Private Wealth - goals-based vs Monte Carlo

CFA Level III Portfolio Management
#1

Murray describes the differences between deterministic forecasting and Monte Carlo simulation in investment planning and the traditional and goal-based approach in constructing portfolios. After hearing about these methods, Virginia states that she thinks that the goal-based investing approach is best suited for her needs because

  • it allows her to specify a level of risk tolerance for each goal,
  • growth toward each goal on a straight-line basis is much easier to understand, and
  • it provides the ability to predict the probability of success of each goal

Q. With respect to Virginia’s preference for the goal-based investing approach, her comment that is most appropriate is the one dealing with:

  1. risk tolerance.
  2. growth toward a goal.
  3. probability of success of a goal

Correct answer is A. However, under C: C is incorrect. Probability of success is not a feature of goal-based investing; it is an outcome of the Monte Carlo method for determining capital sufficiency.

Could someone pls tell me how come this is the case? Goals-based investing is optimized for a minimum probability of sucess, so it does have this probability of success as a feature… Many thanks!

#2

You have answered your own question. Suggest reread it.

#3

:slight_smile: no, that was the answer of the CFA institute, not mine.

So, probability of success is an output of Monte Carlo, which can forecast it for you.

Probability of success exists, however, also in goals-based investing, but in another way/as another type of parameter… namely as an exact target.(if an individual targets 90% probability of success for sufficiently funding his or her goals, then a portfolio is designed to reach and maintain that success benchmark).

Nevertheless, in my opinion, “probability of success” (without the forecasting feature) exists in both Monte Carlo and goals-based…

#4

GBI- Goals are placeholders. You only rank them per your PRIORITY. The ones with highest priority is FUNDED with LOWEST risk. In other words, you adjust your risk tolerance in order achieve the stated goal. Once fulfilled, either the goal is revised, abandoned, or simply substituted by a new goal. Where is probability here ?

In MC, the variables are not in your control and neither their impact. You choose a certain path and decide in a probability based manner, how likely it is to reach the final destination. The key is to understand that the probability is attached to the particular path.

Hope above suffices .