Historical Scenarios

What & Why

Run Historical Scenario is one of two features included in the Stress Testing add-on. It allows you to select a time period from the past and apply investment returns and inflation rates from that period to the current scenario. The other feature is Run Randomized Scenario, which allows you to generate a sequence of returns for your plan based on your expected average rate of return and historical volatility (or your preferred inputs).

We created Historical Scenarios to give you the ability to:

  • find and model natural sequences of returns with their ups and downs (instead of flat sequences, which are typically used for financial projections);
  • show a range of outcomes anywhere between the worst and best case for the period length that you've selected from a historical set of realized inflation and investment returns;
  • get an approximate indication of how likely your clients are to achieve their goals in the historical context (you can use this feature to perform a basic form of stress testing);
  • illustrate the importance of the order of returns to your clients.

If you are eager to get started, you can jump straight to use cases, but you may want to learn the basics first. This article provides detailed information on the Run Historical Scenario feature. If you prefer to see this feature in action, please watch our recorded webinar all about Stress Testing. 


How it works

The basic workflow is to open the historical modal, select a time period from the past, and apply investment returns and inflation rates from that period to the current scenario. Then you will be redirected to the Planning page, where you can see the historical data applied to your scenario. You will also see some new assumptions, including a chart, on the Assumptions page in the report.


Historical modal

You can  enable this feature by selecting Run Historical Scenario from the Planning page, which you can find under the Run Scenario dropdown. You may need to activate the feature.

This modal has everything you need to run historical scenarios:

  • A chart illustrating the historical growth of the three asset classes and inflation from 1965 to the current year.
  • Controls to help you select a particular period from the historical data set.
  • Buttons that allow you to apply the selection to the current scenario and rerun it.


Selecting a historical period

You can select a specific period using any of the following methods.

From and To inputs in the top-left corner of the chart allow you to enter the exact year and month of the beginning and end of the period you want to select.

Zoom level buttons in the top-right corner of the chart allow you to select a specific zoom level (period shown in the main area of the chart). For normal selections, zoom level and length of selection are the same. For inverted selections (advanced feature), the zoom level is the length of time that is not selected!

You can  click and drag your mouse across the main area of the chart in order to select a certain area visually.

  • You can grab the middle of the selected area and move it left and right. This will change the beginning and end of the selection while maintaining its length.
  • You can grab the handles at the edges of the selected area and move them left and right. This will change either the beginning or the end of the selection as well as its length.


Using the slider

When you know the  average real or nominal return that you would like, but don’t know which period is going to give you that return, you can use the slider at the bottom of the modal. The average annual real and nominal rates of return for the current selection are always shown just above the slider.

These rates are based on the asset mix defined in the modal (shown below the return values and above the slider). You can customize the asset mix used for the Historical Scenario modal to help choose your preferred historical period.

The slider has a scale from 0 to 100. The left end of the slider represents the worst or lowest real return for the entered asset mix, while the right end of the slider represents the best or highest return. Note that the range of returns depends on the length of your current selection. The shorter the length of your selection, the wider the range of returns you can find using the slider.

The position of the slider is always linked to the selection:

  • When you change the position of the slider, the software calculates the worst and the best rates of return for the current selection length, then it calculates the real and nominal returns corresponding to the new position of the slider, and then it finds and selects a period that matches the target rates of return the most closely.
  • When you change the selection, the software calculates the worst and the best rates of return for the new selection length, then it calculates the real and nominal returns for the newly selected period, and then it moves the slider to the corresponding position on the scale between the worst and the best.

Important notes:

  • The real and nominal average annual returns are calculated and displayed for the currently selected input sequence. The actual output sequence of future returns in your scenario will likely have a different average and total. This can occur if the period you select is longer or shorter than the period remaining in your projection. You can find the actual averages for each asset class on the Assumptions page of the report.
  • To improve the accuracy of the Historical Scenario modal for your particular plan, you can customize the assumed portfolio asset allocation that is used in the feature. By default, the feature uses an asset allocation of 10% Cash, 40% Fixed Income, and 50% Equity. You can update these values by changing each percentage (which can be found above the slider and below the graph) individually.
  • When you run the scenario, your custom allocations for each Capital Asset will be used instead of the asset allocation entered in the Historical Scenario modal. The customization in the modal allows for the average returns calculated to be as relevant to your scenario as possible.
  • It is also important to understand that the best and worst rates of return may not give you the best and worst outcomes for your client's plan. There is a strong correlation, but it is not always the case due to the sequence of returns within the historical period and due to the asset allocations of individual accounts and the order that they are withdrawn from in the plan.

Worst, average, and best buttons

The three buttons in the bottom-left corner of the modal called Worst Period, Average Period, and Best Period are there for convenience. All that they do is move the slider to the lowest (0), middle (50), and highest (100) positions, respectively.


Inverted selections

This is an advanced feature, so if you are just getting started, it is best to leave this until later. If you would like to enable inverted selections, check the corresponding box near the right end of the slider.

