Tag: wealth modeling

Wealth Modelling – Historic simulation.

Past performance is not indicative of future results. You will notice this disclaimer, albeit with minutely different wording, on every single piece of investment literature available. However we can use the past to see what kind of turbulence investors in times gone by have had to face, and think about how prepared we can be as market volatility continues into the future.

Using our wealth modelling system we can bring history into focus and actually use it to model what really would have happened to you if you had been one of these earlier investors. In other words we can answer the following question:

• If you first invested with this asset allocation many years ago, how would it have performed?

With historical market data, we project forward how your wealth would fluctuate if the market behaved in the same way.

Take our client Mr Example(i), Chart 1 below shows the normal projection for his net worth from today until mortality. His chosen portfolio grows at an average of 6.85% (ii). The chart has been displayed in real terms to allow us to take the inflation growth out of the equation and see how the actual monetary growth of his assets fluctuated over time.

Mr Example is 41 with a projected mortality of 90 so he potentially has 49 years of investing ahead. Taking the most recent 49 years of market information and using this to be the background market data for the next 49 years we can show his projections modelled on the historical data and this is reflected in Chart 2. Chart 3 displays the historical selection we are making.

In essence the system projects forward as though we are living from 1961 to 2010. It thus includes all the booms and busts in between, and we can see how Mr Example was affected in this period.

 

So what does this tell us? Firstly from the calculated growth of £1,000 display in Chart 3 and the significantly higher numbers Mr Example hits in Chart 2, this was a fine long term period to be invested.

Secondly, Chart 2 also lets us consider how Mr Example might have felt at age 53, 81 and 88 (the 70s, 2001 and 2008 recessions). Not good I suspect. This is where would be vital for him to have the investment discipline to ignore market noise that is integral to our investment philosophy. He must think about the long term picture, and he is rewarded for doing so: not even the deepest recessions in recent times hold back his growth for long.

This is just one of the many tools we have at our disposal to model potential losses for our clients. It is something we can all relate to, and for that reason it is a particularly interesting exercise.

Past performance doesn’t indicate future performance, but it can let us know the kind of turbulence we will always have to face as investors.

For more information on this or anything else, please get in touch.

Malcolm Stewart

22 Feb 2012