Most financial advisors understand and realize the importance of a financial plan. The quality of a financial plan largely depends on the methodology used for the underlying assumptions. Still, even though the one-time quality is high, the value of any financial plan diminishes as soon as it is printed out and reality catches up.
This article not only explains how Monte Carlo simulations are applied in practice but also how the underlying methodology can be improved to increase the quality preparing the plan while adding more relevance to the monitoring of the plan. Instead of a standard Monte Carlo simulation, a dynamic scenario approach takes into account current market conditions, broadly supported stylized facts on economic and financial market behavior and considers market conditions that are not captured by historical data. Such an approach improves the often applied straight-line return assumptions by enabling different expected returns for multiple time horizons. By capturing these components the overall quality of financial advice improves significantly, leading to better informed and more satisfied clients.