Brokers are getting a Valentine from the National Association of Securities Dealers.[@@]
The Washington-based group has approved a new rule interpretation that lets brokers use investment analysis tools such as Monte Carlo simulations in discussions with clients.
The interpretation, given in NASD Rule 2210, IM-2210-6, will take effect Feb. 14. The U.S. Securities and Exchange Commission gave its blessing to the self regulatory organization’s interpretation in September 2004.
Previously, NASD members could not make predictions regarding investments or investment strategies.
NASD members now can use analytical investment tools such as Monte Carlo simulations to come up with forecasts.
Traditionally, forecasters have used a “deterministic” approach that shows how a few scenarios involving changes in variables such as interest rates might affect an investment portfolio. In the past, forecasters often simplified their calculations by using a single, “non-moving” value for each variable.
When forecasters are developing a Monte Carlo simulation, they use a random number generator and complicated mathematical models to show how thousands of different scenarios might affect investment performance. In addition, rather than using a single value for variables such as interest rates, the forecasters usually assume that the variables will change over time.
The new Monte Carlo forecast rule will make it easier for financial services companies to explain products with complex designs, according to Joseph Weiss, an actuarial advisor in the Hartford office of Ernst & Young L.L.P.
Although the Monte Carlo investment tool can help advisors educate clients, advisors have to make sure that clients understand that the models generate simulations of possible outcomes and not firm predictions of what the actual results will be, Weiss says.
Using Monte Carlo simulations can give clients a better handle on what they need to do to secure their own retirement, says Theodore Yoos, a certified financial planner with Back Bay Financial Group, Boston.
The simulations can help clients understand how changes in variables they control such as saving and spending can impact retirement planning, he adds.
But Yoos agrees with Weiss that it is important to remind clients that the simulation outcomes are only predictions and that the “real world could play out differently.”