Invert Selection button

When you enable inverted selections, a new button called Invert Selection will appear beside the Best Period button. This button has two states: inverted and normal (not inverted). When inverted, the button appears to be pressed (becomes active). To return to normal, click it again.

The normal state selects the zoomed period (what you see in the main area of the chart). The inverted state selects everything outside of the zoomed period (what you don’t see in the main area of the chart). The best way to understand what it does is to look at the navigator (area at the bottom of the chart). The green mask shows the currently selected period.

Normal selections are in the middle of the range.

Inverted selections start from the right side, going from left to right until the end of the chart, and then continue on the left side, starting from the beginning.

Wider ranges of returns

When inverted selections are enabled, every time you adjust the slider, in addition to searching among normal periods, the software also searches among inverted periods. This gives you a wider range of returns to choose from – the lowest return may become even lower and the highest return may become even higher.

Why use inverted selections

You may be wondering why this option is available. A few reasons (in addition to the wider ranges):

  • If you want your selection to start at a specific point, but you still want to use all available data, you can invert the selection, drag the right navigator handle (with the arrow) to the target starting point, and then click on 1-year zoom.
  • A slight variation of the previous point, if you want your selection to start closer to the end, and you need more data than available between that starting point and this year, you can invert the selection so that it continues from the beginning, and then adjust it using the navigator handles.
  • If you want to exclude a certain period, you can invert the selection, and then adjust it using the navigator handles.

Running Historical Scenarios

When you are ready to apply your selection and run the calculations, click Apply & Run in the bottom-right corner of the modal. This will apply your selection forward. For example, if you select a period from 2000 to 2020, the first year will be 2000, the second year will be 2001, and the last year will be 2020. Just as you expected.

However – and this is another advanced feature – you can also apply the selection backward. For example, if you select a period from 2000 to 2020, the first year will be 2020, the second year will be 2019, and the last year will be 2000. You can do that by clicking the dropdown beside Apply & Run, and then Apply Backward & Run. This may be useful when you want to explain the importance of the order of returns to your clients.

Overrides

If you run a Historical Scenario on your plan, you will not be able to edit the Inflation Rate on the General page or the Rates of Return on the Assets page and you will not be able to override Rates of Return on the Planning page anymore. This is because historical rates will be applied instead.

However, you can still edit and override allocations for any Capital Asset in any year of the projection.

Important things to keep in mind

  • When you run a historical scenario, any existing rate of return overrides are cleared. If you have a plan with rate of return overrides and you would like the option to revert back to the original scenario later, you should make a copy of the scenario before running a Historical Scenario.
  • Historical returns are applied to personal Capital Assets and corporate Capital Assets as well.
  • If you select a historical period that is shorter than your current scenario, then the selected historical data will be repeated.
  • If you select a historical period that is longer than your current scenario, then the excess part of the selected historical data will not be applied.

Clearing historical data

If you want to remove all historical data and go back to a normal scenario, you have two options:

  • Go to the Historical modal and click Clear & Run in the bottom-right corner of the modal.
  • Go to the Assets page and click Clear Historical Returns.

Look for orange buttons in the screenshots above. They will restore your original Capital Asset return assumptions (except for overrides on the Planning page) and recalculate the scenario.


Use cases

Please be sure to read these important notes first. Here are some common examples of how this feature can be used. If you find a different way to use this feature, we would love to hear from you!

Natural sequences of returns

If you want to find and model a historical sequence of investment returns, you have a couple of options:

A. Find a period with a specific average return that you have in mind:

  1. Open the historical modal.
  2. Set the length of your selection (using the zoom buttons in the top right corner of the modal, for example). Try to make it similar to the length of your scenario, if possible. It will make it easier to align the averages in steps 3 and 5.
  3. Update the asset mix to your client's approximate weighted portfolio asset allocation (e.g., 30% fixed income and 70% equity).
  4. Adjust the slider until you find an average return suitable for the scenario. If you cannot find a suitable rate of return, you can try to reduce the length of the selection and/or enable inverted selections to widen the range.
  5. Apply and Run the scenario.
  6. Review the average rates of return on the Assumptions page in the report.
  7. Go back to step 4 if necessary.

B. Find a specific historical period and align it with a future period (for example, you may want to align a past recession with a future retirement):

  1. Calculate the number of years between now and the beginning of the future period (e.g., your client's retirement in 6 years).
  2. Open the historical modal.
  3. Find the year and month that you would like to align with the future period (e.g., having 2000 align with your client's age 65 in 6 years).
  4. Select a historical period that begins the same length of time before your desired period (e.g., select a period that begins in 1994 so that 2000 aligns with retirement in the plan).
  5. Apply and Run the scenario.

Basic stress testing

If you want to find out how likely your clients are to achieve their goals, you can use this feature to perform a basic form of stress testing by running multiple historical scenarios and making simple manual adjustments between the runs.

