Odds Are Retirees Don't Care About the Odds
15 Pages Posted: 13 Jan 2021
Date Written: November 1, 2020
Random events are those that you cannot predict with certainty and the concept of a random event is the basis for probability. But uncertainty is aversive, so people try to mitigate the discomfort of the randomness and uncertainty of retirement-income planning with predictions based on probability theory and Monte Carlo analysis. Although ubiquitous within the financial services industry, Monte Carlo analysis is likely an ineffective tool that wastes resources and distracts most investors from the essence of the problem. It is ineffective because many people lack the numeric skills needed to accurately assess probability and because cognitive biases cause most people, including experts, to be insensitive to probabilities, neglect them completely as risk becomes more vivid or of greater magnitude, or view probability negatively. Monte Carlo is wildly inaccurate in its predictions of how long a retiree’s savings are likely to last and employs a methodology that is the opposite of what retirees want. Eliminating it from conversations should lead to safer, simpler, and more-personalized retirement-income portfolios for investors and help advisors create a brand of original thinking.
Keywords: retirement planning, retirement-income, Monte Carlo
JEL Classification: GO
Suggested Citation: Suggested Citation