Investment Management

Scenario Planning vs. Forecasting

What is Scenario Planning?

We often hear from clients: “What is the difference between scenario planning and forecasting?” Why do we prefer scenario planning at SFG? Scenario planning sits at the heart of our risk management process and philosophy. The official definition of scenario planning is: “The process of visualizing what future conditions or events are probable, what their consequences or effects would be like, and how to respond to, or benefit from them.” As you can see, scenario planning takes into consideration past events, as well as events that we are currently monitoring as probable disruptions.

The Stagflation Scenario

A scenario example that we are working on is a version of stagflation. With a lot of the global supply chain being shut off during the early months of COVID-19, we have seen a dramatic mismatch in supply and demand. If this problem persists, we could have a market environment similar to the early 1970’s where we witnessed globally the effects of stagflation. Stagflation is where inflation skyrockets upwards (in the 1970’s case this was caused by an oil price shock) and high unemployment is present. We are currently scenario planning for what this would look like in 2021 and beyond. We believe that supply chains will begin to stabilize, unemployment will remain low, and we will remain in an inflationary, slow-growth economy. Currently, our base case scenario is that inflation begins to taper down from 5% to around 2% for a period and then increases to a persistent level of 4-5%

 

A historical scenario that we reference quite often is the 2008 Financial Crisis. Using this scenario, we can reference what the economic environment was like, as well as the draw-downs that the markets experienced, and build out a scenario where our portfolios would be if exposed to similar draw-downs but in today’s environment. History never repeats itself but it does rhyme which is why it is just as important to look back at history as it is to look toward the future.
 

Scenario Planning Versus Forecasting

 
The strength of using scenario planning is that it is a mix of qualitative (fiscal policy, geopolitical tensions, etc.) and quantitative (GDP, unemployment, etc.) views when approaching risk management. This allows for a top-down/bottom-up approach, as well as looking forward to the future and seeing how a portfolio might react to certain market situations. We believe this makes scenario planning much less rigid than traditional forecasting methods.
 
Forecasting deploys historical quantitative methods. These methods predict what will happen in the future by relying mainly on data from the past and present. This leads to a very rigid risk management assessment. These models often fail to predict quick and significant changes in market conditions. A weak spot when using forecasting to assess risk is that in dynamic market conditions, these models often break down because they are experiencing new events that are not modeled in their test statistics.
 
We believe scenario planning to be far superior and more strategic than traditional forecasting methods. Scenario planning offers a greater level of flexibility and preparedness than purely quantitative forecasting models. Because we manage money for the long-term, building around scenarios allows us to react and not predict regarding these black swan events, and gives us the ability to help assess risk measures at the individual client level.
 
Looking for more investment management content? Click here.

 

Schultz Financial Group Inc. (SFG) is a wealth management firm located in Reno, NV. Our approach to wealth management is different from many other wealth managers, financial advisors, and financial planners. Our team of fee-only fiduciaries strives to help our clients build their wealth across four capitals: Financial Matters, Physical Well-being, Psychological Space, and Intellectual Engagement. We provide family office and wealth management services to clients located in Nevada, California, and other states. If you’d like more information, please check out our website or reach out to us via our contact page.

Important Disclosure Information: The information contained within this blog is for informational purposes only and is not intended to provide specific advice or recommendations. If third party products or services are referenced in the above blog post, then Schultz Financial Group is providing that information for informational purposes only and is not recommending or endorsing any third-party products or services. Please remember that past performance does not guarantee future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Schultz Financial Group Incorporated), or any non-investment related content, made reference to directly or indirectly in this blog will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this blog serves as the receipt of, or as a substitute for, personalized investment advice from Schultz Financial Group Incorporated. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. Schultz Financial Group Incorporated is neither a law firm nor a certified public accounting firm and no portion of the blog content should be construed as legal or accounting advice. A copy of the Schultz Financial Group Incorporated’s current written disclosure statement discussing our advisory services and fees is available for review upon request. Please Note: Schultz Financial Group Incorporated does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to Schultz Financial Group Incorporated’s web site or incorporated herein, and takes no responsibility therefore. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly.

Where you want to go in life is up to you. How to help you get there is up to us.

Contact us today to start your journey…

Contact

Schultz Financial Group Inc.
10765 Double R Blvd. Suite 200
Reno, NV 89521
Phone: (775) 850-5620
Fax: (775) 850-5639
Email: [email protected]

Where you want to go in life is up to you. How to help you get there is up to us.

Contact us today to start your journey…

Contact

Schultz Financial Group Inc.
10765 Double R Blvd. Suite 200
Reno, NV 89521
Phone: (775) 850-5620
Fax: (775) 850-5639
Email: [email protected]

Design by Jason Design Studio | Design by Refresh Design Services | Copyright © 2018 Schultz Financial Group Inc.

Design by Jason Design Studio
Design by Refresh Design Services
Copyright © 2018 Schultz Financial Group Inc.