How do I present probabilistic outcomes (i.e., Monte Carlo simulations) to financial planning clients?
I was asked this question recently – while consulting with a company on developing their financial planning software. Fortunately, the answer is straightforward: frame Monte Carlo results not as the likelihood of financial plan failure, but as the “probability of adjustment.”
Kitces argues that using the paradigm of “probability of adjustment” over “probability of failure” is the better approach. That’s the case for at least two reasons. Firstly, it’s more accurate. No client is going to continue on a course if it clearly results in their financial insolvency. (This is especially the case if their financial advisor guides them.) Second, the message of “adjustment” is less alarmist than “failure.” Putting emotions at bay helps clients make better financial decisions.
A Writing Sample Presenting Monte Carlo Outcomes to Financial Planning Clients
See below for a sample financial plan. The following can give you an idea of how financial planners can share Monte Carlo simulation data with clients. This sample below stresses the Monte Carlo data as “probability of adjustment” and not the probability of financial plan success or failure.
Dear John and Jane,
Thank you for the chance to help you plan your future. Our team enjoyed learning about your family and putting this financial plan together for you.
Your Odds of Success
You have done a great job of saving for retirement. Pat yourself on the back. This is no small feat. For most, spending money is easy. Saving money is hard. But you’ve managed to strike the right balance – both enjoying yourselves now while also setting yourself up to enjoy the future. In short, congratulations on the nest egg you’ve accumulated for yourself!
When we make our calculations, we look at the odds that you’ll need to make a change to your life. Usually, this means spending less money. Sometimes, changes can be selling something to fund living expenses – like selling a second car, a boat, or a fine art collection. To be clear, you may not need to make any of these changes today – or possibly ever. We’re just here to tell you the odds of needing to make a change to your lifestyle.
Having run the numbers, it looks like you are well set for retirement. According to the information you provided us, there is a five percent (5%) chance that you will need to make future changes to your lifestyle in retirement. Said another way, there is a 95% chance that you won’t have to change anything.
You likely don’t need me to tell you that 5% is a small number. So, once again, congratulations on putting yourself in such a good spot.
As we work together over the years, we will keep an eye on this number – the chance that you’ll need to adjust spending, etc. We’ll also keep an eye on how you’re doing on your financial planning homework, as laid out in your One Page Financial Plan.
Thank you once again for the opportunity to work with you. It’s always satisfying for us to help folks who have done such a great job of helping themselves.
If you have any questions, please never hesitate to reach out to us. We are here to help you.
Sincerely,
The Team at JonLuskin.com
How do you – as a financial planner – present Monte Carlo outputs to clients?
Life is about adjustments!
Thanks for this great article Jon. I just shared with our whole team! We’ve talked about this internally a bit but never had quite the succinct language you’ve put to it.