IV. Straight-line returns vs. probability analysis
Most financial plans rely upon a straight-line return that represents a flat, average annual rate of return. This method works for simplicity sake, but it does not represent the reality of investment performance or how financial markets operate.

Returns are volatile, and that volatility can have a severe impact on investment returns. The sequence of returns will make a big difference in the final results. A downturn in investment performance at an inopportune time relative to retirement can devastate a retirement plan, even if the long-term plan in maintained.

Probability analysis
An advanced method of illustrating investment scenarios. Probability analysis takes into account various return scenarios and the likelihood of achieving one's investment objectives given the reality of volatile returns.

  • Monte Carlo simulation - A problem solving technique used to approximate the probability of certain investment return by running multiple trial runs, called simulations, using random variables. Monte Carlo simulation helps to reduce the uncertainty involved in estimating future outcomes. A Monte Carlo simulation typically is performed using a computer.
V. Pure annuity vs. capital preservation
These are two methods of calculating retirement income from accumulated retirement savings.
  • Pure annuity - This method uses the assumption that the accumulated savings will be depleted at the end of an individual's lifetime after a series of annuity payments over the course of retirement. Using a financial calculator, annuity payments are calculated with an assumption that the future value will equal zero.
  • Capital preservation - This method assumes that all or part of accumulated savings will remain at the end of the retirement period. In this case, the individual would seek to live off the earnings produced by a portfolio while maintaining the capital. Such a calculation would be performed on behalf of somebody who may to leave a bequest to one's heirs. Using a financial calculator, annuity payments are calculated with the future value set to the lump sum an individual wishes to exist at the end of the retirement period.
Projected Cash-Flow shortfalls

Related Articles
  1. Investing

    What Can The Monte Carlo Simulation Do For Your Portfolio?

    A Monte Carlo simulation allows analysts and advisors to convert investment chances into choices. The advantage of Monte Carlo is its ability to factor in a range of values for various inputs.
  2. Investing

    Explaining the Monte Carlo Simulation

    Monte Carlo simulation is an analysis done by running a number of different variables through a model in order to determine the different outcomes.
  3. Investing

    Why Your Investment Growth Calculator May Be Wrong

    Many simple investment growth calculators fall short, so here's one you should use instead.
  4. Investing

    Multivariate Models: The Monte Carlo Analysis

    This decision-making tool integrates the idea that every decision has an impact on overall risk.
  5. Investing

    Scenario Analysis Provides Glimpse Of Portfolio Potential

    This statistical method estimates how far a stock might fall in a worst-case scenario.
  6. Financial Advisor

    How to Build Retirement Income with Annuities

    Annuities may provide an excellent tool when it comes to building income for retirement. Here's why.
  7. Retirement

    How a Fixed Annuity Works After Retirement

    These popular investments can provide a steady stream of income during your retirement years. Here are the details.
  8. Retirement

    Annuities: How To Find The Right One For You

    Fixed, variable and indexed annuities offer different features. Find out which one fits your needs.
  9. Retirement

    Guaranteed Retirement Income in Any Market

    By laddering annuities, you can be sure you'll have income no matter what the market does.
  10. Retirement

    How to Calculate the Value of Annuities

    Here's everything you need to account for when calculating the present and future value of annuities.
Frequently Asked Questions
  1. What's the Best Way to Contact Warren Buffett?

    Learn how to contact Warren Buffett and what kinds of contact is most likely to receive a response from him or from his company, ...
  2. What is the Financial Services Sector?

    A diverse group of companies, beyond banks and credit unions, comprises the financial services sector.
  3. Who are Whole Foods' (WFM) main competitors?

    Whole Foods' main competitors are Sprouts Farmers Markets and Trader Joe's. However, the recent acquisition by Amazon my ...
  4. What caused the Stock Market Crash of 1929 that preceded the Great Depression?

    Find out what led to the stock market crash of 1929, which in turn led to the Great Depression. It sparked a nearly 90% loss ...
Trading Center