Evil Plans of the Assumer

I agree that any forecast is fraught with dangers and will almost certainly prove to be wrong, but I don't think you can avoid assumptions completely either.

For a well thought out and detailed paper on one approach to building the most appropriate capital market assumptions, your readers might enjoy this paper:

http://www.financeware.com/ruminations/WP_hunti...

The above paper is a follow up to an original 2003 paper which can be found here:

http://www.financeware.com/ruminations/WP_areyo...

Thanks Russ.
Yeah IF we are going to use assumptions we better be able to have
a rational explaination as to how we arrived at them.

But I do wonder what good they do...

Thoughts?

Why use projections at all IF they are nothing more than guesses?

Assumptions help us build a framework which we can use to make more informed decisions. Not perfect decisions; just more informed.

For example, your #1 point above to "save as much as you reasonably can" is good advice for everyone to abide by. But we only get once chance to live our lives the best way we can. What if we're so busy saving as much as we reasonably can that we wind up sacrificing things that are important to us along the way?

I've seen people (and some advisors) that operate on an absolute fear of the future. They save and invest out of fear -- not based on a rational plan.

Of course, the other extreme is just as dangerous -- there are many that live for today and are ignorant of their future needs.

I think the answer is to strike a good balance between being prepared for tomorrow (or 25 years from now) while being able to enjoy the fruits of your labor today. Assumptions play a role in helping find this balance.

Is it perfect? No, it isn't.

But until I find a better alternative, it's what I'm using for myself and with my clients.

I hope others will chime in on this important topic.

"Assumptions help us build a framework which we can use to make more informed decisions. Not perfect decisions; just more informed."

Very well said Russ.

Thanks Russ and Dylan!
I agree completely with:

"Assumptions help us build a framework which we can use to make more
informed decisions. Not perfect decisions; just more informed."

Am I wrong when I say that this is NOT the way must people experience
financial planning?

Your comments show that the important thing is the PLANNING and not the
PLAN, but I think many in our industry have the mistaken idea that the PLAN
is the product...

Right?

Wrong?

I know many folks experience financial planning as "if you let me manage your money, than all of this (refereeing to the plan) can be yours." I'm sure that in this case the assumptions do as much if not more for the assumer as the planning client, which can be very unfortunate for the client over time. But I'm not sure how much the scale tips to that side.

I've also come across many folks that call themselves planners who, despite paying lip-service to contrary, view their work product as the PLAN and not the PLANNING. I see this frequently evidenced in criticism of Monte Carlo simulation that attacks the PLAN itself not the process of PLANNING. If MCS (which relies heavily on assumptions) can help us make decisions that won't have to drastically be refined year-to-year, that's very useful, even the next 20 years don't unfold exactly as assumed (they probably won't). At least we are able to respond to that in small, manageable increments rather than just having to say, "oops, those assumptions were wrong."

I think there are a couple of BIG issues to consider here:

1. What are advisors and planners marketing and selling to clients?

2. What do clients think they're getting when they hire an advisor or planner?

I'm always skeptical of advisors that offer planning as a stand-alone service without any ongoing advice. This is usually (not always) a warning sign that they attach value to the plan itself and not the long-term delivery of advice that, when coupled with a prudent plan, offers tremendous value to a client and their family. I'm not critiquing one advisor business model vs another -- this is just something that makes a red flag go up in my mind.

And perhaps the larger problem is that there are literally dozens of ways to deliver financial advice and/or planning. Regardless of how an advisor refers to him or herself (planner, broker, advisor, agent, etc.) that does little to let a client know what to expect. Add in the Wall St. marketing machine that would lead you to believe your stockbroker is going to accompany you on beach vacations and speak at your daughter's wedding, and the waters become murkier still. Finally, with the Bernie Madoffs and other dishonest people tarnishing the good work that we do, it's an uphill battle to win the attention and trust of the very clients that need us most.

Over the last couple of years, I've continued to become more and more disenchanted with "financial planning" and traditional financial advice. I'm beginning to think of what I do as almost anti-financial advice. Trying to explain this to clients, however, just confuses them even more.

Regardless of the tactics used and maybe even regardless of overall strategy and philosophy, the most important part of planning is having a close, trusting relationship with someone that can empathize and truly put clients' interests first. This isn't about being a fiduciary or working for Merrill Lynch or being an independent fee-only RIA -- this about being able to look someone in the eye and tell them I'm going to look after their interests and well being in the same manner I would for my Mom.

