FINANCIAL PLANNING: My Guess Or Yours? Why It’s Absurd And Doomed To Fail From The Very Start
Personal_Finance / Learning to Invest Nov 17, 2008 - 07:48 PMBy: David_Haas
Upon reading that title, I'm sure some of you are thinking that I must have completely lost my mind. Well, of course that's not true. But, how could something as universally accepted, widely followed, and apparently “innocent and necessary” as financial planning be setting so many of those who unquestioningly apply it on a course toward a miserable financial future?
On the surface, IT WOULD CERTAINLY SEEM that I was maligning something both desirable and good. How could planning of any kind be bad? But, if you'll stay with me to the end of this post, you'll, no doubt, end up agreeing with me that there may be better ways to get where you want to go in life and perhaps you'll even decide to abandon your financial plan, fire your traditional or fee-based financial “planner” or broker, and venture out on your own to pursue what may prove to be safer, more logical, more sound approaches to designing and securing your financial future.
Believe me, I've studied all sides of this issue for many years and I know that far better “systematic” and time-proven alternatives to today's financial planning do exist. I also know that some of the smartest, wealthiest, best-informed people are confidently applying these alternative wealth-building techniques and principles with consistent and satisfying results, refusing to rely solely on capricious variables and “markets” to determine and deliver their fate. Hogs and cattle have their fate determined by markets but… should you?
DO YOU FEEL LUCKY?
Modern financial plans are designed and constructed much like an inanimate building and, unlike living beings, they cannot and do not breathe, grow, evolve, or adapt well to constant change. Their primary failing is that they attempt to project the past into the future. We live in a world that is driven by cycles, so any linear projection will almost always turn out to be wrong - often in a very big way. As you're about to see, today's financial planning methodology is built almost exclusively on linear projections and assumptions that are extrapolated from the past.
Financial planners - again, using methods similar to architects - generally begin working with you by asking you to fill out a detailed questionnaire prior to your first planning session. In this questionnaire and in your initial meeting they are trained to get you to focus primarily on things like:
- Your Resources and Budget
- Your Needs and Wants
- Your Goals and Objectives
For those of you who have been through the financial planning process, this probably sounds quite familiar. Some planners will go a few steps further and get you to “envision and vividly describe your hopes and dreams” so that they may gain a deeper insight into your personality, your emotional make-up, and if you're a couple, the dynamics of your relationship.
This knowledge can either be helpful to you or potentially quite harmful. A skilled “sales-oriented” planner - which, unfortunately, too many of them are - can use these emotional “hot buttons” to more effectively sell you the things he/she wants you to invest in by positioning those products as superior vehicles for “reaching your dreams”. It should come as no surprise that these products are often the ones that pay the best commissions and generate the juiciest ongoing fees for the planner.
Conversely, in the hands of an unselfish, ethical planner, a familiarity with your inner motivations and dreams can be used as a powerful tool to coach you and keep you motivated and on a positive track when life inevitably throws you some curve-balls and obstacles that might have otherwise sidetracked you. Though the odds are not good, I would hope that you've found this latter type of “ethical” planner rather than the former, if you're working with one. If you're presently looking for a planner or will be in the future, remember to watch for any such “emotional appeals” as a possible cautionary flag.
Next, your financial planner will probably talk with you about your “risk tolerance” and your “suitability” to purchase risk-oriented, market-based products. In other words, they are sizing you up and, before they make their recommendations, they want to know just how close they can hold your feet to the fire (in terms of market draw-downs and losses) before you'll scream “Enough!”.
Planners and brokers mainly do this probing because their securities licensing (stocks, bonds, mutual funds, investments) requires them to “know their customer”, at least in some sense. To satisfy the regulatory compliance departments at their FINRA-registered firms they must be able to provide verification that they have made an effort to “know” you and to ascertain how comfortable and well-suited you are to risking or even losing your money in volatile markets.
