A Financial Plan is the Sum of its Parts

Ted BraunNovember 29, 2018

Financial Planning

I hope everyone enjoyed Thanksgiving as much as our family did. Good food, friendly banter and sighs of satisfaction were prevalent throughout the day. As we gathered at the table, conversation meandered to topics related to the stock market.

The two most posed questions were: What happens when the market turns? How can financial planning can get you through the next market cycle? I suspect many of you are making similar queries.

Many of our clients have been focused on the recent performance of the stock market. Although that needs to be considered, we believe it is more important to review your personal financial plan. If properly prepared, it will have already incorporated short-term investment fluctuations.

A financial plan should be your road map or blue print to your future. There are several components that make a successful plan. Investment planning is an important part of any sound financial plan, but they key word here is “part”. A financial plan has many “parts”, and without all these pieces working together as a well-coordinated aggregate, it may not perform as well as you anticipated, or it could even fail.

Insurance analysis, estate planning, education planning, retirement projections, stress testing, cash flow analysis and income tax planning are some of the other very important parts of a sound financial plan. A financial plan should look at all aspects of your financial situation.

We are always discussing the markets, the economy and yes sometimes politics with our clients. But when we talk to our clients about the markets, we should be talking about it in relation to its impact on your financial plan. That’s because no one component of a financial plan is bigger than the other, they work together to help you through life’s journey.

This all sounds good in theory, but how does it work in real life. We are all aware that markets do not go up every year, but long-term performance tends to average out investment results. By helping our clients focus on their long-term goals, rather than short-term noise in the markets or on the news, we can shift our priorities to what matters most. The questions like; When can I retire? How long will my money last? Can we afford our dream house? My son just got into Harvard, can we afford it?

A well designed financial plan can help to answer these questions. However, the key discussion you should be having with your financial planner is not the short-term performance of the stock market, but the assumptions and variables used to create your financial plan. Assumptions such as: investment returns, inflation, income and living expenses, future tax rates, major upcoming purchases, expected retirement date, pension and social security projections, to name a few. Since your financial plan will project many years into the future, using conservative assumptions is most important.

Once the assumptions have been validated, your financial plan should stress test the results by using Monte Carlo Analysis. Monte Carlo Analysis considers standard deviation, or the volatility in the market to calculate a probability of success. Generally, 1000 Monte Carlo trials are simulated and a simple percentage from 0-100% is calculated. Pretty simple to understand, the higher the percentage, the rosier the outlook!

Monte Carlo Analysis helps give us confidence about the strengths (or weaknesses) of your financial plan. It helps us to set a long-term strategy and be in position to monitor it as your financial situation changes. It also helps us to make very important decisions and serves as a useful tool to know whether you are on track, or if you need to make some adjustments. It is the instruction manual towards achieving your financial goals and objectives.  

When you get concerned about the short-term performance of your investment accounts, take the time to talk with your financial planner about the assumptions used within your financial plan. Chances are, that market fluctuations have already been incorporated. Investment planning will always be a “part” of what planners do. But as I led with, investment planning is a piece of the puzzle and I’ve never completed a puzzle that only had one piece.

For all the brilliant people in this world, nobody knows when the next 2008 is coming. What the new age “dot.com” bubble looks like, or how bad the impact might be. Surely, everyone has an opinion, or maybe even an educated guess, but do you want to hang your future on an opinion? Instead think about what you can control, which is your financial plan and all its workable parts.