One of the biggest challenges that we face as financial planners is the expectation that we can predict the future. We’re not talking about predicting the winning numbers for tonight’s Powerball, but about the expectation that we have ultimate control over a client’s future financial success. While we can’t predict the future, the accuracy of the plan hinges on the assumptions and questions that are asked. What separates a bad plan from a good plan ultimately depends on WHAT assumptions are being used and WHICH questions are asked. This is not to suggest that there is no merit in financial planning – because there is a lot – it’s rather to bring to light the details that many advisors often overlook and where most financial planners get it wrong.
What Does a Financial Planner Do?
To better understand these common shortcomings, it’s useful to know how the traditional financial planning process works in many practices.
The Financial Planning Process
There are variations of the model above but, traditionally, the process begins with establishing some sort of relationship. Generally, this step involves the advisor or planner getting to know the client on a basic level in order to learn about their specific circumstances and objectives. After developing a foundational relationship, the second step involves gathering quantitative and qualitative information about the client, most often things like their balance sheet, estate planning documents and life expectancy. The third step is to analyze all the client’s relevant information, often using analytical software to run stress tests, what-if scenarios, and Monte Carlo simulations. The last step of the financial planning process is to make recommendations and work with the client to implement them. Typical advisors and financial planners will provide their client a deliverable and end the process here. However, for a good financial planner, providing their client with recommendations is the beginning of a lifelong process. An ideal planner will not only have an established a relationship with the client but will work continuously to monitor and update their plan along the way because, let’s face it, variables tend to change over time. Financial planning should be an ongoing process. Life happens and updates will need to reflect life’s changes both large and small. We encourage our clients to think of a financial plan as a GPS; you set an initial route from point A to point B, keeping in mind that there will always be potential delays and detours along the way.
Common Mistakes Among Planners and Financial Advisors
Not Asking Qualitative Questions
It is important to know the financial planning process because it highlights two common errors made by typical planners and advisors. In the data gathering phase, a planner will typically ask all sorts of quantitative questions about the client’s income or the timing of retirement. However, many often fail to ask qualitative questions such as, what retirement looks like to the client or simply, what’s most important to them. For one client perhaps it’s purchasing a dream home, for another it could be enjoying a comfortable retirement lifestyle or perhaps it’s leaving behind a legacy for their children. Whatever is important to the client should be important to the financial planner as well. While quantitative questions help with identifying the client’s needs, the qualitative questions help communicate the client’s dreams and goals. A good financial planner should ask tough questions that get them to think about what it is that’s important and what it is they want to accomplish. Asking the qualitative questions to learn who the client is and what they want to be allows a planner the opportunity to develop a goals-based approach that serves their needs and dreams.
Thinking the Plan Is the Product
In today’s industry where Robo-advisors are gaining popularity due to their efficiency and cost effectiveness, many people are forgetting the value of having a knowledgeable financial professional looking out for their best interest. There are many planners who are very thorough and knowledgeable, however, the result for the client is a 50-page planning report that doesn’t feel entirely relevant to them. A financial plan can have all the right numbers, come in a sleek presentation, and make the client feel warm and fuzzy inside, but, if it’s not relevant to the client’s life goals, it will become a product that sits on a shelf collecting dust.
Using Unrealistic Assumptions
Planning assumptions are probably the component of a financial plan that is least understood and often overlooked by the typical financial planner. While using assumptions are an important part of our job as planners, it is even more important to carefully consider what assumptions we use. Micheal Kitces is an industry leader who has conducted extensive research in the area of financial planning and statistical modeling. We know that past performance is no guarantee of future returns, yet this is how most plans are put together. This approach often overlooks factors like sequence risk and current market conditions, especially for a client who is near retirement. If you are planning a trip to New York City, it is important to know the weather because you don’t want to wear shorts in the snow. The point being that bad assumptions are a recipe for disaster. We recall a plan for a client who came from a large investment firm that offered financial planning services. In the fine print of the disclosures, we learned that the planner was modeling the client’s retirement assets using investment return assumptions of 16% resulting in over a 95% probability of success in retirement. Assumptions are an important component that can have a significant impact on the results of your financial plan. It is equally important to have those conversations with your planner and advisor about what they are modeling in your plan and how realistic that is.
Planning for Today vs. Planning for Tomorrow
There are many advisors and planners out there who conclude: “Since we can’t predict what will happen tomorrow… it is more important to plan for today’s current circumstances.” As with many things in life, we find we are most at peace when there is balance – the same is true when it comes to planning. It is important for advisors and their clients to understand that there should be a balanced emphasis placed on planning for tomorrow and planning for today. What is the value of planning if all we consider as planners are today’s desires? Financial Sense Wealth Management’s lead financial planner, Paul Horn says, “Our job as planners is to balance today’s wants with tomorrow’s needs.”
Not Following Through
A financial plan does not stop at recommendations. Planning is an ongoing process that requires not only follow up but follow through. If there is no follow through and no action taken based on the recommendations, then there is little value in completing a financial plan. Even the best advice in the world is worthless if it’s not carried out. As planners we know we can’t force people to take our advice. We can be diligent in our follow up and be proactive throughout the process.
The Value of Financial Planning
An important distinction is that a financial plan and planning are not the same thing. A financial plan will be wrong a majority of the time. That’s because life’s variables are constantly changing. Having an objective planner who can keep emotion out of the decision-making process is crucial in creating sound financial decisions. To quote our own Chris Puplava explaining the value of active management, “There is a time a row and a time to sail.” The same can be said for financial planning. There are occasions when we make a financial plan for a client that is already in a great financial position and from that moment on our job becomes less about delivering a 16-page document and more about sailing and enjoying the ride. Often, this looks like playing the role of life coach to keep the client on track to reach their life goals and being there when the unexpected happens. Being proactive planners and proactive managers also means being ready to row at anytime. There are numerous situations that we create plans for clients who have adapted bad financial habits or are in a tight financial position and need guidance and proactive planning to help get them back on track toward reaching their goals. Whether it be a tax-saving strategy, selling a business, relocating in retirement, protecting lifestyle, developing an estate plan or adopting a new investment philosophy, our pursuit will always be moving our client’s goals that much closer to reality.
If you would like to learn more, make sure to check out our latest Lifetime Income podcast episode airing today titled, “Do You Need a Financial Advisor?”
Co-authored by Paul Horn CFP