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Seven key tips for cashflow planning

Andrew Moore, independent financial planner and director of Goodmans Financial Planning, asks whether cashflow modelling forecasts a client’s future, or shapes it.

1. Every plan is wrong and so are the assumptions|

Every client knows that the future is unknowable and that any plan won’t stand the test of time. Assumptions are almost universally incorrect and we all know it. However, a cash flow plan is like any theory or model, it is the best picture we have. It is there to inform decisions, not guarantee the future.

1. Every plan is wrong and so are the assumptions|

Every client knows that the future is unknowable and that any plan won’t stand the test of time. Assumptions are almost universally incorrect and we all know it. However, a cash flow plan is like any theory or model, it is the best picture we have. It is there to inform decisions, not guarantee the future.

2. Client objectives are often built on a reality that does not exist

Client objectives are often built on an incomplete picture of their situation, influenced by perceived wisdom, and often pessimism about the future. The process of building a cashflow model with a client provides a view on their lives that better reflects the true picture of their financial affairs.

A client's objectives can often be dramatically different when a clear view of reality and possibility is presented. Since the suitability of our advice is based on the client’s objectives, it seems sensible to shine some light on them, to test them for robustness.

3. The need for return suggests that ‘alpha’ is irrelevant for most clients

A cashflow model gives the planner a key number that is crucial to the investment strategy. The ‘need for return’. Armed with this number, a planner knows how much return is required to meet the client’s considered objectives. Beta satisfies this need for almost every client I have ever advised, and also lends itself to a very diversified investment approach. Who, then, is alpha relevant to?

4. Return on money or return on time?

Many retirees have entered a world of scarcity, but of time not money. A cashflow model should focus their minds on maximising the quality of that scarce resource. The planner provides a reassuring and impartial voice that pushes to the fore important decisions such as early retirement or additional spending. Drawing down on capital requires confidence.

5. ‘What if’s' come thick and fast

Cashflow modelling is an exploration of potential decisions not a prescription for the future. A client will want to explore different scenarios in real time and that requires a collaborative approach with a confident and skilled planner.

If a planner is not confident in their tools, then this is going to be difficult to pull off. Taking one ‘what if’ away and writing a report is of limited value, and ultimately expensive for the client. Testing and calibrating decisions in real time adds value, mirrors how real people think, and is especially useful where couples hold differing opinions, and worries.

6. Rolling the dice reassures the client

Reliance on capital in retirement carries hidden risks that a cashflow model can disguise. A plan can give the all clear to a spending pattern and show that a client won’t run out of money.

In the real world, returns do not come in straight lines. Any plan needs to be stress tested to introduce the randomness of investment returns, and to surface any hidden sequence and longevity risks. Using a Monte Carlo simulator with the client can introduce a sense of probability to the plan, which in a curious way reassures a client when they assess the merits of different decisions.

7. Creating the future, forecasting the future, or both?

Pensions, investments, tax and legislation are complex and mystifying for many people. This complexity can leave clients unable to craft their future in a confident manner.

The aim of cash flow modelling is to provide the best picture of the future that we can arrive at. That is important to the planner giving regulated advice, but also liberating to a client who wants to shape their future. Guiding clients to confident considered decisions requires more than a suitability report and product recommendation.

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