Investment Management

Scenario Planning versus Forecasting

Scenario Planning versus Forecasting

Investment Management

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.

A scenario example that we are working on is: As government debt grows globally, what would be the economic implications if the United States government defaulted on their debt? Historically the U.S has never defaulted on its debt; however, as the debt moves higher, the threat of this event grows larger. This is where scenario planning comes into play. One solution the U.S has to avoid this situation is through printing its own money and deflating the U.S dollar. So one possible outcome under this scenario may be where we experience inflation and/or are downgraded in credit quality. This event could cause a correction in the equity markets, while Treasury yields could spike and possibly have a negative effect on U.S GDP growth. The implications of a downgrade would not be contained to domestic markets, but rather have an international impact. China and Japan are two of the largest foreign holders of U.S. Treasuries. A downgrade in U.S. credit quality would cause bond prices to fall as investors demand a higher risk premium, which would deplete the value of both Japan’s and China’s reserves.

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.

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.

Important Disclosure Information: The information contained within this blog is for informational purposes only and is not intended to provide specific advice or recommendations. Please remember that past performance may not be indicative of 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: info@sfginc.com

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: info@sfginc.com

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

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