among financial advisors. The conclusion: MC is a powerful and potentially enlightening tool for investors intent on managing risk to their advantage. But there are pitfalls as well, starting with the fact that a fair degree of subjectivity inhabits Monte Carlo analysis. For the details, read on….