The old saying goes, “The devil is in the details.”
This could not be more true than in financial planning – especially for complex situations involving business owners, corporate execs, other professionals and even retirees.
A majority of advisory firms today have chosen to use goal-based financial planning for their clients for explaining where to buy stocks to them. This is a useful approach for families with limited complexity, outstanding discipline and an ability to predict the future well – none of which are applicable for many.
Let’s look at how one might use the goal-based approach. You begin with a set of simple facts (e.g. current asset level), assumptions (e.g. inflation) and desired outcome (e.g. cash flow desired during retirement). You then solve for either the required return or required monthly savings.
This approach takes some skill and offers a good back of the envelope calculation. However, human behavior doesn’t operate in a degree of constancy. Rather, the road is full of curves and hills around and over which we must navigate. Stock options, varying compensation levels, changing economic factors and tax laws, and an integrated estate plan all muddy the waters.
Cash flow based planning is much more comprehensive as it adds “proof” to the goal-based approach by validating assumptions such as savings rate, realistic risk adjusted returns and variability of outcomes. This more comprehensive approach uses data as the key input (versus assumptions) and yields solutions to the inevitable “gaps” that are identified. The outcome is an approach that provides a set of options/choices – each with its inherent pros and cons – that require discernment.
These solutions are not limited to investment related discussions as is common for the goal-based approach. In fact, you can easily identify if your advisory firm is a goal-based or cash flow-based firm by reviewing the percentage of time that is spent on investment related versus planning related topics.
Many professionals find that their financial plan follows the following process: A) gather data, B) clarify objectives, C) develop investment strategy, D) allocate portfolio, E) review and re-loop to “C.”
If this describes your experience, you are more likely in an investment management relationship, not with a financial planning firm.
A cash flow based financial advisory firm adopts a more robust approach, namely: A) gather and validate data, B) clarify objectives, C) develop financial and investment strategy, D) implement plan, E) review and loop to “A.” Note that “A” is augmented by validation of data and “B” should include the creation of a family profile.
The devil is in the details. Make sure your adviser makes the effort to ensure that your details are in order.
