Life isn’t simple, and creating a detailed financial roadmap for your clients isn’t either. Here is a guide to help make the process a little more streamlined.
1. Get the facts
Obviously, a financial plan is only as good as the information that is provided. All the basic information is essential – family members, income, expenses, assets, liabilities, insurance policies. But we can’t gloss over the smaller details – exactly how many years are left on the mortgage; the interest rate; the breakdown of property taxes versus insurance costs. Each nuance has an impact on overall plan development. We need to know precisely when cash flow will change. We need to know which costs (like property taxes) will rise with inflation and which will not (the mortgage itself).
Equally as important is understanding where free cash flow is being directed. Whether your client is contributing to a traditional vs. Roth 401(k), and the presence or lack thereof of a company match, will dramatically alter the outlook towards future goals.
And how do we deal with monthly expenses? It is extremely unrealistic that a majority of your clients will be able to account for every dollar that goes out the door. But it is very important to be able to get round figures that can be put into different categories. Inflation will substantially increase pure dollar spending on groceries over the years, but their term insurance premiums may be locked in for the next 30 years.
This may be the most vital component of the data gathering to fact check together with your client. After entering in all the numbers based on the clients’ estimated spending habits, you will be left with a number representing free cash flow that could be invested for the future. When presented with this number, clients will often get a good laugh, as it is significantly higher than they ever actually have left over at the end of the month. It is clear that they have underestimated their spending in a major fashion. Ultimately, we are going to see if accumulated savings will cover the clients’ lifestyle expenses in retirement – so if we underestimate the expenses from the get go, we will create wildly unrealistic measurements of progress and chances of success.
2. Get the feelings
The clients’ goals and priorities set the parameters for the financial plan. The most common conversations will be around partial and full retirement ages, college education planning, buying a home, travel, and creating funds for children’s weddings or a general legacy to leave behind.
Of course, no one can predict the exact timing of when their children will get married, whether or not a scholarship will be awarded for secondary education, or if their child will ask for help with something like law or medical school. With the volatility of the housing market and interest rates, we cannot know precisely what a starter home will be worth in 7 years and what the final accepted offer will look like for moving into a bigger property. A client may tell you they want to retire the very first day they are financially able, without any knowledge of when that could be. But the bottom line is, we will need to work with clients to get our best possible estimates so that we can actually apply the data to come up with an assessment of current progress and develop recommendations.
3. Take the snapshot
After gathering the facts, figures, and objectives from the client, it is possible to provide a snapshot of where the client is in relation to accomplishing these goals. With all of the variables that occur within financial planning, and within life, simple back of the napkin math cannot provide real value in assessing one’s progress. Even some of the calculators found on 401(k) websites that ask “am I on track for retirement?” are quite simplistic and do not take into account a number of unique factors to each individual’s situation.
A full scale, comprehensive financial planning software program will account for factors such as inflation, taxes, risk/reward of various investment profiles, changing cash flows, and career changes. It can take each goal and assess probability of success.
One commonly used tool is a Monte-Carlo analysis, which will run 1000+ different scenarios to assess the probability of a clients’ assets lasting as long as their projected lifespan. It can often be ran quickly using different parameters (i.e changing the retirement date, current savings amount, or expenses in retirement).
This picture can be a good ‘snapshot’ of where the client stands in relation to their goals.
4. Perform the stress test
The snapshot performed already can provide valuable insight if all assumptions of the plan are met. But of course, that is not how life works. Most financial planning software allows for an additional level of stress testing that can show how the client’s probability of success would be affected by changing assumptions.
Some of the common stress test functions include the impact of: a large market drop in year one of retirement, overall tax rate increases, social security benefits decreasing, longevity past life expectancy, higher than expected inflation, increased health care expenses, or lower returns in the investment portfolio.
Seeing the degree of impact from each of these factors can reveal where the points of weakness and opportunity are in one’s current financial plan.
5. Provide options and make recommendations
With the combined output of a snapshot and stress test, it will be easier to pinpoint elements of a financial plan that should be addressed. Being particularly susceptible to a market drop might suggest a portfolio’s risk needs to be readjusted. Extreme negative results from tax increases might highlight opportunities to diversify the tax structure of the current portfolio. Seeing probabilities diminish with longer longevity might encourage one to increase savings.
Utilizing the analysis of a comprehensive financial plan helps advisors position themselves as educators over salespeople. This level of collaboration can lead to greater clarity of purpose and a stronger professional relationship, while making a significant positive impact on the life of your clients.
5357617RH_DEC24
