Financial planning, when done properly, can be a valuable process to consumers. So say yes to the process of financial planning. However, when it comes to financial plans, avoid the inherent issues of “black box” financial planning and “canned” financial plans by performing a quality check using certain guidelines.

Various financial planning firms offer financial planning/retirement planning/asset allocation plans (hereinafter “financial plan(s)”). The price typically ranges from a couple of hundred dollars to thousands of dollars. What the public is not told and does not realize is that the quality of such plans may vary significantly. At best, such plans are a simple snapshot of a client’s situation at that particular time. At worst, they can mislead a client and cause serious financial.

Technically speaking, the quality of such plans depends on the accuracy of the assumptions and other data entered into the software program used to produce a plan. Most of such programs are highly unstable, where slight errors can produce significant errors. As William Jahnke has stated, “the instability of the return-generating process rips the theoretical guts out of the practice of static asset allocation.”¹ Furthermore, many of these programs are based upon Microsoft Excel, which was never intended to handle the numerous interrelated calculations used by most financial planning softwar

When I am asked to review a financial plan, the first thing I do is review the data and assumptions that were used in preparing the plan. The second thing I do is to reverse engineer the complete plan to see where errors were made in the calculations and/or advice provided by he plan. After thirty years of dealing with financial planning quality of advice issues, most errors that clients would miss are readily apparent and easy to discern to me.

Financial plans assume a constant rate of growth for investments. This simply does not portray reality. Historically, the stock market suffers one down year for every two positive years. Losses suffered during bear markets such as the 2000-2002 and 2008 definitely one’s financial  situatio

Financial plans use either past performance or projected performance, or “guesstimates,” of investments to prepare the financial plan. The problem with past performance data is that, as the required disclosure for investments states, “past performance is no guarantee or future returns.”  The problem with projected performance, or “guesstimates,” is that they are just that, guesstimates, which can be easily manipulated to convince clients to make decisions that benefit the party that prepared the financial plan more than the best interests of the client.

An investor should always ask the planner who prepared the plan to provide the investor with all the data and assumptions that were used in preparing the plan. One common scenario we see is the choice of the assumptions to ensure that certain investment purchases are mad

One common example of this involves small cap investments. Most people have portfolios that are heavily invested in large cap, blue chip stocks. One reason for this scenario is that blue chip stocks are often stocks that people are familiar with (e.g., AT&T, Coke, McDonald’s). Since most financial planning software favors investments with certain characteristics (e.g., high returns and low risk/standard deviation), a planner can ensure that the plan recommends such products by using assumptions meeting such criteria.  So, if a planner wants to ensure that purchases of small cap products are recommended to produce commissions for the planner, they can manipulate the data to ensure such results without the investor suspecting anything.

Another common scenario I encounter is where the planner blindly relies purely on the financial planning software’s output and lacks the knowledge and or experience to identify software mistakes or poor advice. a situation commonly referred to as “black box” financial planning. As Harold Evensky, one of the nation’s most skilled and respected financial planners has opined,

One of the most frequent criticism of wealth manager optimization is the use of a complex computer program, frequently referred to as a black box. This pejorative description suggests that the wealth manager is implementing an asset allocation policy without understanding how the allocations were determined. The presumption is that the black box, not the wealth manager, is making the decision. Unfortunately, this is often a valid criticism.²

As usual, Mr. Evensky is right on point. Whenever I question planners about the quality of their plans and the advice provided, more often than not the first response is the “deer in the headlights” look, followed with an admission of simply following whatever the software produced and/or a meritless, legally insufficient explanation based on inaccurate interpretations of financial theories such as Modern Portfolio Theory. The quality of advice issues with regard to some financial plans is so bad that Nobel laureate Dr. William F. Sharpe has deemed the situation to be “financial planning in fantasyland.”³

What investors need to understand is that proper financial planning involves more than a financial plan. Proper financial planning is a process, an ongoing process, not a product. CFP® professionals are taught a specific process that includes

(1) determining your current financial situation
(2) developing financial goals
(3) identifying alternative courses of action
(4) evaluating alternatives
(5) creating and implementing a financial action plan, and
(6) reevaluating and revising the plan.

Given the limitations and issues inherent in “canned”, cookie-cutter, financial plans, more and more true financial planners are foregoing the formal financial plan in some cases and focusing more on an effective financial planning process using a modular financial planning process. Given the need to reevaluate and revise the plan as needed, this puts the focus on the client’s best interests and allows the planner and client to focus on building a meaningful and trusting relationship.

If you are a client who has already had a financial plan prepared, I issue the same challenge to you that I make in my wealth preservation challenges. Review the various spreadsheets and check the accuracy of the calculations of the first ten rows on the spreadsheet. Unfortunately, the other forms of deception used in connection with financial plans are often subtle and difficult for the public to detect without the help of someone experienced in such matters.

For what it’s worth, whenever I point out the calculation errors in a financial plan, the planner and his company often respond by saying that they were simply calculating future value, so the last line of the spreadsheet only needs to be correct. When I ask if the customer, who paid for the plan, was informed that the planner knew that most of the numbers were wrong and were simply to fool the customer into thinking a lot of work went into the plan, I usually get more blank stares.

Likewise, when I ask whether the customer was informed of whether past performance or “guesstimates” were used in making the asset allocation recommendations, as well as the inherent issues with either approach, I often get more blank stares or a defense that the plan disclaimed liability the contents of the plan. So the planner asked the customer to pay for the plan, then basically added a disclaimer to the effect that the planner and his company were not liable for the quality of advice provided within the plan . So much for developing a relationship of trust. Your honor, the prosecution rests

So, once again, financial planning, when done properly, can be a valuable process to consumers. As a CFP® professional for over 33 years, I am proud of our commitment to providing consumers with quality advice and our efforts to protect the public. Unfortunately, others holding themselves out as being “financial planners and/or providing “financial planning services” do not share that same commitment, with “financial planner” simply being seen as a marketing tool for selling questionable investment and/or insurance products.

So again, say yes to the lifelong, ongoing process of financial planning. However, when it comes to financial plans, understand the inherent issues and perform a quality check using the guidelines discussed herein.

Notes
1. Gary Marks, “Rocking Wall Street: Four Powerful Strategies That Will Shake Up The Way You Invest, Build Your Wealth, and Give You Your Life Back,” John Wiley & Sons, Hoboken, NJ (2007): 159-160
2. William Jahke, “Getting a Grip,” Journal of Financial Planning, April 2002, 28-30.
3. Harold Evensky, Stephen M. Horan, and Thomas R. Robinson, “The New Wealth Management: The Financial Advisor’s Guide to Managing and Investing Client Assets,” John Wiley and Sons, Hoboken, NJ (2011): 187
4. William F. Sharpe, “Financial Planning in Fantasyland,” available online at http://www.stanford.edu/~wfsharpe/art/fantasy/fantasy.htm

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This article is neither designed nor intended to provide legal, investment, or other professional advice since such advice always requires consideration of individual circumstances. If legal, investment, or other professional assistance is needed, the services of an attorney or other professional advisor should be sought.