Choosing the Right Tool to Solve Your Financial Planning Problem

Technology is a wonderful thing.

Technology creates problems and can come with unintended consequences.

These are simultaneous, if seemingly contradictory, truths. Nowhere more so than in the world of financial advice. Back in the ‘old days’ of financial planning, practitioners created spreadsheets to model their client’s individual financial situations. The process was laborious, time-consuming, and prone to error. And frankly, some spreadsheet builders were better than others.

Then some smart programmers decided that they could help, and thus was ‘financial planning software’ technology born. I’m a big fan of financial planning software in general. It helped improve the quality as well as the consistency of financial projections. It also helped make good planners more efficient, since they could offload routine calculations and focus more of their attention on individual client needs and complexities.

But as the industry grew – and with it the power of financial planning technology – it became easier and easier for individuals who weren’t all that skillful or really interested to simply press a button and “create a financial plan.” And when such powerful technology is applied unthinkingly, we risk having a real planning process replaced by a simple imposition of the assumptions and generalizations that were pre-programmed into the software.

A Technical Difference You Should Care About

Knowing about different financial planning software methodologies would be a topic that only a financial planning geek should care about – if it weren’t for the fact that, as a consumer of financial planning services, what you don’t know about it could seriously impact your own financial future.

I estimate that 90% of all of the financial plans that are currently created for consumers are what we call “goal-based” plans. (For younger consumers, the percentage is probably closer to 100%.) A goal-based plan assumes, very simply, that you’re going to have to save up for various things that you want in the future (i.e., your ‘goals’), including retirement. It estimates how much those future things are going to cost and tells you how much you need to set aside for them now, making various assumptions about priorities and rates of return along the way. By focusing exclusively on future goals and current savings, a goal-based plan ruthlessly ignores all of the current complexity that can invade your financial life.

Goal-based methodology is the overwhelmingly popular choice of major financial planning software providers for two reasons. The first – I must admit – is that it’s pretty straightforward for a planner to apply. Yes, planners are human too; if there’s an easy way and a hard way to do something, most planners will opt for the easy way. The second reason, however – and here I come to the defense of the profession – is that this is the methodology that makes the most sense for many clients, especially younger clients. There are two reasons for this. First, by far the biggest issue that younger clientstypically face is simply learning to save enough. So the fact that a goal-based based financial plan is essentially a lifetime savings plan is a good thing. The second reason, however, is that trying to deal with additional financial complexities can actually be as harmful as it can be helpful. Clients have different capacities for planning ‘work.’ As a result, a simple approach that accomplishes a big (though limited) goal may be a better choice than a more comprehensive approach that the client finds overwhelming.

After all, if a plan isn’t implemented, its return to the client is going to be zero. A simple plan that a client understands and implements is always better than a more elegant plan that stays in the drawer.

So What’s The Problem?

The danger, obviously, lies in those cases when the problem the client actually needs to solve isn’t a simple, long-term savings problem. When the core of the client’s real problem and choices lies in the kinds of current financial complexities that goal-based planning systematically ignores, then the only kind of financial plan that most of the industry has the software to create is going to be useless. Think of it like this. If you go to your doctor because something hurts and the doctor has the technology to treat only one disease, he’s going to diagnose you with that disease, whether he should or not. If that’s the disease you happen to have, well fine. But if not, then you’re in trouble.

The alternative to goal-based financial planning is called ‘cash-flow planning.’ As its name implies, cash-flow planning methodology is based on a much more detailed appraisal and specific modelling of cash flows over the course of a client’s whole life. It demands more, and better, initial information, and is much more time-consuming and demanding to implement for both planner and client. It also accomplishes things that goal-based planning cannot, in my opinion. And many planners don’t have the software or the experience to do it.

I have had many, friendly-but-animated discussions with various colleagues about this topic over the years. We usually disagree. Most of the planners that I talk to do not see the need for cash-flow planning. These are individuals that I hold in high regard, and it has puzzled me that our approach seemed so different. Then I realized that, in fact, they may never have been confronted with the same kinds of problems that my young, affluent, Silicon Valley-based clients urgently need to solve.

Take, for example, the case of a young planner and her client couple in Kansas City. The median price of a house in the “Quality Hill” section of town is approximately $190,000. That implies a down payment of $38,000 and ongoing mortgage payments of around $725/month. Assuming they have a decent income, it’s a good bet that the clients should simply save for the down payment, substitute the mortgage payment for their current rent payment, and worry about how much they have to save for retirement and other long-term goals they care about, like sending their kids to college. Then they can spend the rest of what they make on whatever they want. Problem solved. And the software that everybody has works just fine.

Now compare that to a young tech couple in San Francisco. The median price of a house in Noe Valley is currently $1,690,000. That’s a down payment of $338,000 and a prospective mortgage payment of $6,454/month, not all of which will be tax-deductible. If they’re already living in San Francisco, they may be in a small apartment paying “only” $4,500/month in rent, so the mortgage payment – even after figuring out how to scrape together a down payment that is already almost double the price of an entire house in Kansas City – is going to be a significant change in their current cash flow requirements.

Should they do it or not? Should they take those stock options they have into consideration (and how)? What if they are worried about being able to afford a nanny for the baby they’re expecting? Can they seriously consider sending their kids to private schools? (How) will it work out if one of them takes that job in a startup that gives her an equity interest rather than a robust salary? But perhaps they are expecting a small liquidity event from a company he previously worked for and in which he still holds founders stock. In situations like these, the complexities and challenges of pre-retirement cash flows arethe planning problem – as well as the planning opportunity – and not simply a footnote to be glossed over on the way to saving enough for retirement.

The fact is that in my part of the world young clients come in worried not about whether they’ll ever be able to retire, but rather about whether they’ll ever be able to afford a house (or even a condo) of their own. They worry about what they should (and can) do with the cash proceeds of company sale. They worry about large and ongoing cash flow obligations, as well as about large, lumpy sums of cash moving into their lives – or perhaps not materializing at all. These are pre-retirement financial planning challenges that most financial planning software is not optimized to address.

As a result, it helps to be aware of what you’re trying to accomplish with your own financial plan. If what you need is a straightforward retirement savings plan, then the mainstream technology that most planners have can work fine for you. If, on the other hand, you are looking for guidance with financial events, possibilities, and opportunities between now and your retirement, then my advice is to look for a planner who has both the experience and the technology to address those very different needs.

Image by Anneka from Shutterstock

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While the holiday season is ideally a time for family and friends, it is also a good time to review tax strategies for the current as well as the coming year. Tax planning includes possibilities such as tax-loss harvesting, choices of investment vehicles, order withdrawal optimization, and many others. Given the complexity of these considerations, it’s important to work with a trusted financial professional to best understand each approach and its implications. It’s also important to understand the economic climate’s effect on taxes, especially the impact of inflation. What should investors know as they plan for 2024?
You’ve probably done it all your life. First you (or your parents) enrolled you in a good kindergarten. From there, you ‘graduated’ to a solid grade school. Then came an excellent high school, after which you were lucky (and hard-working) enough to be admitted to a top-notch university. It’s been a step-by-step – and well laid-out – progression your whole life. Isn’t that how careers (and lives) are supposed to work? All nicely laid out with one pre-ordained step after the other?

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