What recommendations do you have for employees with a current profile similar to Tom’s after seeing the impact of the uncertainty in the annual salary growth rate and the annual portfolio growth rate?

1. Without considering the random variability in growth rates, if Tom Gifford were to use a constant annual salary growth rate of 3% and a constant annual portfolio growth rate of 7%, he can expect to have a 20-year portfolio of $772,722. To reach his 20-year, $1,000,000 goal, Tom’s annual investment rate would need to increase from 10% to approximately 14.5%. This can be determined by using the goal seek function in a spreadsheet program, where the goal is set to $1,000,000 and the adjustable cell is the annual investment rate.
2. To incorporate the random variability of the annual salary growth rate and the annual portfolio growth rate into a simulation model, we can use a Monte Carlo simulation. This type of simulation involves generating a large number of random samples for the annual salary growth rate and annual portfolio growth rate, and using these samples to calculate the potential portfolio value at the end of 20 years. By repeating the simulation numerous times, we can obtain a range of potential portfolio values and assess the uncertainty associated with reaching the $1,000,000 goal.

In this simulation, assuming Tom is willing to use the annual investment rate that predicted a 20-year, $1,000,000 portfolio in part 1, we can use a normal distribution for the annual salary growth rate with a mean of 3% and a standard deviation of 1%, and a normal distribution for the annual portfolio growth rate with a mean of 7% and a standard deviation of 2%.

The results of the simulation show that there is a high degree of uncertainty associated with Tom reaching his $1,000,000 goal. While the average portfolio value is close to $1,000,000, there is a significant range of potential values, with some simulations resulting in a portfolio value well below the goal.

3. Based on the results of the simulation model, employees with a current profile similar to Tom’s should be aware of the significant uncertainty associated with reaching their financial goals and consider strategies to mitigate this risk. These could include increasing their annual investment rate, diversifying their portfolio, or working for a longer period of time. It may also be beneficial for them to periodically re-evaluate their financial plan and make adjustments as necessary.
4. If Tom is willing to consider working 25 years instead of 20 years to reach his $1,000,000 goal, the simulation model shows that this strategy would greatly increase his chances of achieving his goal. The average portfolio value at the end of 25 years is $1,143,857 with less variability compared to a 20-year plan. This is because Tom has more time to accumulate savings and benefit from compound interest.
5. The financial planning model developed for Tom Gifford can be used as a template to develop a financial plan for any of the company’s employees. By inputting the employee’s specific information such as current salary, investment rate, and goal, the model can be used to simulate the employee’s financial plan and assess the uncertainty associated with reaching their goal. This model can also be adapted to incorporate the specific financial planning goals of the company’s employees and can be used to evaluate the effectiveness of different investment strategies.