What is stochastic modelling, anyway?

The traditional approach to financial advice uses what is know as "deterministic projections" whereby financial modelling of the client's future is based on a fixed rate of investment return, normally the assumed average return. But that tells you nothing about variability in returns from year to year (i.e. reality!), which can impact client outcomes. The extent of that impact depends on a host of factors including the size and timing of future cashflows (savings, drawdowns, social security etc), the clients goals and the client's desired confidence level (or risk tolerance). What is needed then is stochastic modelling.

Stochastic Modelling is incredibly powerful because it enables a more informed decision by the client as to how to invest their funds and what goals are achievale. It allows the adviser and their client to make a decision based on modelling that reflects reality (returns varying from period to period) and that properly accounts for risk in the context of achieving goals. This is done through simulating the future thousands of times, thus enabling the adviser to show projections at different probabilities or levels of confidence. It starts to move the question away from "how fearful are you of short-term fluctuations in investment performance" - i.e. the current approach - to the question "what level of confidence do you want to plan with when setting your goals and choosing an investment strategy to support those goals?"

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