Simple Forecasting Methodologies

Applying some easy techniques to Real Net Worth

We’ve been doing a lot of analysis on real net worth. And, for good reason! It’s important - representing the underlying wealth of American households.

That metric (as has been the case for almost every metric in this newsletter thus far) has been viewed from a historical perspective:

While understanding the past is important, the world of finance and investments typically cares more about where we are going:

We don’t know what is going to happen in that future light blue shaded area. But, we can make some guesses! Let’s start with the simplest guess possible - a totally flat forecast:

Is this overly simple? Yeah, of course. Is it plausible? I mean, the future probably isn’t going to be that neat but there have certainly been historical periods where real net worth has been relatively flat - just take a quick peek around 2000 on the chart.

We could use some other simple techniques that add a little more variety like a moving average - but that flattens out pretty quickly as well:

But, what if, instead of forecasting the levels of the metric, we forecasted the underlying change and applied that to the future? Here is a simple long-term average growth based on the average historical growth over the last thirty years:

Wow! Now that looks like a bit of a forecast!

Again, that’s not to say this is going to happen - it will never happen exactly as we plan. But, we might expect real net worth to grow in the future, as it has historically grown in the past. There will of course be some deviations but this presents a quick rule of thumb that we could use as a benchmark for comparing future actuals or setting expectations.

The thing is, this methodology was a very simple quick and easy approach. We can make it a lot more sophisticated. We’ll take a look at that in the next post.

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