By Cheshta Dhingra on March 27, 2024

Timeline Planning: Raw to Real

What is magic to you? Everyone has their own definition of the word but ask an investor and they all might just end up saying the same thing- guaranteed returns that outperform the benchmark. At a time in our lives where anything from constantly rising inflation to years-long world wars is possible, real returns being guaranteed in the future is nothing short of magic. At Timeline, we make that magic happen every day. For clarity- it’s not a magic crystal ball that we possess, but a top-class modelling with real data that allows evaluating/stress testing the sustainability of financial plans. The reason we give empirical evidence such importance for future financial decisions is because it encompasses all different possible historical long-term sequences of returns that an investor can experience. An analysis of such scenarios including the worst scenarios is the only sufficient approach to ensuring long lasting sustainable financial plans.

It’s no easy feat to know where to invest and what returns to expect from the investments made. With a plethora of options available, our aim is to help you find the right option that aligns with your objectives. The method of doing so breaks down into a few steps.


Fund Mapping Using Historical Data 

The first step, and probably the most important one is to quantify your expected returns keeping in mind your risk appetite. As financial planners, one of the questions that we’re often asked is “What would be the return of XYZ fund?”. A short question with a short answer- just a number, but we get to it using our tools by mapping the fund to its asset class (For example: Global Equity) and doing a historical analysis of the asset class data from 1926. The fund can only be dated back to the 2000s or 2010s, but an asset class ranges back much further, making it a much more reliable factor to answer the question. Mapping the fund to the index allows one to extend the analysis further back in time. It is understandable that the index does not represent the actual returns of the fund, rather the best proxy that can be used to imitate the fund prior to fund data availability. This method  takes into account macro and micro economic factors over the years and gives you a clear picture of real returns you can expect based on historical data. Our data allows us to do comparisons using multiple relevant filters like nominal and real returns, historical probability and average 10-year cumulative returns, and even the ranges of returns. With a clear-cut comparison of the asset classes, choosing funds that align with the investor’s overall portfolio objectives becomes easier. They can pick the distribution of fixed income vs equity (or water vs whiskey- as we call it) depending on how much risk they’re willing to take on. 

In the realm of financial planning, understanding the concepts of historical and nominal distributions is crucial for making informed decisions. Historical distribution, in essence, encapsulates the observed or actual distribution of data based on past measurements or observations. Just as we might analyse the heights of a group of people to create a historical distribution, this approach reveals the frequency or proportion of occurrences within specific intervals.


Calendar Distribution  

In our meticulous financial analyses at Timeline, we employ the powerful tool of nominal calendar distribution to illuminate the historical performance of two key asset classes—global bonds and global equity. The following chart illustrates the historical calendar return distributions of global equity vs global bonds in real terms.

Global Equities vs Global Bonds Calender Returns in Real TermsThis method organises data in a chronological calendar format, offering a visual representation of the diverse ranges of returns and associated probabilities for these crucial financial instruments. The accompanying charts vividly showcase the ebbs and flows of global bonds and global equity over time, allowing investors to discern patterns, trends, and potential outliers. By presenting historical data in a structured calendar-based manner, we can understand not only the nominal returns of these assets but also the likelihood of various scenarios unfolding. These distributions serve as invaluable guides, bridging the gap between past market dynamics and future investment strategies, and fostering a comprehensive understanding of the ever-evolving financial landscape. 

As you can see in the previous chart, the most likely calendar range of real returns for global equities is between 10% and 20% with a probability of 28%. While for global bonds the most likely range is between 0% and 10% with a probability of 38%.


