Specifying default settings for the Major Loss modelling event and the Loss Capacity simulation
A major loss event (or events) can be added to a planning timeline to create a fluctuation in what would normally be the software's fixed, deterministic growth projections.
Voyant Adviser also features a Loss Capacity simulation that can be run to temporarily add this market flux to the plan and calculate the changes in required minimum rate of return after the loss.
Whether using the 'Loss Capacity' simulation, or adding a 'Major Loss' event, one will need to specify the duration, and the magnitude of the proposed market deviation. In both cases, one is invited to enter details of a deviation lasting anywhere from 1 to 5 years, as well as the magnitude of the proposed deviation – please note the 2 columns:
Setting Major Loss event defaults in Preferences
The default settings used by major loss events and when running the Loss Capacity simulation can be preset in the software's Preferences, on the Major Loss Event Defaults panel.
This entry sets a default age for the Loss Capacity simulation. This is the age of the primary client at which the market fluctuation will begin, at least by default.
Number of Years
A market deviation can last anywhere from 1 to 5 years. The number of years set in this field makes a respective number of fields editable below, in which to set the magnitude of the deviation.
When you enter/change the value under 'Fixed Growth', the corresponding value under 'Allocation Percentile' will change.
The software will do this by taking the 'Fixed Growth' value you have entered, and comparing it to returns (mean, and standard deviation values) for the FTSE All Share between 1900 and 2017, to arrive at a measure of relative performance, given the assumption that investment returns are normally distributed. The assumption of normal distribution means that returns conform to a bell curve probability distribution. For further reading, one might refer to Wikipedia, for example: http://en.wikipedia.org/wiki/Normal_distribution
Thinking about a 'market crash' in terms of finite, 'fixed growth' percentage values requires that one disregards, or sets aside, questions about the specific, underlying combination of investment holdings within one's investment, and/or pension accounts. Consequently, a 'fixed growth' market crash is one that will be applied equally to an account invested entirely in, e.g., fixed interest holdings, as to an account invested entirely in emerging markets equities. The use of 'fixed growth' rates, therefore, requires one to set aside (for the moment) the reality that investment returns are, inherently, probabilistic in nature, i.e, risk-based.
Investment returns are 'probabilistic' in nature (i.e. unpredictable, except in terms of statistical probability), but some outcomes, of course, are more probable than others. Consequently, for any given asset class (or combination of asset classes), there is a 'probability distribution' (based on past performance), which shows the likelihood of achieving any particular return (in any single year). The distribution also sets bounds on the range of (assumed) possible returns, relative to the assumed long-term mean. Typically, it is assumed that investment returns are 'normally distribute' and are, therefore, assumed to conform to a symmetrical 'bell curve' type distribution. The allocation percentile, therefore, refers to a position 'under the curve', along the continuum of (assumed) possible outcomes, between the 0th percentile (worst possible return), approximately 3 standard deviations below the long-term mean return, and the 100th percentile (best possible return), approximately 3 standard deviations above the long-term mean return. The assumed long-term mean return sits (by definition), of course, on the 50th percentile, straight down the middle of the bell curve.
For users who choose to derive investment returns (for investment/pension accounts) based on an underlying asset allocation, the practical upshot is that one will need to specify a 'market crash' in terms not of the investment outcome itself, but in probabilistic (i.e. percentile-based) terms. For users unfamiliar with these concepts, it may be useful to refer an actual 'bell curve' distribution, such as the one shown in the accompanying 'primer' to using Voyant's market-based functionality, linked-to here >>>
'Loss Capacity' simulation vs. 'Major Loss' functionality – differences between the two modes
When seeking to model a 'market crash', within Voyant, one has the choice of doing so either (1) in 'simulation mode' only, or (2) within the client's financial plan itself (i.e. within the Base Plan and/or 'what if' scenarios). The difference, of course, is that any inputs made, or outputs generated while in 'simulation mode' will not persist the moment one leaves 'simulation mode'. One has the option, by contrast, of building-in a 'market crash' as an effectively permanent part of the client’s Base Plan, and/or 'what if' scenario. Both options are outlined, below:
1. Simulation Mode – an explanation of the outputs
One can initiate the 'Loss Capacity' simulation, by hitting the 'Loss Capacity' option, below the chart, in the Let's See screen, as illustrated below:
To reiterate, the 'Loss Capacity' function is for simulation-purposes only – when one leaves the 'Loss Capacity' simulation, the effects do not persist within the client plan. When the 'Loss Capacity' simulation is run (by hitting the 'Calculate Need' button), the software will provide 2 results, as follows:
- Need from Start
- Need after Major Loss
Need from Start – what does this result mean?
This is the average annual return which, if achieved in every year of the plan, excepting the already-specified 'major loss' year(s), will suffice to ensure that there is no shortfall in any single year of the plan.
Need after Major Loss – what does this result mean?
This is the average annual return which, if achieved in every year after the 'major loss', will suffice to ensure that there is no shortfall in any single year of the plan. Note that – in contrast to the 'Need from Start' result – this result takes as a given one’s starting assumptions about investment returns, prior to the incidence of the 'major loss'.
2. Using the Major Loss event
As opposed to operating in 'simulation mode', the software allows one to build-in a 'market crash' as a (semi) permanent feature of a client's financial plan (be it in the Base Plan, or in a 'what if' scenario), using the special 'Major Loss' event, located in the Time screen:
Note that one can add as many of these events to the Timeline as desired. Once an event has been added to the Timeline, one will want to hit the 'Edit Settings' button, to determine the duration, and magnitude of the 'loss', or deviation from the mean.
Plan Preferences vs. System Preferences
Changes to this setting on the mirror Taxation panel in System Preferences, on the left side of the screen, will be used only going forward, as you create new client cases. System Preferences are used as a template only for new client cases. Changes to System Preferences will not retroactively affect your existing client cases.
If you want to change this preference in any existing client cases, you will need to open and edit them individually, in each case's Plan Preferences.