“I’m convinced that before the year 2000 is over, the first child will have been born on the moon.” –Wernher von Braum (1912 –1977) German Rocket Scientist
Predicting the future is difficult, if not impossible, especially when one selects a specific time in the future for that event to happen. I have observed over the years that the public seems to think that successful financial advisors have the ability to predict the future and structure financial plans and investments to take advantage of their predictions. Nothing could be further from the truth.
What is it then that makes financial advisors successful in the eyes of a client?
It’s not the ability to predict the future, but instead, to prepare clients for the certainty of the known unknowns – or the probability of an occurrence whose timing cannot be anticipated. A successful financial advisor knows what he or she does not know with any degree of certainty and uses that skill to prepare clients for the certainty of uncertainty.
How do they do this?
A really good financial planner will transform ones anxiety about the future into strategy, progress, and the achievement of goals. They start by getting to know everything about you, your family, your finances, your goals, risk exposures and your tolerance for risk. Then they employ their skills, knowledge and experience to develop a collaborative plan for you and your family.
They start with a review of the basics such as:
- A proper emergency fund
- Life insurance coverage
- Disability insurance coverage
- Medical Insurance coverage
- Auto, homeowners and excess liability coverage
- Long term care insurance
- Income and Expenses
- Assets and Liabilities
These are important basics because they can have catastrophic financial outcomes if you don’t have them or don’t have the proper amounts of coverage should an event occur.
Next the advisor will take a look at current cash flows and estimate what they might look like in the future. For example:
- Analysis of expenses now and during retirement
- Your tax situation, now and in retirement
- Review of capital gains now and in retirement
At this point the advisor is completing his or her picture of your current situation and what it might look like in the future. For example:
- Calculating required retirement accumulations
- Calculating required education funding requirements
- Calculating the required funding for other goals
- Estimating what your estate might look like and it’s tax consequences
Notice that through all of this the advisor is not predicting the future. The advisor is making estimates that are based on documented historical averages for things like inflation, return on investments, and cost of living increases. In addition, the advisor is developing portfolios to meet the client’s goals, time horizon, risk tolerance, and tax situation.
At this point the advisor has still not discussed the known unknowns with the client; that’s next.
The Known Unknowns
Getting to the known unknowns is where technology, experience and wisdom come together. Today, we have the technology to run Monte Carlo Analysis which calculates the probability of success to help show the client different scenarios for how their recommended portfolio(s) will hold up under various conditions.
We can start with an average return scenario based on historical return data for the components of the portfolio. An experienced advisor knows that an average return of seven percent for a moderate risk portfolio will not happen every year. Therefore, we want to run worst case, best case, and bad timing (two really bad years of returns right after retirement) scenarios.
This helps the client visualize what can happen and aid the client in making decisions about their future. Under the average return scenario, the client might be fully funded, but under the worst case scenario the client will most likely have a shortfall. The client can then decide to add additional funds to their savings, possibly work longer, or a combination of both, to get the portfolio back to a fully funded position under a worst case scenario. They may also decide to add additional funds and/or work longer when faced with the bad timing scenario, which will require less sacrifice but continues to improve the outcome.
Finally, experience and wisdom come into play. An experienced advisor will have the wisdom gained from surprises and failures along the way. Here are some examples:
Examples of Known Unknowns
- The daughter of a client gets married. Over the years she and her husband have three children. One day the daughter announces that she and her husband are getting divorced and that she is moving in with our now retired clients until she can get a job and get back on her own feet financially. We have seen this one frequently.
- A 53-year-old bachelor son with no meaningful savings just lost his job and is moving in with his recently retired parents. This does not occur as frequently as the example above.
- Grandma lives alone and has been diagnosed with Alzheimer’s disease. She can’t afford live-in help to care for her. This scenario occurs frequently.
These are known unknowns that are probable. How do you handle the probable known unknowns? In this case, having your retirement portfolio fully funded under the bad timing and perhaps worst case scenarios allows for a cushion to help you to take care of the known unknowns, should they occur, so you can continue to live the life you planned for retirement. If these additional resources are not needed, then you will have an estate to leave to your loved ones so that they will have a leg up on their retirement funding.
Successful financial advisors help position their clients to weather the unknown disasters, health issues, Boomerang children (examples 1 and 2 above), aging parents as well as personal aging issues. They do all of this by preparing their clients for the certainty of uncertainty, without predicting the future, while developing an authentic relationship with the client and their family along the way.
If you would like to discuss your financial future with a Senior Wealth Advisor at R.W. Rogé & Company, Inc., please call 631-218-0077, or visit our Web site at www.rwroge.com.