Kerry Drysdale examines the benefits of using a cashflow tool in supporting goals-based financial planning
Agoals-based financial plan is one in which a client’s life objectives are identified, refined, prioritised and achieved. Otherwise referred to as lifestyle financial planning, it is about recognising not only the goals that are of fundamental importance to clients such as achieving a comfortable lifestyle but also the more aspirational hopes and dreams that could be achievable if plans are put in place as early as possible.
However, many of us fall into the trap of not paying enough attention to what we want to achieve in life. Many of us are too busy dealing with the challenges of day-to-day life to take time out to consider the future. Sometimes we don’t discuss our hopes and dreams even with those closest to us.
Financial planners have the opportunity to play a significant role in support of goals-based financial plans for clients. They are uniquely placed to motivate the client to take the time to consider not just the financial aspects of their future but also the emotional drivers behind any decisions they make in relation to their finances. Asking shrewd questions is key, as are interpersonal skills such as empathy and active listening. This part of the process is critical in developing a strong relationship with the client.
It is not necessarily easy and it may take some time to develop the interaction into the trusted client-planner relationship that will bear fruit for both parties. It could even get uncomfortable if the process starts to uncover adverse behavioural traits relating to the handling of finances and poor decisions that the client may have made in the past. The planner will need to have the perseverance to prompt and probe, delving deeper into the client’s psyche.
Goals are not likely to trip off the tongue of the client, particularly if they see their planner in a more traditional sense as the provider of a product or investment rather than a ‘financial plan’. Planners can help clients see their vision for the future and what’s important to them, which in turn will ensure the client is wholly invested in achieving those ambitions.
What does the client want to achieve, by when, who is involved and, most importantly, why? Armed with answers to these questions, the financial planner can then set about the ‘how’ of achieving these aims.
Beyond the initial conversation though, which should achieve a deeper and more meaningful level with a goals-based planning approach, how and why can a cashflow tool further develop and enhance the process?
Cashflow tools have been used by advisers and planners for many years and can be helpful in the most basic of scenarios. However, I would argue that the value provided by such tools can be maximised when used in combination with a goals-based financial planning process, one where the client’s goals have been identified, fully explored and prioritised.
The power of the visual
The visual nature of a cashflow tool can be extremely powerful. Research suggests that human brains are capable of interpreting visual images faster than written information, which is unsurprising in view of the fact that the majority of information transmitted to the brain in our daily lives is visual. When a financial planner presents visuals to a client, they are likely to be conveying information faster and with less effort. If a financial plan is presented to a client only in verbal and written form, it could take the client longer to process and fully comprehend. This could lead to a delay or even some resistance from the client to act, so the process may take far longer.
Visual images interact with emotional stimuli in the same part of the brain and, therefore, they can provoke strong emotional responses. For example, let’s say the financial planner wanted to highlight to a client the impact that their premature death or serious illness would have on their family. The presence of the red bars in the image below, when shared with the client, is likely to elicit a strong emotional response, one of concern or even alarm. In turn, this is likely to encourage them to act as quickly as possible to resolve the situation.
Showing the client the impact, rather than merely telling them, reinforces the message and visually displays the impact. There is much less chance that the client will walk away, forget the conversation and bury their head in the sand.
Visuals can also help to keep clients engaged and invested in their planning. Where else can the client see their life plotted out before them? Where else do they get to explore the reality about how much they’ve got, how much they need and how much they might be able to leave to their dependents when they die?
Seeing their life played out before them can encourage clients to start thinking more consciously about their goals. If the financial planner has added other family members into the plan, thoughts on providing for them can also come to the fore. Clients also start to realise how important it is for their assumptions on aspects such as expenditure in retirement to be much more considered. They also understand that unplanned expenditure can have a significant impact on their plan outcome. A cashflow plan can therefore promote more diligent spending habits.
Many tools can be used interactively with clients, which can provide a couple of advantages. Firstly, valuable time can be saved if the client realises that something in the plan isn’t correct. For example, if a value is out of date, it can be updated there and then. Secondly, the interactive use of a tool can help to keep the client interested and engaged during planning meetings, as they can get fully involved and may naturally start to ask questions like “What if we retired earlier?” or “What if we want to help our daughter with a deposit for her first home?”
Provided the planner is adequately skilled in using the tool, these changes or additions to the plan can be built there and then in the moment.
Some tools also have a version that can be accessed by the client in their own time and even used at the onboarding stage, with clients entering details of their assets and goals in advance of meetings with the planner.
How feasible are the client’s goals?
Typically, a cashflow tool will start off with a base plan reflecting the client’s current situation. For new prospective clients this can be useful as a way of demonstrating the pre-advice scenario. It should show where the client is now, how that situation will project forward and highlight any gaps or opportunities to improve their position.
