Your Retirement Plan Indicates You Have Nothing to Worry About
Greetings! This is the second post of a five part series which is designed to help investors determine if they are working with a financial salesperson or a financial advisor who is committed to their personal situation.
It might surprise people, but I regularly recommend for potential clients to talk to several different advisors at other financial firms. The reason I do this and recommend it to prospective clients is to allow them to see the difference between my approach and the approach of other advisors.
While it could obviously backfire, it rarely does. Experienced financial professionals who are focused on their clients’ goals and objectives first will almost always win out over financial salespeople. The real problem is that many people do not take the time to shop around when considering a financial advisor or advisory firm.
This is an approach that I strongly recommend, because investors that do not shop around with different financial advisors are potentially missing out on tax based planning, specialized estate planning, and even potential investment opportunities that makes sense from a risk tolerance perspective.
In today’s post, I wanted to share an example of a situation with a prospective couple that actually happened recently. Immediately after meeting with the couple, I knew they would potentially be great long-term clients. The initial consultation went very well, but as always with a higher net-worth client, I recommended that they talk to other advisors. They were surprised, but they told me they would talk to a few other advisors before making any final decision about who they were going to work with in the future.
A few weeks later they came back in to meet with me and they immediately started discussing the financial plan that had been presented by another advisor. I asked them if they brought the plan with them and they indicated that they had. Instead of focusing on their situation, I told them we were going to review another financial advisor’s work independently and honestly.
This is not a rare occurrence by any means, but many of the plans that have been presented to prospective clients by other advisors that I have seen are questionable for a variety of reasons. However, on those occasions when a client has been provided a high quality financial plan, I typically tell the clients that the plan that was prepared for them certainly is worth following-up on. Unfortunately, in my personal experience a strong financial plan is a fairly rare occurrence.
The premise behind my negativity regarding many of the plans I have viewed from other financial advisors is the fact that their plans are consistently built using unrealistic expectations. Instead of using the financial plan as a guide toward the future, some financial planners are using their plans as a sales tool to help attract and retain new clients. So here are a few things that I look for when reviewing another advisor’s plan with prospective clients:
- Inflation is not considered now or in the future in investment expectations or income projections.
- Portfolio construction and assumptions are not considered or adjusted based on age, allocation, objectives, or risk tolerance.
- Constant investment returns applied over long periods of time.
- Social Security planning does not exist as part of the plan.
- Estate planning is not mentioned or discussed.
- Risk planning using various insurance policy types has not been addressed.
- Withdrawal rates that are assumed to produce retirement income are excessive and well above the recommended 4% withdrawal rate rule.
- Taxes on investments or retirement income have not been considered.
- Wage and savings growth rates shown in the future are not realistic.
These are just a few of the areas that I try to focus on with prospective clients that have been provided with a so-called financial plan by another advisor. When a significant amount of the topics above have either been overstated or simply omitted, the advisor who prepared the financial plan is a salesperson, not a financial advisor.
In order to demonstrate a specific example, the chart below illustrates what a financial plan may promise in the future versus what happens in the real world.
“This chart or graph is hypothetical and for illustrative purposes only. It is not intended to show the performance or return of any particular investment. Past performance cannot guarantee comparable future results.”
Chart Courtesy of STA Wealth Management
As can be seen above, the promised growth of $10,000 at a 7% growth rate produces investment returns that ascend to a staggering level over a long period of time. However, when the same $10,000 is invested in a portfolio that has a fluctuating return, suddenly the actual portfolio performance is reduced dramatically. The differential is built around the principle of compounding interest. The impact of compounding interest is enhanced further over long periods of time.
The shortfall shown in the chart above worsens when you begin to add in the impact of investment expenses, asset management fees, taxes, and inflation over long periods of time. The chart above demonstrates the single largest mistake that can be made by a financial professional when designing a financial plan . . . a constant rate of return applied to the investment or allocation.
Going back to the example of the couple I met with recently, when I reviewed their plan the advisor had not only shown a constant rate of return for the rest of their lives, but also a rate of return which was unreasonable at 9%. I think most financial professionals wish we all had access to an investment that returned 9% with very low portfolio volatility. Unfortunately, in the current investment climate this simply does not exist, but if I am wrong please send me an email as quickly as possible!
In addition to insane growth projections, the plan did not address taxes, inflation, or any estate planning concerns. I explained to the prospective clients that they were looking at nothing more than sales propaganda when viewing the plan they were given.
Unfortunately, some financial advisors will show prospective clients a financial plan which is completely unrealistic in an attempt to convince the clients that they are great financial prognosticators and the investment returns they can produce for clients are second-to-none. If this sounds familiar to you in terms of your experience with your financial professional, I would strongly encourage you to meet with several outside financial professionals and get their thoughts on the financial plan that you have been presented.
A financial plan should cover much more than portfolio returns and withdrawal strategies. There should be discussion of a variety of items such as an appropriate withdrawal rate, after tax income needs, and lifestyle changes or adaptations to name just a few. A financial plan built around false pretenses to begin with will likely underperform the clients’ stated goals and objectives over the longer-term.
Remember, when working with an advisor that wants to put a plan together, they should be requesting a significant amount of personal information from their clients. Tax returns, social security statements, estate planning documents, personal balance sheet or financial statements, etc.
A financial plan that is built around a single portfolio, is not a plan . . . it is sales literature. If you are presented a “financial plan” for the rest of your life that seems too good to be true . . . it probably is. A financial plan is nothing more than a guide toward an unknown future, but it should be reviewed from time-to-time and adjusted for market conditions or personal changes that occur in the clients’ lives along the way.
Ultimately, a financial plan should not be a sales tool . . . it should be used to make sure that a client is prepared as much as possible for an uncertain future. A financial advisor cannot predict the future, but they should be able to help their clients make decisions that make the future more manageable from a financial perspective.
The next topic in the series covering the 5 Investing Myths Used by Financial Salespeople will be the old adage that the buy-and-hold strategy is always the best. Until then . . .Happy Investing!