The world of financial planning and wealth management has been heavily impacted by technology. The advent of mobile devices and cloud computing has ushered a more scientific and mathematical approach to financial planning. This is now within the reach of
not only large firms, but also smaller independent advisors. This is also now within the reach of the end consumer, either directly or through their wealth manager or advisor.
So how does the Finance Industry currently do Financial Planning?
- Goals Based. This is where you are saving up for the “holiday of a lifetime”
- Cash Flow Forecasting – This is giving you a tool that says in order to get £70,000 when you retire you need to save £200 per month.
In trying to predict the future some tools just use a mathematical formula that arrives at a number, and some use probability theory to predict a range of outcomes.
In the world of technology, it is hard to know good from bad. But the consequences for both the client and their advisor (or wealth management firm) of choosing the wrong approach can be disastrous.
This is why, up until now, it has proven difficult to formulate a model or algorithm that safely predicts the future of stock markets, interest rates and inflation. What is also usually overlooked is that we are all individuals with different chances of
living a long life. We also have to now plan for a slow ignominious decent into the world of either dementia or long term care when we get old. And none of us know when we are going to die.
So to model for changing economic environments, changes in longevity, as well as how well your investments are going to do is tricky, but not impossible. I am working with a product called Envizage whose methodology has been used to manage over a trillion
dollars of wealth, and has the answer to this tricky issue.
If we can replace the dangerous tools that are out there, that only consider a small part of the picture and thereby distort the big picture, we will be well on the way to a number of things:
- “Goals” vs “Outcomes”
In Envizage, outcomes are much more human and realistic. They can include things like taking a sabbatical, having children, making partner, etc.
Each outcome in Envizage has its own inflation characteristic through time, its own funding sources and methods, and its own definition of success or achievement. For example, “Success” for retirement means not running out of money while you are still alive.
- Interconnectivity of goals
In Envizage, each outcome impacts all others, just like in the real world. So each outcome in itself is a “lever” that the household can adjust to make all other outcomes more achievable.
This, of course, is how life works in practice.
- Risk in terms of “Outcomes Risk” vs “Portfolio Risk”
In Envizage, we define “risk” in terms of a user being unable to achieve their desired future outcomes. That’s bad. But in order to reduce the risk of not achieving a desired future outcome such as Retirement (as defined above), the household may actually need
to increase the risk it takes in its retirement portfolio, perhaps moving away from cash and bonds and towards equities.
This is particularly relevant when considering the prospect of longevity, which of course we do model. If at age 75 you are in a portfolio with over 50% bonds and cash, when you are quite likely to live another 20 years, that portfolio (which is low risk) may
actually contribute to a higher risk of a bad outcome - in this case, running out of money before you die.
- Modelling of all types of risk factors
In Envizage, we consider the impact of actuarial life events - longevity, mortality, illness, disability, long-term care, and more - on the household’s desired future outcomes. We model the likelihood of a household having one or more of these events happen
to it, and the impact (if selected) of insurance or protection against these life events.
Why is this important? Solving for a long-term plan that either ignores the impact of these life events or considers them to be yet another “pot of money”-style goal for the future is quite likely to result in bad outcomes for the client and consequently for
the advisor and their firm. On the other hand, offering these solutions on the basis of “What if if you die” or “What if you become ill” is unlikely to appeal to most consumers today. Our is a more intelligent and realistic approach.
- Broad solutions in terms of Protection, Borrowing and Lifestyle choices
In Envizage, the solution to help a household go from low likelihoods of achieving their future outcomes to a better picture may well include savings and investments. But it could very likely also include an element of insurance, borrowing or other practical
lifestyle choices and tradeoffs that the household may wish to consider. All in all, this is a more engaging way of serving the customer across the spectrum of product solutions: savings/investments, borrowing, and protection.
I believe that approaching Financial Planning in this way will be the future- Future Planning if you like. All the Financial Authorities are going to be testing outcomes not process in the future. All Consumers are going to want to engage with Financial
Firms that help solve an issue, not sell a product- You all know who you are!
This is the future, and it is here now.
HMU – I believe is what the hipsters say!.