The problem with most financial
planning is they accept a return rate on each of
your investments and project your financial
future on those rates. The argument is over a
span of years your investments will return that
rate "on average." Unfortunately this
is an invalid and risky assumption. Investment
rates vary from year to year. Sometimes they vary
greatly. We cannot accurately predict the return
rate on investments or the inflation rate.
Consider the following simple example
You have $1000.00 invested
and you expect a 10.0% average yearly return
on your investment. In two years your
investment will be worth $1210.00.
Now lets assume your same
$1000.00 returns -10.00% the first year and
+30.00% the second. Your investments after
those two years is worth only $1170.00 even
though your investment returned "on
The above example demonstrates
the need for a mechanism to account for the
volatility of investment return rates and the
variability of inflation. The J&L Financial
Planner has chosen to include two alternatives, a
Monte Carlo Analysis and
a Historical Return Analysis, as that mechanism.
Financial Planner's Historical Return Analysis
The following paragraphs outline
how the Historical Return Analysis is implemented
by the J&L Financial Planner.
The J&L Financial Planner
allows you to create simple or complex financial
scenarios (financial plans) revolving around your
existing accounts consisting of investment,
retirement, asset, and equity accounts. You
can create and assign up to 10
asset allocation classes for each of your
accounts. A simple example would have you create
three asset allocation classes Stocks, Bonds, and
Cash. You would assign each account the
percentage of each of its allocation classes. A
mutual fund account may consist of 70 percent
Stocks and 30 percent Bonds, whereas a savings
account would be 100 percent Cash. For each
allocation class you assign a historical return
data file representing the returns for that class
over an historical time span. The planner comes
with 6 example data files including 2 stock
files, 2 bond files, 1 cash file, and an
inflation file covering the years 1928 through
2003. The files are provided as examples and
should be replaced with data files which meet
your needs. You can create and edit up to 10
files, each corresponding to an asset allocation
The planner gives you two options
with the Historical Return Analysis.
The first allows you to execute
your financial plan over the historical time
span. This generates your net worth for each year
of your plan based on the returns of the
historical data starting with the first year of
the data. In the provided files this would
generate a net worth (a line graph) starting with
the returns from 1928. Next it would generate a
net worth (another line graph) starting with the
returns from 1929. It would do this for each year
of your financial plan.
The second and default analysis chooses a year of data
from the historical data files for each year of your scenario by the
following methodology. It creates 4 groups (g) of sequential historical
data years based on the number of years provided in the files. It creates
a list of the 24 possible combinations these groups can be arranged.
For example g1, g2, g3, g4 followed by g1, g3, g2, g4 followed by
g1, g2, g4, g3 and so on for all of the possible combinations.
For each age in your scenario trial an entry into the historical data
files is selected starting with the first group and sequencing
though the years in that group followed by the next group in the list.
If the list is exhausted the program will start again, but from the
2nd group in the list.
The second analysis also allows you to choose the number of sequential
years the program will use starting at the current age in your scenario
and the current entry into the historical data files. For example, if
the current entry into the files is 1931 and you have chosen 3 sequential
years the program will execute the current age of your scenario with
data from 1931, the next age with data from year 1932, and the next with
data from 1933 before choosing the next entry into the files.
In summary, the Historical Return
Analysis is able to estimate the probability of
achieving the success of your scenario by
accounting for the yearly variability in the two
main factors contributing to it's outcome, the
return rate on your investments and the inflation
rate. You can execute up to a thousand trials of
your scenario. Each trial is a fully independent
execution of your financial plan, where each year
the return rate on your investments and the
inflation rate can take on a range of values
based on historical asset class return data.
The large number of trials allows
the analysis to compute the statistical
probability your financial plan will be
successful. For example, if after 1000 trials,
750 of those trials achieved your financial
goals, your financial plan success rate is 75.0%.
If your financial plan success
rate is below your expectations the J&L
Financial Planner allows you to make easy
scenario changes to play "what-if" with
your financial future.