Nominal vs Real Returns  

A vital factor to consider while looking at returns is the big ‘I’- Inflation. It is the benchmark that either makes or breaks the power of future returns. We ensure to not provide you with a plan that works today but fails to stand its ground in the next 10 or 20 or even 50 years. Thus, comes in the debate of real versus nominal returns. In simple terms-real returns are adjusted for inflation and nominal returns are not, making real returns a better and more accurate picture of the future power of the returns. To elaborate how we ensure the sustainability of portfolios, we take the following chart as an example of where the global equity real returns are negative, but the inflation is positive. As you can see in the chart below:

Global Equity 1 yr rolling investment - Historical Distribution

The x-axis shows brackets of the global equity returns and the blue and purple line graphs show the probabilities of when the Consumer Price Index (CPI- which is the measure of inflation) is in between 0-10% and 10-20% respectively. So, what is the probability that inflation is between 10-20% but the equity return is between -10-0%? The answer is 1.50%. In over a 1000 monthly rolling scenarios, 1.5% is objectively quite low and thus makes it very safe to invest with respect to the risk and return tradeoff. Essentially, our data and method of calculation can figure out the probabilities of a number of permutations and combinations of scenarios. Whether it is equity or bonds, real or nominal returns, and 1 year or 5 years, we’ve got the historical answer. 


Short Term vs Long Term Investing   

The next step is to give it a timeline (pun intended, of course). Planning for the future can range from 5 years to 50 years. The core of all our decisions goes back to historical data and proven results. Keeping the same in mind, we encourage long-term and passive investing. As you can see in the charts below:

Global Equities 1 yr. Rolling Investment - Historical DistributionGlobal Equities 10 yr. Rolling Investment - Historical DistributionAclear comparison between short term (1 year) investments and long term (10 years) demonstrates how the left tail is flattened, i.e. the probability of experiencing a negative return is far smaller, and the distribution for longer investing both in real and nominal terms is far more rewarding. 
Our studies show that while trends may come and go- disrupting the market every now and then, eventually when the dust settles, only the ones still standing get to reap the fruits of their patience. This philosophy extends to passive-investing boasting higher returns over active-investing as well. We firmly believe in letting the market do its own thing rather than trying to control it. The following chart demonstrates exactly the same.

Global Equities - Annual Returns and Intra-year Declines 2024

It is true that they’re two sides of the same coin, but passive investing also boasts several advantages like low fees, transparency, tax efficiency, and most importantly, consistently safe returns.

UK Bear Market Recovery  

To explain this further, let’s have a look at the ‘Bull’ and ‘Bear’ markets. As the name suggests, a bull market is when the stock market is on the rise and the prices of most stocks go higher. On the other hand, a bear market is when the stock market is significantly down, and most stocks are declining in value. Naturally, a bull market is every investor’s dream, it’s the bear market that truly tests if the forethought put into a portfolio is strong enough to withstand the worst scenarios. 

 We identified 11 historical scenarios where the UK equity market drops more than 20% from the current maximum value. At the exact starting point of each bear market, we test an investment of £100,000 to see how long it takes to reach the worst point in the bear market and then from that point how long it takes to reach back to its original value of £100,000. 

UK Bear Market RecoveryFor example, in scenario 7 we invested the amount in June 1972, and as we can see that within 30 months, approximately 70% of the value of the portfolio was lost as it hit an all-time low of less than £40,000. At this point due to a steep drop-down and high volatility, while many would sell these stocks to cut their losses, what’s interesting to observe is that it takes just 20 months to be fully recovered. Furthermore, a Subsequent Bull Duration (SBD) awaits and in 154 months (less than 13 years), the value of this portfolio reaches to £1,207,342. The other 10 scenarios also exhibit the same lifecycle; backing our philosophy that even in the face of significant downturns, our data-driven strategy illustrates the potential for robust growth over time.
At Timeline, we understand that data is today's most valuable asset. The journey from seemingly abstract numbers to tangible financial goals underscores our commitment to converting raw data into real returns. Our clients entrust us with their financial future, and through our meticulous planning, we strive to turn the abstract concept of time into a tangible ally on their path to financial success. In conclusion, Timeline’s planning software transforms raw data into real returns by navigating the intricate landscape of financial planning. While the magic of guaranteed returns may sound like an illusion, our method relies on a meticulous analysis of historical data spanning almost a century. This extensive dataset acts as our crystal ball, allowing us to project future outcomes based on the best and worst scenarios the markets have weathered. 


Published by Cheshta Dhingra March 27, 2024