The retirement health check projections are based on assumptions for how you will save towards your retirement and draw an income once you retire. We then use a set forward looking assumptions for market returns, and an assumed volatility of those returns. The forward-looking assumptions for market returns are derived from:
An analysis of historic real returns (i.e. returns above inflation);
An assumption of future inflation of 2%; and
Where appropriate, adjustments based on future expectations of particular asset classes. As an example, assumed forward looking returns for UK gilts have been adjusted down, since historic total returns have been considerably higher than can reasonably be expected looking forward.
The range of potential future portfolio values are calculated based on a simulation of thousands of different market return scenarios. In order to create these simulations, we use what is called a “mean reverting stochastic model”, which takes into account the average return expectations, a measure of the expected variability of those returns (the “volatility”) and an assumption that returns will have a tendency to revert towards the average return over the long term (which stops the model generating completely unrealistic scenarios).
Each simulation will be different, ranging from very strong returns to very weak returns and including different combinations of strong and weak periods. After we have run thousands of simulated paths for the value of the portfolio, we then calculate and plot the range of values in incremental bands, with each band showing the range of values for each date for 5% of the different simulations.