Prime Time - Jane Fonda [117]
Monte Carlo Modeling
When you’re approaching retirement, you’ll need some advice about how to invest with less risk (since you will no longer be making big contributions to your retirement plan) and how much money you can safely withdraw every month so you can make your money last as long as you do. For that kind of planning, simple averages or casual guesswork just won’t do.
Savage explains the strangely named Monte Carlo modeling process, a sophisticated computer program that takes in all your answers to a detailed questionnaire and models multiple alternatives to come up with investment and withdrawal strategies for your retirement years that have a high probability of meeting your goals. The Monte Carlo process can also be used if you’re younger; it will show you, among other things, how much you should be saving, whether you are investing appropriately, how much money you can afford to take out every month, how inflation will affect your savings, and what your income goals should be.
“Monte Carlo modeling goes far beyond the law of averages,” says Savage. “It illustrates the range of probabilities so that you can observe the trade-off between risk and return.”4 Monte Carlo modeling is available at a number of leading financial services firms. Which firm may be appropriate for you depends partly on whether you are in what Savage calls the “accumulation phase” or the “withdrawal phase.”
THE ACCUMULATION PHASE
You are in the accumulation phase if you are still working, still trying to save, or still contributing to a retirement plan at work. If this is the case, Savage says, “Your company 401(k) retirement plan (or 403(b) savings plan for non-profits) isn’t the only place you could be saving. If you’re self-employed or own your own small business, you can set up a Keogh plan, an IRA, a SEP-IRA, or an individual 401(k) plan. These plans differ in their contribution limits and in whether those contributions are made by the employee or employer.” You can find definitions and instructions for opening these accounts at any major mutual fund or brokerage website because they also offer the mutual funds and stocks to make your retirement plan grow.
“It can be difficult to force yourself to save, so the trick is to do it automatically—to have the money taken out of your paycheck before you see it and spend it,” notes Savage. But the really tough part is deciding how to invest that money, how much risk to take, which investments to use, and how to maintain a disciplined approach to your investments even when the stock market is plummeting. For that you need professional help—and it doesn’t have to be expensive. Many of the nation’s largest employers offer 401(k) investment advice to their employees through independent services.
FINANCIAL ENGINES (www.financialengines.com). Savage likes this firm’s modeling services for those who are still in the accumulation phase. It includes modeling for your tax-deferred accounts, your non-tax-deferred accounts, employee stock options, and multiple goals. You are asked to fill out an extensive questionnaire that asks about your financial matters as well as your goals. Financial Engines is an independent firm that receives no fees for its buy-and-sell recommendations. You simply follow the suggestions to switch investments among the funds in your company plan.
But you need different advice—and investment choices—as you enter retirement. Savage advises that you not leave your money in your company 401(k) plan after retirement because your firm’s type of investments are more suitable for the accumulation phase than for the withdrawal phase; also you have no choice over the investment decisions. In addition, many company IRA or 401(k) accounts require immediate distribution of the funds when you die, which prevents your heirs from spreading out distributions and delaying taxes on withdrawals. She suggests instead that when you retire you roll your company 401(k) plan into an individual retirement account (IRA). And then