Limits to Financial Planning
When you breakaway the colourful slides, graphs and reassuring rhetoric, you can see the limits to financial planning. I can summarise financial planning as follows:
Future projections, using a range of assumptions built upon a foundation of other assumptions.
If financial markets themselves are unpredictable, how can I accurately make a financial plan for you, with these plans themselves dependent upon a wide range of factors, such as financial market performance, future interest rates, future inflation rates, your future health, your future life choices, relationships and circumstances?
The uncomfortable truth is that it is impossible for me to get this entirely correct and as the future changes, your life changes and your thoughts and feelings change, any plan is flawed whilst it is being created.
Does this mean that we shouldn’t make any plans?
Well no I don’t think so.
From my army days I remember a few phrases on planning which I feel are helpful.
We should plan for our future, otherwise it will be difficult to ever achieve anything.
With respect to financial planning however, our desire to use mathematics and precision can make it more difficult for a layperson, or me for that matter, to actually make the correct decisions in the first place.
I also run the risk of misleading you if I provide reassurance about a future we frankly know nothing about.
Many other financial planners and advisers use reassuring rhetoric to put you at ease and to make you feel comfortable, yet this is dangerous as it can give you a false belief in the security of your investments and the appropriateness of your financial decisions.
When planning, it’s important to not fall prey to this general’s flaws when planning.
– Kenneth Arrow, Nobel Laureate Economist. . .recalling the response he and colleagues received during the Second World War when they demonstrated that the military’s long-term weather forecasts were useless (from Future Babble: Why Pundits Are Hedgehogs and Foxes Know Best, by Daniel Gardner).
It is only by thoroughly explaining the world’s risks and the uncertainties we face can we ensure that the decisions you make are based upon the truth.
The uncertainty of the world indicates to me the importance of exercising prudence when creating your comprehensive financial plan and how important it is to fully understand your financial choices, the investments you select and the risks inherent within them.
It is also clear to me that the financial plan we create will not completely match what will happen in your life and financial returns in the future.
We should therefore regularly review what has developed in order to adapt and keep you on your path to prosperity.
From your perspective, you will also have to accept that things won’t always go to plan. Just because I’ve put your comprehensive financial plan in colourful and engaging terms, doesn’t mean the world will plan out the way we would like, or even expect.
When creating a plan for you, the use of precise cash flow planning/projections and forecasts could potentially lead to the incorrect decisions being made.
For example, do I say to a young person that as their target fund is £x per year in retirement, they need to save £y per month as a precise figure, or is it better to explain they should simply save as much as they can afford?
Personally I feel it is far better to have a ‘problem’ of surplus savings than the very real PROBLEM of too little.
You won’t struggle or go broke by having too much money.
Retirement Planning Challenges
When it comes to income planning for retirees we’re in challenging territory.
With a fixed amount of assets that you’ve accumulated over your working career, we make forecasts using a number of assumptions to suggest a ‘safe’ or reasonable amount of income you can withdraw from your investments.
This can be dangerous.
Firstly, any mistakes that we make in our planning cannot be rectified by further labor on your part to make up for the lost income or capital.
Secondly, it is difficult to establish the right balance between living for the moment and being a miser.
Too much income in the earlier years could impoverish you in later life, and too little can leave you missing out on lifelong dreams.
Unfortunately what this magic number is can only ever truly be 100% ascertained individually and even then it we would need the benefit of hindsight.
If only I could go into the future to get the answers and then come back and tell you what to do!
Added to these difficulties is the uncertainty of when investment losses take place. Losing too much at the beginning of your retirement can seriously damage the long term returns of your investments
More importantly, one or two mistakes in your investment portfolio can render the best-intentioned financial plans useless.
Keeping you content in the short-term, but solvent in the long-term. Balancing opposing forces.
I have a duty to not lead you into financial poverty, combined with the need to keep you happy today.
It’s here and now when you’ll decide to pay me for my services, but whilst I can provide lots of insights and helpful coaching, you won’t truly appreciate the full value of my financial planning until 10, 20, 30 years down the line.
This is a challenge for both of us because a comprehensive financial plan is not cheap and nor should it be.
You are essentially paying me for financial wisdom. I’ll be using that wisdom to your own personal benefit on a bespoke basis, taking full account of your life, needs, present financial position and goals.
Obtaining, maintaining and enhancing that wisdom takes a considerable amount of my time researching a wide range of topics from investing, financial markets, economics, financial history, taxation, legislation, human behaviour and general financial planning developments. I then need to take the time to ensure which parts of this accumulation of knowledge are actually relevant and appropriate to your situation.
This inevitably limits the number of clients I can work with to ensure I provide a high level of service, with in-depth and comprehensive analysis of your life and needs.
The process will take some time and I don’t intend to take any shortcuts. Your finances are too important.
Anything that takes a long time to create in a bespoke way isn’t cheap, but the quality is expected to be high and rightly so.
As I’ve mentioned previously, the main challenge is not always seeing the quality and value my services represent. For example, with a high-end tailor you can physical feel and see the quality of the work, yet with financial planning, the true value is not seen until far into the future, but you still need to pay for my skill, wisdom and service today.
This challenge can lead financial planners and advisers to take the easy road in order to keep a client happy and paying their fees.
Many don’t even realise they are doing it.
From my past experience I feel many clients tend to take as much money as someone else suggests to them. The higher the better, which is completely understandable, but not always wise.
There is a huge difference between eating your income and eating your capital.
Simultaneously satisfying the desire for a high and steady income and maintaining your capital for decades is unlikely to prove achievable. There simply has to be some informed trade-offs.
I feel many regulated financial advisers are failing their clients with this as they tend to brush over these discussions and risks and place a warning paragraph about the risks of investment withdrawals on page 14 of some jargon filled suitability report.
This isn’t exactly customer friendly and not particularly helpful when assessing the life changing and important financial choices you need to make.
As I don’t recommend (read sell) financial products, I take a very unique approach to financial planning.
Firstly, I want every client to be fully aware of all of the risks when investing, not just get them to fill out some silly little questionnaire and still be completely unaware of what they are actually doing. This is why I’m putting together a book on all the risks you face when investing and different ways you can lose money.
Avoiding mistakes and losses takes you a long way to achieving success and gains.
Secondly, I put uncertainty at the heart of my financial plan and because of this embracement of uncertainty, I encourage the use of prudence.
Finally, I want you to fully understand every stage of the process, not hoodwink you with glossy jargon filled marketing material and then say don’t worry about not understanding this, you can trust me and the products I’m selling.
If at any stage you don’t understand a term I use, a part of the plan or an explanation of a concept, this is my fault so please tell me and I will ensure you fully understand and are happy before moving forward.
I would conclude that we should be extremely careful when making your comprehensive financial plan, recognise the limits of our foresight, and not attempt to be too precise about a future that hasn’t yet come to pass. In the words of Keynes