“Everyone has a plan ’til they get punched in the mouth.” – Mike Tyson
Given the comeback bout scheduled for September, the cliche Mike Tyson quote is especially relevant today. And as it applies to financial planning, in particular. Imagine being his planner when he earned over $700 million boxing, then ended up declaring bankruptcy in 2003. Now Tyson runs a cannabis business said to earn $500,000 per month, and his return to the ring is not for the money (his paycheck will go to charity), but rather to satisfy some non-financial goal.
This is one of the conundrums of financial planning. No one can foresee what they will want or need to do with their time or money far in the future. Current events have further exposed this concept – who planned for 2020? However, human nature for most people would result in no savings at all without some sort of savings discipline, and far too little without some semblance of a plan.
“All models are wrong, but some are useful.” – George E.P. Box
Current planning software uses the George Box idea, and approaches the task from two angles: goals-based planning, or cash flow planning. Some combine the two. Goals based planning starts with the end in mind, and often uses bucketed strategies to get there. Cash flow planning starts from today’s budget and looks ahead. From the practitioners standpoint, there are reasons to use one or the other depending on the client:
- Can be used with limited information about client spending and still adequately cover the essential planning topics.
- Can be used for clients who are savers by nature.
- Best for plans that are limited in scope.
- Can be overly simplistic and may not adequately represent all the relevant factors (taxes, social security, medical costs, etc.)
Cash flow based:
- Helpful for folks who are just starting out, to see the impact of their major life decisions
- May help motivate spenders when they see how saving can make a difference in the future
- Good for detail-oriented clients.
- Can be overly burdensome to both initially develop and to maintain – the more detail that is included, the more that has to be updated going forward.
The other big difference between planning packages available today is the method of calculation available; the “engine” of the software. Most planning software estimates a likelihood or probability of plan success based on the savings and spending plan, some assigned asset allocation, and associated capital market assumptions. Here are a few highlights of options available today:
- The engine driving the calculation. Most software uses normally distributed Monte Carlo methods. Market returns are known not to match a normal distribution, but it’s the closest and simplest method of estimation. Right Capital uses a complex fat tails stochastic model that more closely matches actual market returns. GDX360 options include bootstrapping samples from actual historical returns. NaviPlan only includes the Monte Carlo calculation as an option – this software calculates outcomes using a CFP-style deterministic method, which gives a very different feel to the process than using a more probabilistic method.
- The CMAs: Capital Market Assumptions (includes returns, standard deviations, and correlations between assets). Most common are historical actual data. However, many planners and software providers feel that historical norms are overly optimistic today, and use CMAs that are derived in other ways. CMAs for MoneyGuidePro are provided by Harold Evensky. CMAs for Orion Planning (Advizr) are from J.P. Morgan. Other software providers set up their own CMAs. Many allow advisors to enter custom CMAs. The importance of CMAs in planning cannot be overstated – these assumptions determine the outcome of the plan, and the planner must know where they came from and understand and agree with the underlying philosophy behind them.
- The level of detail in the assumptions, inputs, and calculations. As mentioned above, some planning software includes incredible levels of detail on tax burdens, social security strategies, and medical expenses. This can have a positive impact on the client, with added confidence in the care and competence of the software and the professional. It may also add an unwarranted level of comfort – taxes, medical costs, and other assumptions modeled into the software will certainly change going forward, which will impact the plan.
Financial planning software is an important tool. It’s the obligation of the advisor to understand its underlying assumptions, how it works, and the strengths and weaknesses of the software package we select for our clients.