“Contrary to Wall Street folklore and, therefore, popular belief, high risk is not what determines a high rate of return. The fact is, some of the highest rates of return can be made with little risk at all. Strategy is what makes all the difference.”
- David
We will always hear financial planners mention the “risk-reward ratio”. In fact, they seem to live and breathe by it. I've included a diagram (below) for you to see what the risk-reward relationship supposedly looks like. Planners and brokers always assume and, therefore, teach you to assume, that you must increase your risk exposure if you hope to increase the rate of return you can potentially receive on your investments. Knowledgeable investors and money-managers know that this is patently untrue.
Take a bank for example. They will make (in normal times anyway) a large number of secured, low risk loans known as portfolio loans. These are the loans they keep and service for themselves. What works for the banks is that the “flow of money” from the numerous streams of monthly repayments they receive enables them to turn the same money over and over many times , compounding their rate of return, while taking very little risk at all. In fact, they have virtually no risk because they are profiting from loaning your money and mine, not their own. This principle, in economic terms, is commonly known as the velocity of money multiplier effect . Banks are excellent risk managers (as I said, in normal times) and take mostly small and manageable risks, yet through broad diversification, they are able to build some of the largest financial institutions in the world. Could this mean they have a better strategy? Is there any reason you couldn't learn it and use it, too?
Some of you might object that banks are in a preferred or privileged position because they can get their money from you at a low interest cost (deposits) and loan it out at considerably higher rates, pocketing the “spread'. This isn't entirely true. The fact is: YOU CAN GET MONEY TO INVEST AT A COST SIMILAR TO A BANK'S COST IF YOU KNOW WHAT TO DO. You can learn to operate your financial affairs as if you were a bank and gain many of the same advantages banks seem to have in their investing and it's not hard to do. What's missing for most people is simply the knowledge of what to do and how to do it.
Looking at this diagram, obviously, a slot machine in Las Vegas or a roulette wheel in Monaco would be near the upper right-hand corner of the graph because these games offer a high immediate rate of return but an extremely low probability of a favorable outcome for you over time. At the opposite end of the scale, a silver dollar in your pocket would be near the lower left. It offers little risk of loss (with a minimum face value of $1) but pays no interest. It would only go up in value if its silver content increased in value and you sold it. Until then, it just sits there and does nothing.
But, just how far are you willing to push your luck in the risk-reward equation? Are you willing to risk your entire financial future with hopes of gaining a few extra percent each year? This is what your financial planner and your broker really want to know because, IF THEY CAN CONVINCE YOU THAT THEIR RECOMMENDATIONS WILL GENERATE CONSISTENTLY HIGH RATES OF RETURN, THEIR “FINANCIAL PLAN” WILL REQUIRE MUCH LESS LIFESTYLE SACRIFICE FROM YOU AND IT WILL BE MUCH EASIER TO SELL YOU, TOO. (Of course, if you work with them they will collect ongoing commissions and fees and you will assume all of the risks.)
Why do these “optimistic” assumptions make it far more likely that you'll work with that planner? First, you'll be impressed that “he must be a better planner” by offering you higher potential returns. Second, because assuming high annual rates-of-return on your investments would mean you wouldn't have to save as much from your current income, you could consume more each year, enjoy life more now, drive a fancier car and live in a nicer home, take fancy vacations, and still expect to have a plump nest-egg to support you in style throughout your golden years. By extending this faulty logic to the extreme, wouldn't just one large jackpot at the casino completely supplant the need to ever save, invest, or plan for anything ever again? Of course IT COULD but few of us would likely go that far because our good sense kicks in and tells us it's unrealistic. But we seldom apply this same precautionary logic to the high expectations given to us by Wall Street until it's too late. In a zero-sum game like the markets, if you lose, guess who wins?
“When was the last time you saw either a planner's or a broker's commission or a money-management fee waived or returned due to poor performance or a down market? If you said “never”, you're on the right track. They just blame “the market” and move on with or without you and your money.”
