A financial plan is the sum of its parts
I hope everyone enjoyed Thanksgiving as much as our family did. Good food, friendly banter and sighs of satisfaction were prevalent throughout the day. As we gathered at the table, conversation meandered from turkey and trimmings to topics related to the stock market. The two most posed questions were: What happens when the market turns? How can financial planning can get you through the next market cycle? I suspect many of you are making similar queries. Countless investors and potential investors probably have been focused on the recent performance of the stock market. Although this needs to be considered, it is far more important to review your personal financial plan. If properly prepared, it incorporates short-term investment fluctuations.
A financial plan should serve as a road map or blueprint to your future. There are several components that make a plan a successful one. Investment planning is an important part of any sound financial program. However, the key word here is part. A financial plan has many parts, and without all these pieces working together as a well-coordinated aggregate, it may not perform as well as you anticipated, or it could even fail.
Among other vitally essential parts of a sound financial plan are insurance analysis, estate planning, education planning, retirement projections, stress testing, cash flow analysis and income tax planning. In short, a financial plan should look at all aspects of your financial situa-
tion. Think of it as a wheel composed of a hub, axle, rim and disc. Without all these elements working together, the wheel will not turn. You won’t reach your destination. Nor will you achieve the financial goals of your hopes if the plan is missing one or more of its parts.
As we did on Thanksgiving, quite a few of us frequently discuss the health and condition of the stock market, the economy and — yes — sometimes politics with friends and family members. These conversions should go beyond supposition when you talk to a financial advisor about the markets. In those meetings, topics should be tantamount to their impact on your financial plan. That is because no one component of a financial plan is bigger than the other. They work together to help you through life’s journey.
This sounds good in theory, you may ponder. But, how does it work in real life? We are aware markets do not go up every year, but long-term performance tends to average out investment results. By focusing on your long-term goals, rather than shortterm noise in the markets, or on the news, you can shift priorities to what matters most. This probably amounts to: When can I retire? How long will my money last? Can we afford our dreamhouse? My son just got into Harvard, can we afford it?
A well-designed financial plan can help to answer these questions. However, the key discussion you should have with your financial planner is not the short-term performance of the stock market, but the assumptions and variables used to create your financial plan. Assumptions such as: investment returns; inflation; income and living expenses; future tax rates; major upcoming purchases; expected retirement date; pension and social security projections, to name a few. Since your financial plan will project many years into the future, considering conservative assumptions is critical.
Once the assumptions have been validated, your financial plan should stress test the results by applying Monte Carlo Analysis. Monte Carlo Analysis is financial planning software, which uses statistical modeling of various outcomes to generate success probability. It considers standard deviation, or the volatility in the market to calculate results. Generally, 1,000 Monte Carlo trials are simulated, and a simple percentage from zero to 100 percent is determined. It is pretty simple to understand, the higher the percentage, the rosier the outlook.
Monte Carlo Analysis can provide you with confidence about the strengths (or weaknesses) of your financial plan. It assists in establishing a long-term strategy and enables you to be in a monitoring position as your financial situation changes. It also helps in making very important decisions, and serves as a useful tool to discern whether you are on track, or if you need to make some adjustments. It is an instruction manual, which supports the achievement of your financial goals and objectives.
When you are concerned about the shortterm performance of your investment accounts, talk with your financial planner about the assumptions used within your specific plan. Chances are, market fluctuations have already been incorporated into the financial plan. Investment planning will always be one of the valuable parts of a complete financial program. But, as I stressed, investment planning is merely a single piece of the puzzle. I have never completed a puzzle that had only one piece.
For all the brilliant people in this world, nobody knows when the next 2008 is coming. What the new age dot.com bubble looks like. How bad the impact might be. Surely, everyone has an opinion, as did our Thanksgiving guests. You, too, probably have surmised an educated guess, but do you really want to hang your future on a conception? Instead think about what you can control, which is your financial plan and all its workable parts. Pete Hoover was destined to be a financial advisor. He has always been intrigued by numbers and money matters. They represent captivating puzzles to be analyzed, shaped and fit into place as pictures of financial solidarity. For nearly 40 years, Hoover has tackled those financial puzzles. In 2005, he launched Hoover Financial Advisors, located in Malvern. Hoover can be reached by emailing pete@ hfaplanning.