NASD Approves Monte Carlo Simulations

When forecasters are developing a Monte Carlo simulation, they use a random number generator and complicated mathematical models to show how thousands of different scenarios might affect investment performance. In addition, rather than using a single value for variables such as interest rates, the forecasters usually assume that the variables will change over time.

The new Monte Carlo forecast rule will make it easier for financial services companies to explain products with complex designs, according to Joseph Weiss, an actuarial advisor in the Hartford office of Ernst & Young L.L.P.

Although the Monte Carlo investment tool can help advisors educate clients, advisors have to make sure that clients understand that the models generate simulations of possible outcomes and not firm predictions of what the actual results will be, Weiss says.

Using Monte Carlo simulations can give clients a better handle on what they need to do to secure their own retirement, says Theodore Yoos, a certified financial planner with Back Bay Financial Group, Boston.

The simulations can help clients understand how changes in variables they control such as saving and spending can impact retirement planning, he adds.

But Yoos agrees with Weiss that it is important to remind clients that the simulation outcomes are only predictions and that the "real world could play out differently."