- David
In my view, the financial planning industry's risk-orientation and the fixation on achieving unrealistically high long-term market-derived returns is the major contributor to today's lack of savings. This lack of a savings “ethic” has literally taken the legs out from under our economy and our country. In years past, Americans used to diligently save, mostly keeping their money in banks and U.S. savings bonds. Today they “invest” with only the hope that a high rate of return will make up for habitually saving far too little. Hope is never a good strategy, as many are painfully learning in today's economic downturn. This preoccupation with aggressive investing and the possibility (notice I didn't say probability) of achieving high returns has, sadly, become the centerpiece for financial planners and the entire planning industry.
“The American people, driven by powerful marketing messages and an innate sense of hope and optimism, have substituted a gambler's mentality for the savings ethic of their forebears. Wall Street interests, the financial media they dominate, and the financial planning industry at-large have worked tirelessly together to create this mindset and our country suffers because of it. They have forgotten the important lessons of the fable of the tortoise and the hare that even most children know. That's precisely why we are, as a nation, where we are today.”
- David
Okay, so now that your financial planner “knows you” and understands your risk appetite, it's time to develop the numbers you'll need to “plug in” and design your plan! This is where it gets REALLY dodgy. There's so much change to envision and plan for! So many variables! So many guesses and assumptions that must be made! So many projections, inter-relationships, and moving parts! It's enough to make your head spin.
Your planner will now either ask you to provide - or maybe provide for you - predictions for such things as:
- What will your income be from your work/business?
- What will your federal income tax rate be? (%)
- What will your state income tax rate be? (%)
- Will these rates go up or down in the future?
- How many promotions will you get and when?
- What will your income growth rate be? (%)
- What percentage of your income will you save?
- Do you think this percentage ever change?
- If so, when and how much?
- What savings vehicles will you use?
- What rate of return would you expect?
- Will you make other investments?
- If so, what “blend” will you select and…
- How much will you allocate to each segment?
- What type and what rate of return will you get? (%)
- What % is interest, short-term, long-term capital gain?
- Will you contribute to a pre-tax (IRA, 401k) account?
- If so, how much of your pay will you put in?
- Will your employer make a matching contribution?
- If so, how much? (%)
- What will your living and lifestyle expenses be?
- At what rate will your expenses go up? (%)
- Do you anticipate inflation in the future?
- If so, what rate? (%)
- What is your annual budget for gifts?
- What is your annual budget for vacations?
- Will your lifestyle increase with your income?
- If you borrow, what loan interest rate will you pay? (%)
- Will you take advantage of new technologies?
- If so, how much would you budget for them?
- How many cars will you own?
- Will you drive new or used cars?
- How much will these cars cost?
- How frequently will you replace them?
- How much will they go up in price? (%)
- Will you buy cars for your children?
- Will you own your home?
- If so, how much will you pay for it?
- How much of a down payment will you make?
- Will you use a 15 or a 30 year mortgage?
- Will you pay your mortgage off early?
- If so, how much extra will you pay each month?
- How often will you move?
- Will you want to own a second home?
- How much will your homes appreciate in value (%)
- Will you have children?
- If so, how many?
- Will your children attend private schools or public?
- Will your children attend college?
- If so, public or private schools?
- What will college costs be at that time?
- How fast will those costs go up? (%)
- Will your children get loans or a scholarship?
- How many years will your child attend?
- Masters? Law School? Med School? PhD?
- Will your child work and help pay?
- At what age will your children leave home?
- Do you plan on paying for your children's weddings?
- If so, how much would you plan to spend?
- If you're still alive, at what age will you retire?
- What will inflation do between now and then?
- What income will you “need” to retire upon?
- Will you take Social Security at 62? 65? 66? 67? 70?
- Will Social Security BE THERE for you?
- Will your home be paid for then?
- Do you intend to sell your home and downsize?
- Where will you retire to?
