How are investment returns calculated?
The Retirement Income Explorer tool uses stochastic modelling; a method used to estimate the probability of outcomes using random variables, to predict what conditions may be like under different situations. It is most well known as the technique used in weather forecasting.
The tool uses this technique to forecast the performance of your client’s investments and the likelihood of it sustaining them throughout their retirement. This is achieved by looking at their current asset allocation and utilising the eValue Economic Scenario Generator (ESG) model to forecast the likely returns achievable in the future. The tool runs 1,000 different simulations of future predicted economic conditions for each of the variables that are being modelled on an annual basis, and shows the central 90% of those outcomes that are either likely or quite reasonable to expect. It takes into account economic variables such as interest rates, real GDP, price inflation, equity dividend yields and growth rates, property yields and growth rates, currency strengths, and the future price of annuities at retirement age.
All assets are treated consistently, and since inflation is part of the model, the forecasted real returns are both sensible and realistic. You can easily show a range of the possible outcomes based on good or poor future market conditions using a slider. The default is set to ‘Most likely’, which is the mid-point of all of the forecasts, where there is a 50% chance of the actual returns being either more or less than that figure. This is also known as the median, or the 50th percentile outcome.
Stochastic modelling is more accurate and realistic than the deterministic modelling used by many other retirement income planning tools, which uses the same single assumption for the returns on assets based on past and current conditions only.