In order for clients to be able to relate the outcomes from an asset model to their investment goals, forecasts need to take account of inflation. Telling someone that £10,000 invested for 20 years could give them £25,000 sounds great, but it misses the point that £25,000 would only buy £15,000 worth of goods at today’s prices.
To be fit for purpose, the inflation used in the asset model needs to be coherently and consistently linked to the asset returns and other factors within the investment forecast.
Plausible and realistic scenarios
When an asset model is used to produce a range of long-term possible outcomes for a consumer, not only must the model be right on average, but each individual scenario that makes up the total range of forecasts must be capable of occurring.
An example of this is fixed interest bond yields, which, while very low, when modelled into the future cannot become significantly negative.
Bruce Moss is director of strategy at eValue
Asset models: Expert view
Bruce Moss, from eValue, explains why advisers need to understand what the asset model does:
“From April 2015, consumers will be given more control than ever before over their pension assets. However, with these new proposals comes a greater need [for advisers] to provide clients with realistic forecasts of what they may obtain in the future.
“One way to achieve this is for advisers to ensure that the underlying asset model used in financial forecasts is real world, takes account of both interest rates and inflation and produces plausible scenarios.
“In this way, advisers can be confident that they are providing their clients with the means to take sensible and informed financial decisions that make the most of their new-found pension freedom.”