- Will it be more or less costly than where you live now?
- Will your spouse retire when you do?
- Will either of you work part-time?
- If so, how much could you expect to make?
- Will your lifestyle be more frugal after you retire?
- Will you travel? Golf? Boat? Fish? Ski? Gamble?
- Will your investment allocation change when you retire?
- What rate of return will you receive if you do?
- How much of your investments will you draw?
- Which accounts will you draw from first?
- What will interest rates do?
- What will the stock markets do?
- What will the bond markets do?
- Will your tax bracket be higher or lower then?
- How long will you live?
- How about your spouse?
- Will either of you need living assistance?
I know I may have embellished the questioning a little bit but my point is the same - these are all the kinds of micro-economic considerations that are wholly unknown and unknowable and yet a critically important “life's plan” is about to be made based upon them. The most baffling part may be that the entire financial planning industry is built upon these same shifting sands and still considers itself a “profession”.
THEN FINALLY, YOU'LL BE ASKED THE GOLDEN QUESTION:
Given these assumptions, how much money do you think you might need to begin saving and investing TODAY and at what rate-of-return must you invest it, in order to increase your likelihood of accomplishing all of your needs, goals, and objectives? This will help us determine a proper allocation to the various asset classes available to us.
Obviously, you don't know, your head is spinning, and this overwhelming sense of GNAWING UNCERTAINTY is precisely why you consulted a planner for help in the first place. And now it's all back in your court? This seems so unfair! At this painfully awkward moment your “planner” will have no option but to turn to you, politely smile, and say “Don't worry, this is where I can really help you. This is why you need a financial plan. And, now that we've determined all your needs and assumptions, we're ready to enter this data into my trusty computer and LET IT CALCULATE YOUR FINANCIAL PLAN.”
The planner then hits “print” and out flows nearly a ream of 24 pound paper filled with WHOLLY IRRELEVANT BUT ATTRACTIVELY LAID OUT AND COLORFUL charts, graphs, and tables with copious columns of numbers. A cursory scan through the pile reveals that most of the columns trend ever optimistically upward into the future. So, it all looks very good. Little to worry about here!
Or is there?
CONSTANT CHANGE IS THE ONLY RELIABLE VARIABLE IN ALL PLANS
Here's the overarching problem: Everything in this “plan” is likely to be dead-flat-wrong, perhaps even by the day after you so proudly took it home and tucked it neatly in your bottom desk drawer under the stapler, the packing tape, and the old Windows 98 diskettes you still have. Markets change, assumptions change, taxes change, people change.
Financial plans shoot at moving yet unknowable targets. And the more perceptive reader already understands that this type of “plan” is not only irrelevant, inaccurate, and misleading but it has no bearing on the truth, no real relationship to anyone's future and, therefore, is seldom worth the paper it's printed on. I pity people who actually pay for these things! At best this plan is a distraction and, at worst it is dangerous to your future by giving you the false hope that, “since you've planned, you'll be fine”. This is hogwash. Little or nothing in this plan will work out the way it was imagined or predicted and, therefore, it is a dangerous exercise in futility.
“Back to my architect example: “Financial Planning” would be just like an architect designing and building a multi-story, multi-generational structure that must be safe and beautiful and last a hundred, or so, years using ONLY materials that have yet to be produced, tried, proven, or even invented. And yet, he'll recommend that you begin building TOMORROW using much of YOUR savings, all of YOUR investments, and much of YOUR future earnings. Would you hire such an architect or walk away?”
- David.
So how do we resolve this formidable problem of working with unknown and unknowable future variables with hopes of building the best possible future for ourselves? It's really quite simple. First, we must never break the cardinal rule of investing which is “NEVER LOSE YOUR PRINCIPAL”. Ask yourself, isn't this rule subject to immediate threat by virtually every financial planner you're likely to ever meet?
