Sorry in advance for a very long post.
I've given this a lot of thought recently and this is the conclusion I've come to. I think Ryo will eventually defeat Lan Di, but will not kill him, as to take revenge would totally undermine everything everyone has been trying to teach him up until now, and make him effectively not very different from Lan Di. Perhaps Lan Di will even renounce his evil ways and be redeemed as Zhao Longsun. Either way, I think an ending of "Ryo kills Lan Di, the end" would be too simplistic and unsatisfying.
What I imagine is an ending in which Shenhua ends up using her powers to save the day somehow, but has to sacrifice herself to do so - either by dying or by ascending to some higher plane or taking on a guardian role where she stays somewhere to prevent calamity happening again. For this reason, among others, I don't think she will end up with Ryo as others have suggested. I also expect Ren to eventually die, and perhaps also Xiuying.
For me, for the story and the character of Ryo to be truly accomplished, Ryo has to return home. Though Yokosuka is much the same, he is a changed person and has matured immeasurably. Along the same lines, I think it is a fitting ending if he ends up with Nozomi - who perhaps overcomes her own challenge of parents wanting her to stay in Canada, and follows her heart back to Yokosuka and Ryo.
The ending I have imagined goes like this:
After a bittersweet victory in China, Ryo returns home to Yokosuka by boat and arrives to find Nozomi has come to meet him at the harbour. (How does she know he would be here? Maybe Fuku-san told her Ryo was coming?) They could get a bus back home, but Ryo says he would prefer to walk as he has been on the boat for so long. The long walk back from the harbour to Dobuita, Sakuragoaka and Yamanose mirrors the long walk with Shenhua to Bailu Village. The journey is split into stages and the player is given the option of talking to Nozomi about various things or hurrying on. Along the way they perhaps remark on things they see, like maybe the school they went to or the sports hall where Ryo used to compete in martial arts tournaments. Somewhere along the way they see a couple riding past on a motorcycle; Ryo and Nozomi look at each other and laugh.
They walk back through Dobuita and Ryo remarks on what is the same and what has changed. Perhaps they stop somewhere and we get a scene similar to the crag stopover with Shenhua, where Ryo shows Nozomi pictures of the friends he met in China. When they finally return to Yamanose and walk past the shrine, we see the cat from the first game run across the road - now fully grown and with its own kittens. When they get to the Hazuki Residence gate Nozomi says something about needing to get back, but that he should call her soon. Ryo at first seems as taken aback and awkward as ever, but then his face relaxes, he smiles and says he will. In contrast to the times we saw her walk away close to tears in the first game, this time she turns away and smiles. Ryo walks through the gate, we hear Fuku-san joyfully shout "Ryo-san!" and as the camera zooms in on the restored Hazuki dojo sign, the screen fades to black.
Then we have a timeskip - a few months or perhaps even a few years. When the game resumes, we begin with a black screen and Fuku-san shouting something along the lines of "Hazuki-sensei, the next pupil is here". "Just give me a minute," Ryo replies, and he comes into view. We see he's in the Hazuki dojo basement, wearing the same sort of clothes his father wore, with the Hazuki name on his chest - the new Hazuki-sensei. The music is more like the Hazuki residence music than the old basement music, and we see Ryo has moved things around a bit and turned it into his own space.
Alongside his father's old souvenirs and mementoes Ryo has now added his own, and the game allows us to go around the room and inspect each of these. On certain items it allows us to "meditate", a call back to the first game when we see Ryo meditate in the Hazuki dojo, closing his eyes as he imagines his father training with a sword. When the player chooses to "meditate", Ryo closes his eyes and then reopens them imagining himself back in a relevant situation. For example, meditating on a photo of a street fighter from Kowloon might let you replay a fight against that person.
The player would be free to stay down in the basement indefinitely, but as soon as you have Ryo walk out of the dojo basement, the story ending plays. We see Ryo start to teach some young students under the cherry tree, the same as how Iwao used to teach him, with Fuku-san assisting. They address him as Hazuki-sensei. The camera then shifts slightly to show Nozomi is in the background, tending to the Hazuki residence garden. She looks up at Ryo teaching the youngsters and smiles. Ryo says something along the lines of "OK... now let's begin", and the students start to practise moves. The main Shenmue theme then swells as the camera pans up and around the scene around the cherry tree, before sweeping in and through the dojo to where we see Ryo has put the old picture of Iwao and Zhao Sunming back in the basement, alongside pictures of his various friends from China. We shift to a dramatic version of Shenhua's theme as the camera pans past these photos, and finally comes to a rest on a photo of Shenhua. As the music concludes, we fade to black.
After the credits, I would propose a sort of "post-game" in which Yokosuka becomes a truly open world; the date no longer advances and the player is free to go around town and talk to people, play at the arcade, train up moves or do whatever he/she likes. You would also be able to go back into the basement to use the "meditation" feature I mentioned before. This might provide a decent route for DLC, as more meditation options could be provided in the form of recreated segments of previous games or indeed entirely new stuff - perhaps something from the first boat trip to Hong Kong, or a bit of action from the train journey that was originally planned (presuming that doesn't come up in a subsequent game). You could even have a meditation where Ryo imagines himself in his father's shoes, allowing the player to briefly play as Iwao, or give Ryo the option of imagining himself fighting characters from outside Shenmue. The options would be very open.
Anyway - please forgive me for the rather long and self-indulgent post, but I hope at least something interesting was here.