How can I apply sensitivity analysis to my investment decisions?

Modified on Tue, 19 Jun 2018 at 08:43 AM

Use sensitivity analysis to estimate the effects of different variables on investment returns. This form of analysis is designed for project management and profitability forecasts, but you could use it for any type of uncertain projection. The practical benefit of using sensitivity analysis for your investment decisions would be to assess risks and potential error.

Perhaps the most common investment application of sensitivity analysis involves adjusting the discount rate or other streams of cash flows. This allows you to re-evaluate risks based on specific adjustments.

Taken one step further, sensitivity analysis offers an insight into how your investment strategy is structured. You can use it to compare investment models by demonstrating how profitability depends on underlying model data or other assumptions.

Sensitivity analysis does not produce any specific prescriptions or generate any trading signals. It is left up to the individual investor or project manager to decide how best to utilize the generated results.

[ Sensitivity analysis is an effective tool that can be used to evaluate potential investment decisions, as well as to evaluate performance of a project, department, or an entire business. Learn how to create a detailed financial model that leverages sensitivity analysis through step-by-step instruction and interactive Excel workbooks in Investopedia Academy's Financial Modeling course. ]

Source : Investopedia

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