  • Open the historical modal.
  • Set the length of your selection. Longer periods include more unique annual return values. Shorter periods give you wider ranges of returns. However, going too short is not recommended because it may break natural market cycles. An extreme example would be using 1-year length – it provides the widest range of returns, but if you apply and run that, you will see the same rates of return every year, which is unnatural.
  • The goal of the remaining steps is to find the lowest average rate of return (and the corresponding position of the slider) that makes the scenario successful. When we say that a scenario is successful, we mean that the client is projected to achieve their goals, which usually means they do not run out of money.
  • If you already have a good estimate of that rate of return, then move the slider to the corresponding position. Otherwise, simply move the slider to the middle, if it is not already there.

Repeat the following steps until you are satisfied that you have found that return.

  • Apply and Run the scenario.
  • If the scenario is successful, then go back to the historical modal and reduce the rate of return by moving the slider to the left. How much depends on how far the scenario is from being unsuccessful.
  • If the scenario is unsuccessful, then go back to the historical modal and increase the rate of return by moving the slider to the right. How much depends on how far the scenario is from being successful.

Once you have found it, look at the corresponding position of the slider. It will give you an indication of how likely your client is to achieve their goals in the historical context. The lower the better. Note that the result of this process depends on the length of the original selection and whether inverted selections are enabled. You may want to review what the slider is showing.

There are many ways to quantify the likelihood of success in stress testing. This is only one of them. Another option is available through our Randomized Scenario feature that is also included in the Stress Testing add-on. Which solution to use will be based on your and your client's preferences. Using a historical context is often easier to understand and explain to clients. Using a random sequence provides more flexibility to generate a particular sequence with your target rates of return and volatility.

In extreme cases, none of the available returns will be able to make the scenario successful or unsuccessful.

  • If the slider is set to the lowest position and the scenario is successful, it means even with the worst investment returns in history (for the selected period length and in the context of available data) your client would have made it. You can try to widen the range of returns using inverted selections.
  • If the slider is set to the highest position and the scenario is unsuccessful, it means even with the highest investment returns in history (for the selected period length and in the context of available data) your client would not have made it. You can try to widen the range of returns using inverted selections.

Please remember that in real life there are countless factors that can affect your clients’ ability to achieve their goals. Investment returns are only one of them!

Order of returns

If you want to illustrate the importance of the order of returns to your clients:

This will display that even if the client experiences the same annual rates for each category (i.e., Inflation, Cash, Fixed Income and Equity) their final outcome can vary significantly depending on the order of these rates.


Reports

When you open the report and look at the Assumptions page, you will notice some differences between regular and Historical Scenarios.

For Historical Scenarios, we show the beginning and end dates of the selected historical period as well as the direction in which the data has been applied (typically forward). See the left column.

For regular scenarios, we show the default rates of return per asset class (these are the rates that are used as the default for new assets). For historical scenarios, we show average rates of return instead. See the right column. These averages are calculated from the resulting scenario that is created after you select Apply & Run. They may not be the same as the average returns you see in the historical modal – those averages are for the years in the historical period you selected.

For regular scenarios, we show rates of return per asset, and how it changes over time if you create any overrides. For historical scenarios, we show asset allocations per asset, and how it changes over time if you create any overrides.

For complete transparency, we show the historical data used for the projection as a chart that illustrates hypothetical growth of $1,000 during the future time period of the projection, which is based on historical data from the selected time period in the past. Combined with the information above, this gives you and your client everything you need to understand the assumptions that were made for the historical scenario.


Additional notes

  • Returns are nominal, before taxes and fees, calculated in Canadian dollars, and include dividends.
  • For the asset classes, we use the same indexes as the FP Canada Guidelines:
    • Cash returns are based on the historical performance of FTSE 91-day T-Bill Index.
    • Fixed income returns are based on the historical performance of FTSE Universe Bond Index.
    • Equity returns are based on the historical performance of 1/3 of S&P/TSX Composite Index + 1/6 of S&P 500 Index + 1/6 of MSCI EAFE Index + 1/3 of MSCI Emerging Markets Index.
      • This combination of indexes represents the arithmetic average (equal weight) of the following regions used by the guidelines: Canada, Developed Markets, and Emerging Markets.
      • We use the same weights to calculate the default rate of return for equities when you choose to use the guidelines for a new scenario.
  • Monthly returns have been approximated from annual returns published in the FP Canada Guidelines.
  • Past returns are not indicative of future returns.

Activation

If the Stress Testing add-on has already been activated, you will be able to access the Historical Scenario feature right away. Otherwise, you will be prompted to activate the add-on when you try to access it for the first time. If you click Activate & Update Billing, you will activate the add-on only for yourself. Other users in your organization will not be affected.

If you are the administrator of your organization (or you have an individual account), you can also activate or deactivate this feature for all users in your organization on the billing page. You can learn more about managing add-ons in another article.

Deactivation

If you deactivate this feature, your existing Historical Scenarios will continue to be based on the previously selected historical data, the assumptions will remain the same, and you will be able to rerun your existing historical scenarios, but you will lose access to the historical modal and will not be able to make any further adjustments to the historical data unless you reactivate the add-on.

Even when the feature is inactive, you still have the ability to convert your existing historical scenarios back to regular scenarios. Just go to the Assets page of your scenario and click Clear Historical Returns. See clearing historical data for more information.

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