Eternal optimist

Chris P pointed us to the "Financial Comeback" calculator, surely a well-meaning joke from the folks at the Times.  Here is how one gets to make a 40% loss back in just six years!


Surely, someone has to tell them about simulation.  They have to assume a probability distribution on the annual returns, and show us some sample paths.  Using the average annualized historical return in essence wipes out all variability and no wonder it's smooth sailing upwards.  Eternal optimist.  

Here is Chris' comment:

The bad news is that the range of values it offers does not include the return on the market from last year (-31% to -36%).  I guess they are optimistic.

The interactive features of this chart, however, impressed me.  The smooth adjustment to the chart as one slides the control, including the automatic choice of appropriate axis labels, is very nice indeed.

Okay, they want to trademark the name of the calculator so perhaps this is serious.

Reference: "Calculate your financial comeback", Jan 6 2009.

Comments

[JamesK]

I would agree, wonderful interface.

However, I would not trust the forecasts.
Certainly not data driven.

[Christian]

Interface: Yep. But the whole tool is SO misleading, it's almost funny.

The point in time when it marks your "comeback" actually is the point when your portfolio is up to it's original value again. However it depends on your contribution - 5.000 a year, by default.

So with the settings as by default of:
At peak: 100.000 USD
Current: 60.000 USD
Contrib: 5.000 per year
Return p.a.: 4 %

The "comeback" is in 7 years. However, in those 7 years you would have contributed 35.000 USD - so, actually, you'd have made returns at around 5.000 USD and would, correctly, sit at 65.000 USD rather than back up at 100.000 - quite a significant difference, in my book.

[Brian]

Why the hate for this graph?

So the graph 1)conflates contributions and returns and 2) uses average returns that ensure accuracy only over the long run.

So what?

On 1) If you have a retirement number (e.g. "I need $1M to stop working"), it really doesn't matter whether the funds come from returns or from increased contributions.

So this graph is bad for people who want to wallow in misery and good for those who want to figure out how they are going to save enough for retirement.

on 2) What is the alternative to using an average annual rate of return? A random function that would make some years pull 4% some pull 9% and some pull -3%? Change your assumptions and we re-roll the dice?

That would be accurate to the real world but the random noise would obscure the power of compounding returns and annual contributions.

On a side note, I was hoping to see some discussion of this turd of a chart: http://swampland.blogs.time.com/2009/02/06/how-bad-is-it/

[Kaiser]

Brian, your suggestion of a "random function" is precisely what they should have done. Technically, this would be a simulation. If readers are exposed to such randomness, by rolling the "dice" multiple times, they can develop a sense of the variability of the "average long-run return". Alternatively, the site can run 10,000 simulations in the background and show us the histogram of returns.

[Patrick O'Shei]

The tool is fundamentally wrong in terms of how it handles future contributions in terms of the word description but not the math. The value of long-term investing and compounding should not be diminished.
Once the wording is corrected the tool correctly calculates very simple modeling of scenarios. The choice of an unrealistic scenario is where the greatest error would come from.
Histograms as proposed, would have discounted the probability of the events of the last 16 months.

[Bryn Davies]

This graph tells you what it tells you - i.e. if you have $X now, invest another $Y each year and earn Z% interest then, after the calculated number of years you get back to your starting point.

Once you start adding simulations you don't know what its telling you, because it depends on what assumptions are made about the likely distribution of returns. And what the last couple of years should have told us is that we simply do not know enough about the distribution of returns to make worthwhile projections.

The issue of variability is important but the idea we can make worthwhile projections has gone. We've got the computing power. We don't have the knowledge.

[Luc Girardin]

Since it seems you liked the interactive features of the "Financial Comeback" calculator, I thought you might enjoy our InvestView tool...