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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