Monte Carlo - FAQs about the Monte Carlo simulation

Frequently Asked Questions About the Monte Carlo Simulation

Q - Does the Bottom 5% shows the results from a worst case bottom 5% performance during the simulation? I think there is some confusion over how a plan can have a 100% projected success rate even when the 5% performance marker falls below the need line.

A - The bottom  5% line represents the bottom 5 percentile performance for each year in the plan.  It’s the very worst performance in every year of the plan.  A Monte Carlo is randomized performance over every year of the plan.  Some individual years may actually be worse than the bottom 5 percentile, but overall, the entire trial in all probability will not perform that badly each year.  Hence, one should never expect that because the bottom 5 percentile line is below the need line the plan cannot have a 100% success rate for a given number of trials. 


Q  - Update Frequency – what is this?

A - The number of iterations run by the simulation before the screen refreshes.

Q - Iterations – do the number of iterations correlate to the accuracy of the simulation?

A - The number of iterations directly affects the range of probabilities that will result.  Accuracy is not a word we should use when it comes to Monte Carlo.  The number of iterations will constrain the range of probabilities that are likely to be seen as a result from the Monte Carlo.

Monte Carlo is tool to test the tolerance of a plan to market forces.  The larger the number of iterations run, the more likely it will be to get a more representative probability of just how tolerant the plan is to these market forces.

The larger the number of iterations, the longer the simulation takes to run and we don’t have a way to preserve the results, which makes long runs problematic.

Q - What is a good definition of a successful year and in turn a successful plan? One in which, over the course of in this case 100 randomized iterations no shortfalls occur?

A - A successful year within a single iteration of the Monte Carlo simulation is one in which there no shortfall occurs.  A successful iteration through a plan is an one in which all of the years are successful, meaning no shortfalls occur in any year for that iteration.

It should be stressed that the output of the Monte Carlo simulation is a probability.  A plan that receives a 90% probability of success after a 100 iterations will probably be more likely to be successful than one that returns a 10% probability of success.  Note that a plan which returns a 100% probability of success after 100 iterations could either be a very safe plan or this probability could be due to the small number of iterations used when running the simulation.