Russ,

I agree that the perception/expectations associated with how planning is marketed is a key consideration.

However, I disagree with the idea that offering planning as a stand-alone service without ongoing advice should be a warning sign as you indicate. This happens to be my business model, and I have several colleagues that work this way as well.

Offering planning as a stand-alone service and the long-term delivery of advice are not mutually exclusive. In my case, most of my clients do not retain me for ongoing advice, but they can (and do) periodically initiate my services to review and update their plan, which I encourage them to do, with or without my help.

I believe you see a red flag because you may be assuming the advice or relationship ends with the delivery of a plan; that is usually not the case.

I also agree that trust is great, but I have encountered more trustworthy, ethical, and well-intentioned "financial [fill in your favorite title]s" that don't get what planning is really about, than I have that do get it. It's not that they're not bright people; it just that many haven't ever actually been exposed to what planning really is.

Dylan - I didn't mean to step on your toes. I know you get it, Sheryl Garrett gets it and the rest of the Garrett Planning Network get it. This if further evidenced by your email newsletters and the language on your website. Perhaps I shouldn't have made such a blanket statement . . .

However, despite the good work you do, I still see too many advisors that charge $2,000 - $5,000+ for a stand-alone plan without the ongoing follow up and availability to update things that you promote to your clients. If fact, I've encountered clients that worked with planners that charged them $5,000 to do a plan and if they wanted to update it 12-24 months later, they were told it would be another $5,000. That's not planning . . . that's ridiculous.

When I left Merrill, they were beginning to downplay their Financial Foundation "plan" even after upping the price from $250 to supposedly lend it more credibility. They were beginning to promote their Private Wealth Plan with was basically a 150 page NaviPlan analysis. They were charging $10,000 + for this, and trust me, it was merely a product -- it wasn't a true planning service. These were supposedly designed for the ultra-high-net worth types.

So despite the fact that you, Carl and myself are focused on the planning and not just the plan, my sense is that we're the exception and not the rule across our industry.

Thanks, Russ. There is certainly no shortage of one-time, plans for sale. And there are too many people that have come to believe putting together a $10,000, leather bound book with the client's name in it is what financial planning is about. We're trying to change that.

I like to say that any given PLAN becomes less-and-less accurate with the passage of time; However, PLANNING makes it more-and-more accurate over time.

I think the planning aspect has to be a relationship between a client and the adviser over a long period of time. The plan should evolve based on changes in peoples lives and circumstances. Portfolios get rebalanced, tax losses get taken etc etc. My dad is a financial adviser and this is the approach he takes with his clients. He's had most of them for a decade or more. So in summary, I agree that it's the planning, not the plan, that's important.

Adam-
Thanks for the perspective. My experience with clients that I have had for a
decade or longer is that most of our "planning" gets done on the back of an
napkin.

More than anything they are looking for assurance that the path they are on
is "reasonable". You can use sophisticated software to help put some
framework around "reasonable" but in the end I wonder if that is any better
then a NPV calculation on the back of napkin?

I agree that the focus should be on the things that we can control. But, it's those assumptions that can help define what is "reasonable" in "Save as much as you reasonably can." The assumptions do not have to be spot on. In fact, you should assume that they are not. But assumptions, when not used for evil, are what point us in the right direction. Over-saving (i.e. unnecessarily depriving yourself now) can be a considered a costly mistake too.

I did once see a financial plan that was prepared by a large insurance and financial company that contained "current" vs "proposed" plans. The plan presented a wonderful looking proposed plan build around the company's products while a current plan illustrated a catastrophic failure. Upon closer inspection, I noticed the proposed inflation assumption was half a percent lower than the current one. There were other differences, but the different inflation rates stood out.

Yeah, defining what is "reasonable" - striking the balance between living in the present and saving for the future - seems to me to be the Holy Grail. I think about this a lot. My fiancee and I are in our early 20's, we both have good incomes, and we are savers by our nature. We could easily live on $25k/year for the next few years, max out our Roth IRA's, and buy our first home with cash before we are even 30 years old. But then I wonder if that is really the best idea. You hear stories of people who sacrifice for years to retire early, only to lose their health or die before they can enjoy or see the fruits of their labor. Maybe we should take this time as newly-weds in our 20's, before being anchored down by kids, to travel and make the most of our good fortune?

You're asking a question of huge importance, Carl. I don't agree with your take. But just generating discussion on this topic is a significant advance.

I'll discuss safe withdrawal rates (SWRs) since you mention them in the blog entry and I have a lot of knowledge in this area.