The plan may therefore show that the client’s aims and objectives are not fully achievable if the assumptions in the plan remain as they are. Alternatively, the plan could show the aims and objectives being fully achieved if there is surplus wealth in the plan. The latter could lead to a different problem of having too much money left over at the end of the plan and, potentially therefore, a hefty inheritance tax (IHT) issue that might need to be mitigated.
In terms of projecting the assets in the plan, there are two broad ways of performing the underlying calculations: deterministic or stochastic. Stochastic tools build in a range of possible outcomes for the way in which assets will develop over time and are designed to show a client a more realistic journey in terms of investment volatility and sequencing risk. They highlight the fact that there is risk and uncertainty involved with investing.
A stochastic tool will typically measure the probability of the client’s goals being met. Usually, a percentage score will be presented reflecting the number of outcomes where the client’s goals are fully met in every year of the plan. For example, as shown in the image below, we can see that the ‘lifestyle costs’ goal score is 60%, indicating that the client has an above-average chance of sustaining a comfortable lifestyle. Too high a score is likely to mean there will be a large surplus left on death and too low a score is likely to mean the client will have to make some adjustments to their plan to sustain a comfortable lifestyle. For example, they may need to consider retiring later or reducing their spending aspirations.
Deterministic tools, on the other hand, will produce a single, straight-line forecast using fixed assumptions that are easy for a client to understand, but only one outcome is produced. The answer to whether the client’s goals are achievable is therefore a definitive ‘yes’ or ‘no’ result. For example, the cashflow chart shown on page 28 indicates a shortfall as reflected by the red bars, meaning that the client’s liquid assets will run out prior to their assumed mortality age.
Providing the client with an idea of how likely they are to achieve their goals and sustain the lifestyle they wish to experience is a key benefit that can be provided through cashflow planning.
There is then the opportunity to create a what-if plan. This alternative plan can demonstrate how the client’s situation can be improved, by taking action to rectify any shortcomings, or how it can be improved on by building on opportunities for tax efficiency or IHT mitigation for example. In so doing, the value of advice can be clearly demonstrated.
In some tools, the tax planning capability is such that a planner will be able to reflect a more tax-efficient plan, one that the client would have been unlikely to be able to put together on their own without the expertise of a financial planner. The time spent not only on constructing the advice but also on building the plan in the cashflow tool itself can help to validate the cost of advice.
A focus for regular meetings
Regular reviews for clients can focus on updating the cashflow plan. The path from where the client is now to where they want to get to will undoubtedly take twists and turns. The plan will become outdated for a variety of reasons. These could be reasons personal to the client, for example a change in personal circumstances such as a marriage, a divorce, a change of job, the arrival of children, the onset of poor health or a change to their aims and objectives. Or the reasons could be external to the client, such as a change in legislation or a major economic disturbance.
For all these reasons, a cashflow plan must be regularly updated to take account of any changes. The cashflow plan is never going to play out as assumed. From the moment it is created, it is out of date and won’t reflect reality. Tracking progress is essential and it’s likely that adjustments to the plan will be needed even if there are no significant changes to circumstances.
If, for example, the client has the need to take an unplanned withdrawal from their pension in retirement due to unforeseen expenditure, the cashflow plan can model how this will impact on their future income sustainability. It may be that the client will need to reduce their ongoing regular spending for a period of time to accommodate this expense. Far better though to be in an informed position than in the dark about the impact of such an eventuality.
Focusing on the plan, rather than the products and investments that help to achieve the plan, takes the focus away from the more traditional role of the ‘adviser’ as the facilitator of products and investments, which are broadly the same across the industry. There are also digital and non-advised platforms offering similar products and investments at far less cost.
So, there must be a differentiator within an advised process and more to the role of the planner. That differentiator can be the personal, meaningful, trusted relationship that can exist between planner and client. A digital engine cannot replicate the human skills of empathy, compassion, sensitivity and affinity.
Ultimately, clients do not want to buy products and investments, they want to feel the emotions associated with achieving their goals, whether that be experiencing the joy of giving money to their children, or the pleasure and excitement of a trip of a lifetime for example. The planner should be seeking to provide these feelings to the client, not the products that are the means to get them there.
A regular planning meeting focusing on the development of the client’s plan is surely more interesting and engaging for both the planner and the client, than one that is focused on the past performance of the products and investments that underly it.
The cashflow tool can capture the holistic picture, incorporating the client’s aspirations and the financial information relating to products, investments, taxes, etc, designed to help them achieve their ambitions.
Exploring alternative strategies and stress-testing
Some clients may know what they’re looking to achieve during their lifetime. It might be as simple as being able to afford a comfortable lifestyle, for example. They just want to know they’ll be okay. Others may not be so sure; they may have ideas but no set plans.
