Considering portfolio volatility and inflation scenarios
When you want to forecast the future value of your investment, you usually use the Future Value formula, which states that:
There are many websites helping you to calculate the future investment value using the formula above. The r (interest rate) is the percentage by which the investment value is expected to steadily increase over a number of periods.
The problem is, the formula above does not consider the volatility of investment’s returns, nor the impact of the inflation on the final investment value.
The volatility of an investment (also known as the investment’s risk) is the probability of that investment of not achieving the expected return. This means that portfolios with high volatility may reach a future value lower than a portfolio with the same rate of expected return but with lower volatility.
Also, inflation will reduce the future investment value. For the same rate of return, the higher the rate of inflation, the lower the future value.
Considering both the above factors, we think that it is critical to also include portfolio volatility and the inflation when calculating the future portfolio value.
How does Diversiview forecast portfolio value?
Diversiview considers the portfolio’s annual expected rate of return, as well as the volatility to calculate the expected monthly rate of return with volatility. The future volatility value cannot be known in advance, so Diversiview uses a randomised value within the historical volatility range.
The user also has the option of applying an inflation rate (default 3%; the user can change it) to calculate the final expected monthly rate of return with volatility and inflation.
That monthly rate is used to calculate the portfolio value, compounded, for 120 months (10 years).
The forecasted portfolio value graph can be seen in the “Strategy Backtesting & Forecasting” section. See an example below.
Questions?
Please contact the team at hello@diversiview.online and we will be happy to help.
