Why isn’t Monte Carlo Analysis More Common?
In 1997 a financial planner named Lynn Hopewell published a paper in the Journal of Financial Planning titled “Decision Making Under Conditions of Uncertainty: A Wakeup Call for the Financial Planning Profession.” In his now iconic essay, Hopewell implored practitioners to improve upon traditional, straight-line planning methods by using simulation techniques like Monte Carlo analysis.
Nearly a quarter-century on, Monte Carlo capability is commonplace among the industry’s major software programs, and an increasing number of finance pros are using it to serve clients. And although the wider adoption of stochastic planning techniques is encouraging, there remains plenty of room for improvement in terms of method and presentation. Moreover, a lot of pros still shy away from simulation methods or even advise against them altogether. We can think of a number of reasons why this might be the case:
Inertia. The personal finance industry has been around for a while, and old habits are stubborn. These old habits have overstayed their welcome despite improvements in technology that have made stochastic financial planning affordable and accessible.
Practitioner limitations. Unfortunately, many finance pros still don’t have a basic understanding of Monte Carlo simulation. These folks are less likely to grasp the benefit of stochastic analysis or offer it as a service to clients. Plus, it’s easier to crunch numbers and provide advice using simple averages and familiar rules of thumb.
The “Ostrich effect”. Stability is more alluring than randomness—people really like to feel like they are in control. Monte Carlo analysis demonstrates the opposite. As we’ve seen, the pathway to a successful retirement might require a bit of luck. When faced with this fact, perhaps it’s easier for some advisors to stick their head in the sand than explain this reality to clients.
Lack of demand. Most people don’t know what Monte Carlo analysis is, let alone why it’s so valuable. And people can’t demand from their advisors things that they don’t know exist.
