This HowTo page is an illustrated sumary of the five-step process to seek and judge investment choices that offer best prospects for an investor’s dollar investment plan, future financial goals, and priorities
1. Lay out the investment cash flow plan and goals
It could be as simple as investing $18,000 in each of the next 15 working years,
with the goal of taking out $18,000 in each of the following 25 retirement years.
Or it could be more complex.
2. Define a conservative-to-aggressive range of asset-classes-mix portfolios
It could be as simple as this:
Or it could include more asset classes in more intricate allocations.
3. Compare them all in probability of meeting the future dollar goals
With Pathfinder software, mouse-clicks will compare them for you on a graph, like this:
On this Goal Frontier graph, the dots are the portfolios, from most-conservative #1 at left to most-aggressive #11 at right.
Portfolios higher on the graph offer higher probabilities of meeting the future goals. In this illustration, for the investor portfolio #4 is best, and #5 is almost as good.
On this graph, you can move to any of the portfolio dots for a visual graphread of the goal-meeting probability it offers, as illustrated for portfolio 4 above.
4. For the best portfolios, make further graphic comparisons
a. On the graph just below, you can compare any two portfolios in probability for how far above or below the future dollar goal the result may be.
b. On the graph just below, you can assess any portfolio, or compare any two, in probabilities for the investment’s dollar value every year from here to the final dollar goal.
On this graph, just above, for any year in the life of the plan, the graph will show you dollar amounts the investment has various probabilities of being above.
c. On the graph just below, you can see for any portfolio, or compare for any two, examples of what the year-by-year path of ups and downs may be from here to the final goal.
In this graph, the investor can see the tradeoff and judge for himself: among competitive portfolio mixes of asset classes, those with higher possibilities also have bigger ups and downs along the way and greater uncertainty about the final result.
5. Test changes in key assumptions, and in key elements of the plan
Some folks criticize Monte Carlo simulation because it has to be based on assumptions that nobody can be sure are right. But that makes the simulation and these graphs more valuable — you can change the assumptions, and on the graphs see what the changes do to result probabilities for the goals.
Test changes in future return-rate arithmetic means for the asset classes. Nobody knows what they will turn out to be. With the changes, prepare and review the graphs again.
Especially if the results on the graphs are not good enough, test changes in the cash flow plan, such as increases in amounts to invest, reductions in goals, or delays in year to retire. With the changes, prepare and review the graphs again.
6. From these graphic comparisons, select the portfolio you think best for your dollar plan, future dollar goals, and priorities