Monte Carlo simulation
TheoryDefinition
A technique that runs thousands of 'what if' scenarios with random inputs to estimate the range of possible outcomes. Instead of one forecast, you get a probability distribution: for example, a 70% chance your retirement portfolio lasts 30 years.
Used heavily in retirement planning, investment risk analysis, and options pricing. The quality of the answer depends entirely on the quality of the assumptions you feed it. Garbage in, garbage out.
Used heavily in retirement planning, investment risk analysis, and options pricing. The quality of the answer depends entirely on the quality of the assumptions you feed it. Garbage in, garbage out.
Example
A retirement calculator runs 10,000 hypothetical market paths based on historical returns. In 7,500 of them your portfolio survives 30 years. That is a 75% success rate.