Television's steady drumbeat of James Bond reruns prompted me to think about Monte Carlo and the value of "perfect storm" simulations used in investment analytics.
When it came to naming one of the more sophisticated tools for managing money, the choice of "Monte Carlo" was unfortunate, because it conjures up the wrong image for an inherently valuable concept.
I dusted off my understanding of Monte Carlo simulations with a trip to Lafayette -- the Switzerland of the East Bay, so named because of its heavy concentration of money management firms.
There, I met with Nicolo Torre and Neal Ringquist, president of ASI Advisor Software. Their product, available on the Web (advisorsoftware.com), is one of the more sophisticated planning tools on the market. Its genesis goes back to the early days of advisory tools pioneered by Andrew Rudd who founded Barra Corp. in Berkeley after writing the book, Modern Portfolio Theory.
His new company, ASI, offers an "everyman" Web-based, cost-effective version of an advisory device that was originally highly valued by anyone having to brood over a vast sum of money -- and who had an extra $100,000 a year to spend at Barra Corp.
The Monte Carlo simulation technique arose in the 1940s as an effort to predict the outcome of nuclear bomb explosions.
It amounts to a computerized study of the composite result of many naturally occurring variables happening simultaneously. Each one is given a probability rating, and then the computer starts crunching to arrive at an average outcome.
In fact, the outcome that really matters is the "median" which is different than the average. The median illustrates the midpoint of events, where half are above and half are below. By comparison, the average can be influenced by one big event such as when Bill Gates walks into a soup kitchen and raises the average income of the group to $10 million a year.
Using the median approach, Gates would have no more weight than any other person whose income is in the upper half.
The book, "Perfect Storm," chronicled a unique combination of meteorological events occurring simultaneously in the Atlantic Ocean. Similarly, the Monte Carlo simulation illustrates the probability of a "perfect storm" of economic and financial market events, so that we can see how our money would be impacted in a "doomsday" situation with low probability.
Starting with $1 million, the Monte Carlo calculation in ASI's software indicates the following results for a portfolio allocated 80 percent to stocks and 20 percent to bonds.
Over the next 10 years, the median expected result is a gain of approximately 8.6 percent, which compounds the million to about $2,263,000. The downside is about $1,147,000, but there is only a 10 percent probability that a million dollars today would only be worth that amount 10 years from now.
On the high side, with only 10 percent probability, there is the chance of winding up with $7 million.
Here's how those numbers change with 75 percent in bonds and 15 percent in stocks: The median accumulation on today's $1 million is to $2 million in 10 years. This is exactly 7.2 percent (the rule of 72).
The downside is $1.2 million (less than 10 percent probability that you would have anything less). The upside is $4.5 million.
ASC's software allows you to plug in your actual collection of all investments -- every stock, bond and mutual fund you own -- and these numbers will be spit out based on the Monte Carlo simulation of what you actually own.
You can get a free trial at their Web site. If you have a financial adviser, he or she probably already has what is a relatively inexpensive tool.
Most other techniques for assessing investment risk and possible returns is based upon past results of specific funds or stocks.
As Vanguard Group founder John Bogle says, "It's easy to see what has been a winner in the past, but there is no way to know prospectively who will be a winner into the future." Yet, when most people are choosing investments, these past performance numbers become their primary focus.
Monte Carlo adds a different dimension. It shows what can happen to a composite result of all your assets combined. So, check it out.