There’s a common question we hear — what precisely is the 95% Historical Range, is it a normal distribution, and why do I see the 5% outside of the confidence interval only on the downside of the range?
The 95% Historical Range is a normal distribution of historical returns for the investments in a portfolio. That said, we created the analytic as a one-sided distribution where 5% of the worst case (left side) is not included in the confidence interval of the normal distribution. This is an important distinction because it differs from a more traditional two-sided distribution with 2.5% on either side.
Why did we make this design choice?
It really comes down to setting expectations with your clients. Our mission at Riskalyze is empowering the world to invest fearlessly, and the fear that undermines and sabotages investing arrives with a vengeance when portfolios explore their downside risk — particularly the risk below the 95% confidence interval.
Put another way, we’ve yet to meet an investor who was fearful of “extreme returns” that exceed the 95% confidence interval to the upside. And we’ve certainly never met a financial advisor who got fired by their client for that outcome.
When you present the 95% Historical Range to your client, we recommend using language like this: “There’s 5% of the risk we can’t quantify for you. Those are things like the global pandemic. The 2008 financial crisis. We call these ‘black swans.’ My job as your advisor is to control the 95% of the risk we can quantify. So six months from today, it would be normal historical behavior for your portfolio to be anywhere within this range.”