What-if plans within cashflow tools are a great way of exploring different options and stress-testing the plan to see how sensitive it is to market disturbances or unexpected changes of course, for example being off work through illness. This capability within the tool allows the planner and the client to investigate the pros and cons of alternative courses of action, for example using a lump sum to pay off a mortgage early versus keeping the mortgage as is and investing the lump sum.
Perhaps the client is concerned about the possibility of needing care in later life. Will they be able to afford it? Will they need to sell their house? Perhaps they want to explore what their plan would look like if they downsized, if they gifted money to their children, if they paid for their grandchildren’s education costs, or if they set up their own business. The opportunities really are unlimited in terms of what can be explored.
Cashflow tools can also highlight, in a simple visual, areas of need that may not have crossed the client’s mind. Even plans where, on the surface if it, no problems are apparent because there are no shortfalls, can be improved. For example, clients who have a surplus of wealth are likely to have an IHT issue. Tools with the relevant capability can model IHT mitigation strategies that can clearly show the benefit of adopting such a recommended strategy, again evidencing the value of advice.
Since the introduction of pension freedoms in 2015, the ability to be able to test the sustainability of a client’s income in retirement has been a fundamental requirement. Cashflow tools are an ideal way to perform this analysis. A tool with sufficient capability can not only perform the most basic of tests in this regard, but also compare the relative merits of various decumulation strategies. It can help to demonstrate a decumulation strategy in which a combination of withdrawals from different tax wrappers can provide a far more tax-efficient outcome than the client may have been able to construct had they not taken advice.
Stress-testing is hugely important and could take the form of market crash scenarios to reflect a major downturn in pension and investment performance. With a deterministic tool it is important to show something over and above the single outcome produced, for example by building in a market crash, or several market crashes if there is a long time horizon. Or the planner could demonstrate what the outcome would be if the growth rate was higher or lower. This will ensure the client understands that their projection isn’t guaranteed and that actual outcomes will be different. The impact of such eventualities can be explored and any contingency plans can be considered to alleviate a negative outcome.
Stress-testing could also include modelling the impact of the client dying prematurely or being unable to work due to serious illness. After all, there is no point in constructing a financial plan that will be redundant if the client can’t continue to make their pension or investment contributions because they are unable to continue working. Exploring these areas may highlight a gap in the client’s protection needs.
Capturing the client’s goals within their cashflow plan will invariably include goals relating to their family members. A cashflow tool can, therefore, also lead to intergenerational planning opportunities with the client’s parents, with their children or even with their wider family members, such as siblings.
Use of the tool provides an opportunity to bring all the family members together in achieving their overall objectives and to make sure, for example, that everyone is aware of one another’s wishes on death. While these can be difficult conversations to have, the tool can be a conduit to facilitate these.
Importance of assumptions
Whatever type of cashflow tool is used, the assumptions used in the cashflow plan are of critical importance. For a tool that uses fixed-rate assumptions, these will be used from the start of the plan to grow savings, investment and pension accounts, and increase expenses with inflation for example. Over a medium- to long-term period, a small difference in a growth rate can make a significant difference to the plan and could mean the difference between the plan showing that the client runs out of money too soon or has assets left over on death.
Using a set of unrealistic and, therefore, misleading assumptions could lead to unsuitable outcomes for clients. The assumptions used should therefore be reasonable and have a source of evidence justifying why they are reasonable, for example based on a long-term view that considers current values, past trends and future forecasts. There are a variety of sources that could form the basis for research, including: the Office for National Statistics, various house price indices (such as from the Halifax or the Nationwide), Financial Conduct Authority regulatory guidance, and HMRC guidance. Assumptions must also be regularly reviewed to ensure they remain reasonable and justified in light of changing economic conditions.
A cashflow tool can add significant value to the advice process and lead to enhanced client outcomes. Indeed, many clients are now starting to expect or even demand the use of such a tool to model their future financial picture
With a stochastic tool, the planner must educate themselves on the underlying methodology relating to the calculation of the range of outcomes and, if possible, look at the previous track record of the tool in how well the scenarios have matched reality. Planners must ensure they know how the tool works and be able to explain this to their clients.
For all the reasons outlined, a cashflow tool can add significant value to the advice process and lead to enhanced client outcomes. Indeed, many clients are now starting to expect or even demand the use of such a tool to model their future financial picture. Once embedded into the way of working, the financial planner can centre onboarding and ongoing meetings on the financial plan, creating maximum opportunity for client engagement, interaction and referrals to likeminded colleagues, friends, and family members.
Many planners tell me that the ultimate satisfaction in their role is being able to experience their clients realising their hopes and dreams. The cashflow tool can play an important part in making those dreams a reality.
As author Alan Lakein puts it: “Planning is about bringing the future into the present so you can do something about it now.”
Kerry Drysdale is head of holistic planning at Technical Connection