Excel Monte Carlo Retirement Calculator

Published: December 7, 2013 at 7:24 pm

Last Updated on

The importance of a solid retirement plan cannot be stressed enough. The importance of ‘stress testing’ a retirement plan also cannot be stressed enough! Here is an Excel Monte Carlo Retirement Calculator that allows you to do just that!

If you wish to plan for your retirement,

That sounds good and doable. The only trouble is, when we use a retirement calculator, we used a fixed number for inflation, pre-retirement return and post-retirement return.

We know from experience that none of these numbers are fixed. So we need to find out how good our retirement plan is.

In order to do this, we will have to vary inflation and returns. That is, introduce some volatility. We can then determine the probability of achieving our goal.

There are two ways to introduce volatility in financial goal planning.

  1. Use historical data. Known as back-testing or aft-casting
  2. Randomly vary inflation and return numbers using a pre-defined distribution (uniform distribution, normal distribution etc.)

To do a back-testing we will need to use several decades of market data in order to get reliable results.  This is possible with US markets. Here is a fantastic online calculator: FIRECalc

The first ever calculator I made was based on back-testing methods outlined in this book: Unveiling The Retirement Myth, by Jim Otar

It was not in Excel but in a platform known as Labview, that I use for my experiments. Unfortunately, after spending months on it, I realised that it is useless for India since the market here is young, and we have only about 35 years of market data.

Since each market cyclelasts a few years (4,5 or even 10), we will need several 10s of such cycles for the data to be reliable. Therefore, we would need several decades of market history.

That leaves us with the Monte Carlo technique. Although this has several limitations (eg. pretty difficult to imitate the market with a statistical distribution), we don’t have a choice.

Monte Carlo Retirement Calculator

Monte Carlo is famous for its gambling. In a Monte Carlo Retirement calculator, the inflation and returns (pre- and post-retirement) are varied randomly (hence the gambling analogy). We could then determine

  • how long a corpus is likely to last
  • how much corpus we are likely to need
  • how much monthly investment is needed for maximising the probability of success.

Safe to say, there are many ways to do this!

I made MC retirement calculator in Excel a while back. It allows you to randomly vary inflation and returns simultaneously a good 50,000 times! I have now made this more user-friendly.

The calculator tells you, the likely effectiveness of a retirement plan for a given investment amount. If the result is less favourable (it will most likely not be!), don’t get upset. Try to reduce expenses and invest a little more.

New version:  Stress Test Your Retirement Plan (Aug. 2014)

Old Versions: Download the Excel Monte Carlo Retirement Calculator 

I will be delighted to hear your thoughts on stress-testing a retirement plan.

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