The Old School SWR studies say that the SWR is always 4 percent (so those with $1 million on the day of retirement can safely withdraw an inflation-adjusted $40,000 each year from their portfolios in retirement). I have a New School SWR calculator ("The Retirement Risk Evaluator") that adjusts for the effect of the valuation level that applies on the day the retirement begins. The Evaluator shows that the SWR can drop to as low as 2 percent (a $20,000 withdrawal) at times of high valuations and can rise to as much as 9 percent (a $90,000 withdrawal) at times of low valuations.

You are suggesting that we don't need to make assumptions. But how can we know even roughly how much we need to save for retirement if we do not do so? If we assume that for the first time in history valuations will have zero effect (this assumption is made in the Old School studies because they were developed pursuant to the Passive Investing model for understanding how stock investing works), the SWR really is always 4 percent. If we assume that valuations will continue to effect long-term returns, the safe withdrawal rate varies wildly depending on the valuation level that applies on the day the retirement begins.

You are right that the assumptions chosen have a huge impact. But I don't think that the answer is to avoid making assumptions. Without assumptions, we cannot plan.

The problem is that we are too arrogant about the assumptions that we make. The people who came up with the Passive Investing model have known for 30 years that the academic research does not support their assumptions. But they don't want to admit the errors they made because they have caused such great human misery.

We need to make assumptions. But we need to adopt an attitude of humility when doing so. And we need to pray for the grace to be able to correct our assumptions when we learn that our first cut at understanding a subject was in error.

Rob

"The problem is that we are too arrogant about the assumptions that we make. The people who came up with the Passive Investing model have known for 30 years that the academic research does not support their assumptions. But they don't want to admit the errors they made because they have caused such great human misery.

Rob, its not clear. Is the assumption you share about the people who came up with passive investing being offered as an example of your first point?

This comment is defensive, Dylan.

Rob

Lets NOT turn this into another argument about Passive vs. Something else
and ruin a great discussion about planning and proper place of the assumer.

Carl:

People can of course discuss any aspect of the question that they care to discuss. All sorts of thing can be examined profitably.

But it's not possible to examine the question of bad assumptions in a coherent way without looking at actual examples of assumptions that have caused huge financial pain for those buying into them. Passive Investing had been the dominant model for 30 years and most of the assumptions that have caused losses for today's investors are rooted in the principles of the Passive Investing Model.

I am not picking on the Passive model. It just happens to be the case that that is the model that caused most of the bad assumptions of recent decades. Many have come to think that it is stock investing in general that is the cause of the bad assumptions. It is not. It is one particular approach to stock investing that has caused most of the problems. Passive is not the only possible approach. Assumptions do not need to be bad.

Rob

Carl,

I'm glad to see you address this topic, and enjoy reading how others have responded as well. I agree that even minor changes to the assumptions can have dramatic affects on the plan, and this is why I spend a large portion of my time reviewing why certain assumptions were made. I explain that things do change, and it is the long term relationship that will allow us to make adjustments as time passes.

I agree with your points numbered 1,3, & 4, but am not clear on what you mean by #2 - don't lose money. Does this mean avoiding risk all together, or avoiding the buy high sell low mentality, or something else?

What I mean by "don't lose money" is that losses have far greater impact on performance in dollar terms than most of us account for. I have working on ways to protect against downside risk because "not losing" have become so important to me.

This is obviously a topic for another day, but for the sake of this discussion lets just say that I view not losing as the #1 rule of investing.

How you do that is clearly up for debate.

Great - looking forward to that post in the future!

Russell- That assumes there will be one...

This is most definitely how I prefer planning, even in this simplistic 1-4 outline there are small assumptions being made and (here is the important part) continuously monitored. It does not need to be rocket science and algorithms to create extreme value for the client.

In my humble opinion it goes back to your society of real financial planners. Thinking about this, debating this and looking at it from different angles stresses the fact there are people who always think about the client first and go the extra mile to make sure they question themselves and how to perform for the client.

The litmus test here is how many BD's come defend the assumptions for the VUL they just sold last week that pocketed them $10,000 in commission. The more complicated the product the more continuous monitoring it needs and the better the assumptions have to be. As we discuss long term assumptions generally can be taken out with the trash.

Thanks Chris.

****UPDATE: this conversation prompted me to write something in the same vein over at Morningstar this morning. If you have a minute give me your thoughts here: http://www.morningstaradvisor.com/articles/blog...