Cashflow modelling is no longer an option
Think you can practice financial planning without using cashflow modelling – think again, says Brett Davidson, chief executive, FP Advance
At the heart of the advisory process there has to be a cashflow model otherwise you are short changing yourself, your business and the client.
I realise that a cashflow model won’t get used for some clients but this should be the exception, not the rule. How else will you and the client know if your strategies and recommendations will allow them to live happily ever after and not run out of cash?
I’ve had this discussion many times over the years with various advisers. There are a number of erroneous arguments that advisers make when it comes to the use of cashflow models, which I would like to knock on the head right here:
1. They are wrong – so I don’t use them
There is a view that no matter how precise you try to be in building a cashflow model that it is always wrong. That’s true, but it doesn’t mean you shouldn’t build one.
Building no model won’t be wrong, but it won’t be any help whatsoever in painting at least some sort of a picture of the future that both you and the client need if you are going to make better decisions.
In fact, one of the main benefits of working with cashflow models when you first start is being able to play with (model) a few different scenarios.
For example, what would happen if the client retired three years later? Or if they just spent £2,000 less per year in retirement? What happens if they gift that £50,000 to their daughter and son-in-law; will they still have enough money for themselves later in life?
It is only after you have modelled these sorts of scenarios multiple times for a wide variety of clients that you get a feel for what the implications of a decision might be without having to build a model, but you have to go through the process first before you acquire that rule of thumb knowledge.
It can also be the assumptions that underpin the model that advisers worry about. Do I assume inflation is 2% or 5% pa? What about earnings rates on investments and pensions? These are decisions to agonise over a little bit and whatever you choose they will be incorrect, but as long as you are making assumptions that you believe are reasonable today, you can always adjust them year to year as you move forward with the client. This is not a one-off piece of work. Each year you can update the model with actual investment performance and make some revised assumptions for everything else based on more information. Whatever the shortcomings, this has got to be better than no model whatsoever.
2. My clients won’t run out of money so I don’t need to use a model
I’ve worked with firms that have a large number of clients who are still lucky enough to be in good defined benefit pension schemes. The view from some of the advisers in these firms is that they don’t need to prepare a cashflow model because the client isn’t going to run out of money – their pension provides the bulk of their income and will keep paying until they die.
Once again, they’re right but I would still recommend using cashflow models as part of their advice process.
For experienced advisers it might be perfectly obvious that the client will never run out of money, but for the clients’ themselves viewing a cashflow model has some major benefits. Typically, although the defined benefit pension is a major portion of their retirement income, it is not 100% of it.
Therefore, there is a floating and variable portion of their income generated from their assets and investments.
These people still face the same decisions and have the same concerns as any other clients:
• How much can I afford to spend in retirement?
• Should I consult a little on the side for the first few years of semi-retirement to generate some extra income?
• How much can I afford to loan or gift to my children and grandchildren to help them?
• Will I need to downsize my main property to live well in retirement?
• How much can I afford to spend on a new home?
• If I take that world trip, how much can I afford to spend on it safely?
These and many other questions are best answered by showing people the implications of the various actions they may choose to take. This is a much more engaging and empowering process than simply telling people they can do this or that. Rightly or wrongly it inspires more confidence in the client when they can see that a detailed financial model has been created (despite its shortcomings). Providing those feelings of confidence is a key part of the value added you deliver to your clients.
3. They are too complicated
There is a view in some quarters that the better versions of cashflow modelling tools are too complicated. The underlying sentiment behind this is really “I can’t use them”.
So get some training or get someone in your office (a paraplanner or other adviser) to get up to speed to assist you. You don’t have to be the expert on using this stuff.
The ability to model complex scenarios is one of the main benefits of using a more sophisticated version of these tools.
4. In the wrong hands they are a dangerous tool
Some advisers are concerned that in the wrong hands cashflow models are a dangerous tool, as they could end up showing incorrect outcomes if errors are made in the model and not picked up, or some crazy assumptions are used. There is also the worry that unscrupulous advisers might create models that support their preferred recommendation – to make the sale rather than provide best advice.
Once again these are valid issues, although not a good enough reason to refrain from using a cashflow model.
If these concerns are about other firms besides yours then let them worry about that stuff – you can just do your great job for your clients. However, if the concerns relate to some of the advisers within your business then surely it is an education and training issue to be addressed. The benefits of having this tool sitting at the heart of your business outweigh the effort and costs required to get started. So if you haven’t already, get into cashflow modelling.
For more information on FPAdvance go to: www.fpadvance.com