As an engineer-turned-financial planner, I was quick to put my seven-year process engineering practice to use when reviewing many of my client’s financial plans. While some of these plans were drawn up by qualified planners adopting industry best-practice, many of them were created using templates to fulfill basic regulatory requirements. Whether it is planning for your retirement, or working out the shortfall when a critical illness or disability event strikes, it is really not that hard to identify many misses present in the financial plans your planner draws up.
Yet, for more than a decade, financial planners mostly gloss over these misses. Few pay careful attention to avert them with their highly accurate spreadsheets. Why? 99% of planners earn from product commission, not from an advisory fee, and may not focus on good planning. As consumers, are you aware of these misses?
The Wealth Pyramid
My own financial planner shared with me back in 2002 that to plan for my finance, we use the Wealth Pyramid model. She then drew a pyramid with three layers – with wealth protection (insurance) at the base, wealth accumulation (savings/investment) in the middle, then wealth distribution (wills/trust) at the top. Arranging our financial plan is like building up the pyramid: from the base up. I taught my clients the same model from 2008 to 2010. What’s the miss here? What does it mean to treat Protection and Accumulation separately? You cannot fully protect yourself if you are unsure how much to accumulate (set goals). Likewise, you cannot fully accumulate (achieve goals) without understanding the risks you are taking.
Reservoir with Disconnected Inlets and Outlets
Your financial report has a page called Cashflow Statement, that is (Income – Expenses). Another page called Balance Sheet, i.e. (Asset – Liability). Sounds professional. Unfortunately, you quickly realize these two sheets don’t interact. The mortgage installment you pay monthly does not go to debit your outstanding loan, or so the report does not show. Similarly, you may not find the value of your stock portfolio that you contributed $300 monthly in 5, 10 or 15 years’ time. In other words, if your net worth is like a reservoir with the water level rising and falling each year, your cashflow pipes are certainly disconnected in a typical financial plan.
Setting Goals One by One
You set goals in your plan, be it getting your first property, preparing for the arrival of the first child, and/or retirement lifestyle at 65. Next, your planner works out the shortfall for each goal. You are told to set aside a certain budget for a saving or investment plan for each of these goals. Systematic as it seems, you realize your goals are now put into separate “saving jars”. When circumstances change down the road, your financial plan is less likely to help you re-allocate money from one jar to another. By setting goals in silos, there is less flexibility to optimize your resources.
Be Careful with Average Returns
Working with your bankers and investment specialists on average investment returns of say 5% may seem correct until you hit the retirement age. Three retirees (S1, S2, S3) with $100,000 a nest egg withdrawing $7,000 per year while staying invested have very different outcomes depending on the order of negative and positive return years. Referring to the table below, you will quickly realize the problem with the average return.
Table 1. Accumulation Maths
Table 2. Drawdown/ Withdrawal Maths
The Computational Scourge of Central Provident Fund
CPF formulas and rules are designed for computers, not humans. Hence, since CPF forms a sizeable portion of the average Singaporean’s asset base, I call it a computational scourge. Account ceilings, contribution, and allocation rates are ever adjusting to keep tab with inflation. There is the 1% additional interest added to up to $60K across your Ordinary, Special and Medisave Accounts – how do we account for that? Retirement and housing schemes that apply to someone presently aged 55 is different from someone aged 35. Indeed, with the exception of a few planners with great Excel skills, most planners just gloss over your CPF analysis hoping that you do not notice.
Dismissing The “In-Betweens”
You set your goals and put in place a savings plan to achieve them. What is going to happen in the “in-between”? What if you encounter a drastic lifestyle change. What happens if your spouse stops working? Can you still finance the policy if you are laid off too? How would a 10% market correction at the halfway mark affect you? What is the impact on your rental income if SIBOR interest rate rises 1%? How would your financial plan cater for these common scenarios?
Over-simplified Shortfall Calculations
“John, in the unfortunate event that you are critically ill, or are disabled, how much would you need on a monthly basis? How many years do you want for this replacement income to last?”
Are these two questions sufficient to work out your insurance shortfall? The better planners discuss with you adjusting current expenses to work out your shortfall (expenses replacement approach). But that’s over-simplified. A better way is for planners to project future expenses and add in goals expense to calculate actual shortfall. Is there a way to calculate those? Yes. Are most planners really interested to help clients to calculate the actual shortfalls? Well, not really.
What is the real value of a financial plan if these misses are not handled? Nothing much. What, then, is financial planning if the financial plan cannot be a reliable and accurate guide into your future? Today’s decisions will impact tomorrow’s reality. Without accurate insights and projections into your future, how can you make smarter and more-informed financial decisions?
Talk to your GoalsMapper adviser today for high-resolution, high-clarity financial planning today.