Although you will never know exactly what your long term investment returns will be, there are ways to assess risk.
The Monte Carlo simulator can give you an idea about risk factors, but it canâ€™t guarantee the future.
When helping clients decide on an asset allocation, I spend time discussing the risks and benefits of every investment. Often, I am asked, “Will this guarantee my future? Will I be able to retire in style when the time comes?”
Unfortunately, the only thing we know about the future is that it is unknown. While this may be rather disconcerting for a client to hear, a financial advisor can’t give a definitive answer as to which investment vehicles can guarantee profitable returns. While past market performance shows us what was, we cannot foresee the future. One can never foretell the unexpected war, crisis, or crash that may hit the market, taking investors unaware.
Nonetheless, it is possible to navigate risk levels in investments. Some economists make predictions based on what is known as “The Monte Carlo Simulator.” This is a way to make future calculations based on random samplings of market movements over a certain past period. The basic premise is that markets are unpredictable, they can rise or fall unexpectedly, and this has to be taken into account when assessing the future. We cannot simply say that the market behaved in a certain way over a particular period, and that is what is about to happen.Monte Carlosimulations use assumptions based on computational algorithms connected to the probability of what could possibly happen over a certain time period, examining various options and possibilities all at once. Monte Carlo simulation helps make reasonable choices, not predictions.
It is important to note that even the Monte Carlo simulation still relies on certain assumptions to work and is therefore not perfect. Even the most sophisticated calculations and software cannot guarantee the size of the return on your investments over time. However, you can do the best you can by looking at the pitfalls and advantages as far as possible, with the help of a qualified and competent advisor.
If you are interested in seeing how your personal portfolio fares in a Monte Carlo simulation call your financial planner.
Disclaimer: This article is for educational purposes and is not a substitute for investment advice that takes into account each individual’s special position and needs. Past performance is no guarantee of future returns.