August 30, 2019
One thing we can predict with 100% certainty is that forecasting the future direction of financial markets won’t turn out right every time. Future stock and bond returns are uncertain, and consistently making accurate predictions about them is a tricky, if not impossible, task. But that doesn’t mean all forecasts are a waste of time; quite the opposite. We believe the proper use of personalized, long-term wealth forecasts can help investors make better, smarter choices on their way to achieving their financial goals.
Here’s why we’re so sure forecasts should have a place in every investors’ toolbox. First, the type of forecast an investor chooses to consider is important. The most useful wealth forecasts are ones that start with a range of investment return values, calculated by combining expectations of future investment returns with historical financial market movements and information about how different markets tend to move relative to each other. This sort of analysis can produce thousands of possible, plausible return outcomes, based on expected asset class and portfolio risk and return. This helps investors to understand what could happen to their investment portfolios given a variety of different market conditions over the forecast timescale.
Forecasts should also incorporate market and economic conditions that reflect the current financial environment.
So far, so good, but useful forecasts should also incorporate market and economic conditions that reflect the current financial environment. This is really important because we believe the initial conditions chosen for a forecast can have a major effect on the forecast’s outcome. For example, starting with the high-inflation, high-bond yield and low-equity valuation conditions of the 1980s would produce strikingly different forecast results to using the low-inflation, low-bond yield and above-average-equity valuation conditions of today.
Another important trait of useful forecasts is personalization. To produce a range of predicted values indicating an investor’s level of future wealth, each set of forecast investment return data should be married with investor-specific information. We think this should include the value of their current assets, their income, their tax bracket, their predicted future expenditure and the most appropriate time horizon.
The final forecast result can enable investors to understand what their future wealth could look like given a wide range of scenarios, reflecting the ups and downs of financial markets—and changes in personal circumstances—that can happen over a long stretch of time. This is crucial knowledge to have ahead of making important choices around investment allocation, the right time to retire and sustainable levels of retirement spending. And it is a sure thing that armed with this information making those life-changing decisions becomes a little bit easier.