Forecasting the investment weather

Forecasting ‘expected’ returns on portfolios is a little like forecasting the ‘expected’ weather in the UK.

Yet despite sensible generalisations - such as it's usually sunny and warm in the summer and cold and frosty in the winter - we all know that the day-to-day, month-to-month and even year-to-year variation is high.

Let’s start by taking a look at the weather in Newquay, Cornwall for 1st August each year, to illustrate the point.

We know that it is likely that August will be warmer than January, and if we had to describe an ‘average’ day it would probably be mainly sunny, warm, with a gentle breeze and no rain. In reality, a wide variation from our ‘average’ sunny day exists.

The weather in Newquay, Cornwall on 1st August, on average each year at 3pm
Data source: www.weatherspark.com

Forecasting the investment weather

When it comes to making estimates of future asset class returns, it is evident that there is no absolute certainty, only reasonable, informed guesses. Expected returns are not single point estimates of guaranteed returns – absolutely not - as the chart below demonstrates.

Expected after-inflation return distributions of short-dated bonds and global equities.
Source: Albion Strategic Consulting.

You can see that the ‘expected’ return* sits within a distribution of other possible returns and the range of these potential outcomes is wider for equities than bonds. Summers are hotter than winters. Planning alternative returns scenarios is, therefore, a critical part of building a robust financial plan.

To explore this subject in more depth, take a look at Volume 45 of Acuity.

* To be precise, the arithmetic return – not the compound or geometric return - sits in the middle of the distribution.

AcuityINSIGHT: Diversifying in the USThis issue takes a look at the lost decade, providing a useful reminder of why diversification is an important pillar to an investment philosophy.

AcuityINSIGHT: Presidents change, markets remainThis issue was written just days before the results of the 60th U.S. Presidential election. Now that we know Donald Trump is the president-elect, it’s clear that, as with any election, media coverage has intensified, creating a flurry of commentary. However, the message for long-term investors remai

AcuityINSIGHT: Setting sensible expectations for investment returnsThis issue gives a high level insight into the framework in place used to build a sensible starting point for portfolio expected outcomes, whilst also illustrating the fact that investors don't have the benefit of knowing which future path markets could follow. The financial planning process is a ke

Forecasting the investment weather

Forecasting ‘expected’ returns on portfolios is a little like forecasting the ‘expected’ weather in the UK.

Forecasting the investment weather

Quick links

Contact us