When we are younger, we dream of reaching “financial independence.” As we age and approach or achieve that dream, the desire for “financial independence” becomes “financial security.” We created MyRetirementLab with state-of-the-art technology as a place to evaluate, optimize, and stress test different investment and economic scenarios, so that you could realize and translate that dream from “financial independence” to “financial security.”
The Scientific Method
MyRetirementLab reflects our belief that investing, and the retirement planning process should be treated as a science. We approach the planning process much as a Doctor or Scientist approaches a problem by using the scientific method as outlined below:
- Have I achieved financial independence, and if not, how will I?
- Have I achieved financial security, and if not, how will I?
In our process Hypothesis is synonymous with Goal and represents a possible answer to the question in step one. Retirement is not one single goal, however, and each of the following objectives is matched with their respective investment solution and tested individually.
- Liquidity Reserve – Funds required to cover emergency expenses such as extraordinary health care, custodial care, or unexpected home repair.
- Necessary living expenses - Food, housing, utilities, clothing, transportation. Recurring healthcare costs, such as insurance premiums, deductibles, prescriptions, and other predictable costs.
- Discretionary spending - Maintain a preferred lifestyle, travel, hobbies, dining out, and other leisure activities
- Legacy Plan - Wealth transfer to heirs or charity
Using the latest in retirement planning techniques and theory for all future-date predictions, we use advanced Monte Carlo simulations. It generates 1000 different return scenarios to illustrate potential paths for each hypothesis or goal.
Monte Carlo simulation is a powerful approach to quantify long term risk over many different possible outcomes. However, it does have its limitations. Most Monte Carlo simulations used by Financial/Retirement Planners only focus on market risks such as equity returns and interest rate levels. State insurance regulators now require life insurance companies to run stress tests on the Monte Carlo Simulation and submit those stress results for regulatory review as part of their annual AAT (Asset Adequacy Test) filing.
For retirement planning, we believe that it is imperative for financial advisors to borrow from insurance companies and apply stress tests to retirement Monte Carlo simulations. Unfortunately, too often, many key variables are left out of the simulation model, such as taxes, social securities, longevity, inflation and health care costs. What will happen to your probability of success if your tax rate is higher, you live longer than expected, inflation increases, social security is reduced, or retirement health care costs go up?
Do our chosen investment instruments and allocations meet or exceed each goal, but more importantly when looked at in total, result in your financial security and provide for the lifestyle you’re looking for?
If the initial hypothesis is supported, we perform additional tests to confirm it. If not, we adjust the investments and allocations and test until they do.