Graeme Keith and I went on a quest to model our lives by applying state of the art risk management techniques. In the previous article we covered income and the associated risks, as well as basic living expenses and the risks associated with expenses growth. In today’s article we will talk about the risks associated with investments and the value appreciations and depreciation of assets.
This is an important part of the life equation, since we assumed that not buying a property doesn’t mean we spend all the saved money on cognac and travel but instead it is reinvested into a diversified portfolio in the market.
This of course comes with its own risks, recessions and various other scenarios leading to capital loss.
Read the first part here and second part here and third part here.
Interest rates & growth rates |
||||
| Mean interest rate | 4% | |||
| Year on year sigma | 0,0711 | |||
| House price inflation index | 2% | mu | 0,02 | |
| Volatility | 3% | sigma | 0,03 | |
| Equity growth | 8% | mu | 0,07 | |
| Volatility | 10% | sigma | 0,09 | |
| Recession risk. Year on year probability | Frequency period (years) | 10 | 0,1 | |
| Valuations cut to up to 50% | VaR10 | 60% | mu | -0,37 |
| VaR90 | 80% | sigma | 0,11 | |
| Expected year on year growth | 1,05 |
Ask questions in the comments below if you want to find out more. What assumptions would you put into market growth for property and equity as well probabilities for recessions?
For example below is a particularly dramatic scenario which one included in our simulation. In this example the equity markets collapsed and never recovered, while property showed a slow but steady growth. So in this scenario buying would’ve been a much better choice. But, this is only one of 10000 scenarios we modelled.
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