Continuing on the themes of uncertainty, we wanted to explore how we can still plan for the future with such a large range of possibilities. We will be boiling down all outcomes of the past 27 years into something we can use for investment planning.

A wide range of outcomes

Looking at all the 12 month outcomes from July 1991 to now

The tangled mess below shows every possible 12 month outcome, by quarter, over nearly 28 years for a globally diversified portfolio of shares. We can see the majority of outcomes are positive, with a few years of very strong performance and a few with very weak performance.

Truly average outcomes

No smooth rides in any "average" year

The average outcome for all periods is a gain of 10.5%. The chart below compares an "average" period from January 2014 to December 2014 to the average of all outcomes. We see it is far from the smooth ride investors may wish for.

We can also consider an average outcome over 5 years, a gain of about 60%. The period from October 1993 to September 1998 starts with a year and a half of no returns, includes a one month drop of 13.5%, but ends nearly exactly in line with our expected average.

Creating realistic models

How we account for uncertainty when planning ahead

Let's revisit the ball of yarn chart from earlier, over five years and take useful information for our plans.

Instead of considering every possible outcome, we can consider instead the probabilities. For example, let's add a line which 15% of outcomes fall beneath, and another which 15% of outcomes fall above. This gives a range covering 70% of outcomes surrounding the average. We have also included the "average" five years from above.

Now we have a basic framework we can use in our plans. We can adjust the range between our boundaries to reflect the chance of success we believe is needed for our goals (maybe 25% instead of 15% for the bottom range). If the portfolio value falls below the bottom 15% range, we could increase contributions or reduce withdrawals to improve our expected outcome. If it rises above the top 15% range, we may consider taking on less risk in the future.

This is an simplified version of the Monte Carlo analysis we complete for our clients. A Monte Carlo analysis includes a few more statistical inputs and accounts for cash flows, inflation etc. However, the foundations remain the same and show how we account for uncertainty in returns to plan for the future.