Financial planners like to do what they call a “Monte Carlo” simulation to test the strength of their clients’ retirement assets. They reason that simply taking the average return on stock and bond indices over the past 50 years and applying those numbers to yield a straight-line result doesn’t paint a true picture, because the markets go up and they go down, rather than delivering a rate of constant return. Monte Carlo simulations use random elements to build in years with different degrees of negative and positive performance, including during the years when you might be selling some of your portfolio to fund your retirement. The underlying concept is that if your holdings can weather the impact of a few really bad years, they will be a more reliable platform on which to build your retirement plans.
2022 has been the kind of year that Monte Carlo simulations dream about.
It’s hard to overstate just how bad this year has been in the financial markets. It is the proverbial “black swan” year, where every potential target for investment has turned to mud. As CNBC reported recently, the S&P 500 index is down 24 percent for the year, and the Bloomberg U.S. Aggregate Bond Index is down 16 percent. If both stocks and bonds finish the year in the red, it will be the first time that has happened in decades.
That’s not supposed to happen. Every financial planner advises clients to follow a mixed portfolio strategy, because bonds are supposed to hold or increase their value if stock prices are falling. All told, CNBC says this has been the worst year in the financial markets since 1969–when Richard Nixon took office as President, the Vietnam War was still raging, the Beatles were still recording music, hippies roamed the country, and Neil Armstrong set foot on the Moon. In short, it has been a long time since the markets were this bad.
The CNBC article notes that these terrible black swan years tend to happen when multiple negative economic factors converge. This year, those factors include persistent inflation, rising interest rates in response to the inflation, and a recession that is either here or on the immediate horizon–the financial types can’t quite decide which. You could also add an energy crunch, supply-chain issues, a volatile housing market, and a shooting war between Russia and the Ukraine to the mix of troubling developments.
The “Monte Carlo” name is supposedly based on the casinos in that tiny nation, where random chance plays such an important role in whether you win or lose. This year, the “Monte Carlo” name suggests that investing has been a gamble–and thanks to all of the negatives the dice have come up snake eyes.