Where financial advice falls short, and can leave you short.
Is your financial advisor asking the right questions?
Is your portfolio routinely stress tested to keep you on course?
The typical advisor is quick to find an appropriate
asset allocation based on a client's objectives, risk tolerance
and time horizon. That's the easy part.
Take-aways
• Your financial security may be based
on faulty planning!
• Modern wealth planning can stress test thousands
of scenarios
• Your advisor's main objective should be your financial
security |
David B. Loeper and George Chamberlin, of Financeware
Inc. in Richmond, Va., give a good example of what can go wrong
in traditional planning. Loeper is the founder and Chamberlin
is the vice president of financial strategies at Financeware,
a software and services company.
In one of their examples, a client with slightly
more than $1 million to invest in 1992 and a $300,000-a-year job
seeks advice based on a "growth" objective for his portfolio.
His advisor comes up with a conservative growth portfolio of 80
percent stocks and 20 percent bonds geared to an 11.3 percent
return assumption.
Through the roaring '90s the portfolio grows 17
percent a year, and with a $4 million portfolio in 1999, the client
begins talking about retirement. He and his wife want a comfortable
retirement income, plus $40,000 a year to pay for their two children's
college educations over the next six years.
At the end of 1999, the future looks rosy. The advisor
concludes the children's educations can be funded and a safe spending
level would be $140,000 a year in retirement. He plans for the
scenario by assuming what seems in 1999 a conservative return
of 8 percent annually and recommends a portfolio weighted 90 percent
to equities with a rebalancing at retirement.
A year later, the client has retired and is spending
$160,000 a year, and the portfolio has lost 4 percent. The financial
advisor encourages the couple to stick with their long-term investment
philosophy. They do, and suffer another portfolio decline in 2001.
The bear market stretches into 2002, and the investment declines
continue, but they keep paying for college and spending $160,000
a year – though Chamberlin's hypothetical advisor's analysis
shows the diminished portfolio can only support annual spending
of $125,000.
What went wrong? The advisor identified investment
objectives and risk tolerance, diversified and rebalanced the
portfolio along the way.
The portfolio was managed well, no doubt. But the
advice missed the ultimate objective – to ensure the portfolio
would fund a comfortable retirement for the client.
Chamberlin and Loeper in "Improving Advice:
Going Beyond Traditional ‘Best Practices'' point out that
the traditional financial planning approach is fraught with troubles.
Too often an understanding of the parameters of
your goals and your priorities is missing. A more thorough approach
would have you pinpoint, for example, a minimum acceptable annual
retirement salary and a range of ages at which you would like
to retire.
With priorities and parameters clear, your advisor
would be able to provide several scenarios. An advisor should
be able to stress test your proposed investment portfolio by running
thousands of historical simulations that show returns through
bull and bear markets.
This "comfort assessment" would produce
a spectrum of probability for any portfolio. Your ideal might
be to save $45,500 a year for retirement to retire at age 57 on
$160,000 a year and pay for a child's college education. But,
a portfolio stress test might reveal a slim 57 percent chance
of achieving such an outcome.
At the opposite extreme, you might save $70,500
a year, hope to retire at 60 on $140,000 a year, and partially
fund college. A portfolio analysis might conclude that while this
is not ideal, this acceptable outcome has a 96 percent change
of success.
We contend that any wealth management strategy with
less than a 75 percent chance of success is unacceptable.
Over time financial situations change, goals change,
and market fluctuations affect the value of a portfolio. Any reputable
financial advisor will stay abreast of all the factors affecting
your financial dreams.
Your advisor should keep running scenarios with
updated variables – portfolio values, income objectives,
return projections – and show you high probability outcomes.
In a prolonged or dramatic market decline, for example,
you advisor should be comfortable explaining the implications
and helping you adjust. Perhaps you'll need to increase the portfolio's
risk level and reduce projected retirement spending; or perhaps
you'll need to contemplate postponing retirement a year or so.
Your wealth advisor should help steer you back on
track whenever the probability of achieving all that is important
to you has dropped below 75 percent or exceeding 90 percent.
It is rarely a simple matter of just adjusting investments.
You should demand a wealth advisor who works with you, who genuinely
wants you to achieve what is important to you and your family.
Christopher G. Snyder and Haitham "Hutch"
E. Ashoo are principals of Pillar Financial Services in Walnut
Creek. Contact them at 925-356-6780.
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