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The Unintended Consequence of Using Historical Returns in Financial Planning


Financial plans created using historical returns as the expected return estimate will likely break during the next crash, leaving advisors to explain why a plan that looked solid just a few months ago now looks like it will fail. This is because you will be running the same analysis with the same growth rate post-crash, but the starting asset value will be much lower. This makes the ending value much lower and, potentially, well short of goal. The same things happens if you use some "conservative" fixed rate return.


A "forward-looking" return estimate differs from one that uses historical returns because it can take into account the current market conditions. For example, it can assign a higher expected return when valuations are low and a lower expected return when valuations are high. By using an academically derived higher expected return after a market crash, advisors can unify the pre-crash and post-crash analysis to show clients they are still on track despite the market turmoil.


For example, the chart below shows a sample financial plan before and after a market crash. What was a solid financial plan (blue line) becomes completely broken (green line). This is not an easy conversation to have with a client, particularly since tensions are high during times of market dislocation.

Using a forward-looking return that takes into account current market conditions creates a much better comparison, as you can see below. This analysis unifies the pre- and post-crash analysis demonstrating to the client what the advisor has likely been saying all along: don't panic, just hold on and you will be ok over the long term.

For more details, please read our white paper by clicking here.



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