Top-down and bottom-up approaches to forecasting may seem to some like six-to-one, half-a-dozen-to-the-other; they’re not.
With the top-down approach, you aggregate low-level items (apples, oranges, walnuts) and forecast them together as a group. You can then apply an allocation scheme to break down that high-level forecast into lower-level, component forecasts. This works well when low-level data, such as individual items, are statistically similar. Forecasting the group improves accuracy by increasing the volume of data. This volume helps reduce “noise” (random variation) and reveal patterns that are undetectable at the individual-item level. Top-down works well for budgeting and planning because it can predict big-picture revenue and cost accurately.
In financial circles, top-down forecasting often means starting with an addressable market (3rd-party data) and working down to predict your potential share of it in year 1, 2, 3. This kind of top-down often assumes that you’re relying on market data rather than internal historical data to generate forecasts.
With this approach, you forecast each low-level component series, or item, separately. Then, you sum the individual forecasts into group-level forecasts for a higher-level view. Bottom-up makes sense when individual items are statistically distinct, such as individual products with distinctly different markets. Bottom-up also provides the most accurate forecasts at the item level, and therefore is a go-to method for manufacturing and distribution. The downside is that in isolation, many products lack sufficient data to reveal patterns or produce accurate predictions.
In financial circles, bottom-up forecasting often simply means relying on internal historical data to generate statistical forecasts. Roughly speaking, you could say that top-down forecasting shows the big picture well, while bottom-up forecasting focuses on specifics within an organizations portfolio and offerings.
Both types of forecasting look at consumer and investment trends; one looks at companies as a whole and the other looks at the strengths and weaknesses of a company and compares those factors with market trends.
Also known as macro trading, top-down investing looks at the big picture of the market trends and invest in companies within those trending industries.
According to Money Week, “Top-down investing means making investment decisions based on the outlook for the economy and what that is likely to mean for individual assets. So a top-down investor would begin by analyzing what trends they expect to see in areas such as growth, inflation, interest rates, and currency movements.”
Top-down is most often used in the trading of currencies and other areas of the economy that are macro-focused. These types of investors aren’t necessarily investing in a company, person, or product; instead, they give money to the markets that show the greatest potential for growth. Factors that can influence top-down investing include catastrophic events, supply and demand, and industry trends.
Conversely, bottom-up investing is when an investor looks at specific qualities of companies and invests in the portfolios that show the strongest prospects. This type of investing is often referred to as stock picking.
According to Money Week, “The performance of a company will depend on the overall economy to some extent, so bottom-up investors may give some weight to this. But their strategy involves understanding the company rather than forecasting the economy — they won’t buy a stock purely to play an economic trend.”
About Vanguard Software
Vanguard Software introduced its first product for decision support analysis in 1995. Today, companies across every major industry and more than 60 countries rely on Vanguard Software’s Integrated Business Planning (IBP), forecasting and advanced analytic cloud platform. Vanguard Software is based in Cary, North Carolina.