What’s predicting the weather got to do with long-term financial planning? An awful lot!
I listened with interest to Radio 4s Material World (from circa 16 minutes; as a physics graduate I’m interested in this sort of thing) and Dr Spiegelhalter explained how the MetOffice had invented a game to highlight how many people struggle to understand certain illustrations of uncertainty; specifically weather forecasts, and ‘chance(s) of rain’.
Weather forecasting uses a process known as “stochastic modelling” to try to predict the likelihood of rain or other weather conditions. In simple terms, weather is chaotic, and with a given start point there are a variety of different potential outcomes. A computerised model, programmed with a range of realistic assumptions runs many, many times and records the output. This gives a degree of ‘confidence’ over the likelihood of a specific outcome, or range of outcomes. For example, “what’s the chance of rain in Caterham on Tuesday?”.
The game follows a fictional ice-cream vendor, and presents the chance of rain, and projected temperature information in a variety of ways, for example numerical “chances of rains”, along with graphical representations. The findings of the MetOffice, is that people like information in different ways; and there is no single ‘right format’.
A Financial Planner uses very similar models to try to explain the uncertain nature of investment returns. This MetOffice comparison highlights that there is no perfect way to explain this information, and as a firm we aim to explain investment risk and returns in a variety of different ways. There is a clear analogy with a 7-day forecast ‘chance of rain’ and a 7-year financial plan highlighting how likely an individual is to achieve their financial plan. Similarly, whilst we know it rarely snows in May, it can occasionally happen; just in the same way we can may expect a specific investment to show a positive return over a 5-year timeframe, we cannot guarantee it.
Any Financial Planner should have a good understanding of how their models work, and arguably more important, is understanding and explaining the downfalls. No model is completely reliable.
We spend a great deal of time explaining to clients how realistic their long-term (especially retirement) goals are. It is not uncommon for us to encourage them to take less risk, if appropriate, to increase the certainty of achieving their goals. But we are cautious in supplying clients with the full output of our Financial Planning tools, for as this study shows, good information can easily be misinterpreted and the implications of over-reliance on one Financial Plan can be far more dire than being stuck in the rain without an umbrella.
