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Putting planning into context

Bob Freeman, chief operating officer of Voyant UK, looks at how cashflow and stochastic models can be used to make a financial plan more meaningful for clients

The Regulator’s pronouncements on suitability and risk profiling brought into focus the way in which advisers assume and project future investment growth and, just as important, how it is presented to clients.

First, it is worth reiterating the point that all of the FSA pronouncements fit the RDR’s prevailing theme of client-centricity: the absolute, immutable requirement to place the client and the client’s needs at the apex of the financial services triangle of provider, distributor/adviser and client. In the advice world, paternalism, that led from simplistic and crude assessment of client needs and suitability to complex, expensive and opaque products, is dead; the future is informed consent which should lead us from a robust and rigorous analysis of needs, goals and suitability to clear, simple, transparent products.

However, ‘informed consent’ is easy to say but considerably more difficult to achieve and demonstrate. Products may be simple and transparent but investment concepts are complex and there is still scope for the client to feel confused or misled, even if unintentionally, rather than to be informed, educated and engaged.

Stochastic or probabilistic modelling illustrates this powerfully. The use of stochastic modelling in retail financial services and advice burgeoned in the 2000s as a more robust and realistic way to illustrate future returns – and in particular, the range of potential future returns over time. The overriding problem is simply how the stochastic models are communicated by advisers and interpreted by clients.

For example, consider a Financial Planning Report from a few years ago using a stochastic model that concluded for the client that “there is a 68% chance that you will achieve your goals”. This is a little like saying to someone standing at a busy road intersection without pedestrian controls “you have a two thirds chance if you cross here that you’ll get to the other side; that’s pretty good so off you go!”

Also, what’s the definition of ‘goals’? Does failure simply mean one less trip each year to Las Vegas – or does it mean you will literally outlive your money and be unable to afford to feed and clothe yourself in your declining years?

The point is, of course, that what is really critical for the client is not the probability of meeting their goals but the implications of the lesser but still significant probability that they won’t. What does that actually mean to the client?

It may be unpalatable to the adviser who, even if not product centric, may still feel a vested interest in persuading the client to “do something”, but the key discussion in order to obtain informed consent has to be around the implications of the downside risk: what future goals or spending are placed at risk if things go pear-shaped? Shouldn’t we be securing at least enough income that is not exposed to investment risk to ensure we can meet our most basic needs? How are we protected against the twin risks of increased longevity (for most of us good news) and escalating care or nursing costs (for an increasing number of people seriously bad news)?

There’s also a concern in respect of how easy the average client finds it to interpret and draw informed conclusions based on percentage ‘probabilities’. Research suggests that most retail investors respond more positively to, say, a visual cashflow chart of incomes against expenditure than detailed and often complex textual explanations and/or a spreadsheet of figures.

Indeed, some form of cashflow would seem to be essential to any attempt to project future investment growth, whether stochastic or based more simply on deterministic percentage growth rates. Quite simply, cashflow enables the adviser and client to place the growth assumptions – and critically, risk profiles and capacity for loss – in the context of the client’s articulated future financial goals, needs, aspirations, fears and to explore the impact of different planning scenarios and contingencies.

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