Next, we must find a system or a financial strategy that is known to work under any circumstances. One such strategy is The LEAP System that was first developed by Mr. Robert Castiglione back in the 1970's. LEAP stands for “lifetime economic acceleration process” and LEAP is a process that works by applying macro-economic strategies to problems that are generally approached micro-economically via financial planning. The two approaches are vastly different and the “big picture” macro-economic approach will win every time. There are other approaches that have been popularized such as Don Blanton's Circle of Wealth. Don Blanton was a former practitioner of LEAP so you might imagine there would be some similarities. My opinion is that LEAP goes further and is much more comprehensive.
Another approach, even less comprehensive than the Circle of Wealth, is Nelson Nash's “Infinite Banking Concept”. I write about the Infinite Banking Concept in other sections of this site for those who are interested but I haven't had time to add much content yet. Infinite Banking solves a number of the most serious problems of financial planning but it cannot take you as far as The LEAP System can. Being quite familiar with each of the three I mentioned, LEAP is the most comprehensive system of all.
The Goal: MAXIMUM LIFETIME POTENTIAL
To reach our fullest financial potential in life we must first invest in ourselves and continue to maximize our knowledge and earning potential. Then we must pursue strategies that are known to MAXIMIZE each and every one of the following at all times:
- PROTECTION AGAINST RISKS
- Safety (critically important)
- Savings (systematic and ongoing)
- Cost Avoidance (not the same as miserly)
- Cost Recoveries (only smart people understand this)
- Efficiencies (accelerate growth with less risk)
- Velocities (the number of uses of each dollar)
- Tax benefits (not just the ones your accountant teaches)
Furthermore, our strategy must be proven to MINIMIZE:
- EXPOSURE TO EVERY KNOWN RISK
- Certain debts (though not all)
- Expenses (not necessarily lifestyle)
- Hidden costs (they are many and substantial)
- Inefficiencies (literally devour your money)
- Taxes & Fees (impact beyond a lifetime)
- Wealth transfers (few really understand them)
Obviously, I can't go into detail in this article. But let it suffice to say that if you learn to properly avoid and manage risks, eliminate destructive debt, and carefully manage costs (both direct and indirect) while making your savings and investments perform for you in an efficient manner, you will never have to worry about money or even planning for your future. You will be living your “maximization plan” and your financial future will be taking care of itself - as if on autopilot - as long as you “live” the correct strategy.
The strategy I am describing is a certain “body of knowledge” that must be studied, learned, and carefully implemented into your lifestyle if you hope to achieve your maximal wealth potential. The good news is that it can be learned and implemented at any age. It is seldom too late to make substantial improvements given an open mind, some financial resources, and the proper guidance.
Knowing the techniques that enable you to LIVE YOUR LIFE IN PURSUIT OF YOUR MAXIMUM POTENTIAL makes financial planning unnecessary. If the truth were known, traditional financial planning as it's currently practiced is actually a hindrance to your ultimate success. There's no sense in guessing about the future. There's no need to subject your money to dangerous and unnecessarily high levels of risk in pursuit of high returns that may suddenly become disastrous losses from which you may never fully recover. There's no reason to surrender your future to forces you cannot predict or control. What's best is to have the right system in place to systematically generate meaningful wealth and enable you to do it safely.
If you have questions or would like to learn more about this type of wealth-creation and protection system, which is the core of my consulting practice, please feel free to contact me.
For more interesting articles and commentary please visit: http://www.haasfinancial.com
By David Haas
Consultant
In my consulting practice, I work with individuals, business owners, and professionals. I assist business owners and professionals in several critical areas ranging from business start-up, marketing, operational challenges, employee retention, and strategic planning to personal asset protection, financial, and retirement income planning. Often, these areas relate and need to be integrated to work most effectively. I also assist business owners in developing exit-strategies that enable them to maximize the value of their business interests and preserve their lifestyle in retirement. For individuals, I primarily focus on tax reduction, financial, and retirement income planning.
© 2008 David Haas, Consultant
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