Financial Planning Software…Smoke and Mirrors

Transcript

As a former financial professional I can assure you that every company in the investment advisory industry is always looking for a way to justify their fees and the reason for this is probably not going to be very surprising. Everyone in the industry knows that fees tied to picking investments are becoming harder and harder to justify, given the overwhelming evidence of how poorly the industry does. So what they do is try to shift the discussion from something they probably can’t provide much value in, such as investment management, to something they can provide value in, financial planning.

As a result, almost every firm in the industry now provides some type of comprehensive financial planning report. While I’m not going to say these reports are completely useless, my personal experience is they tend to be mostly smoke and mirrors.

Welcome to the second season of Invested Poorly: Sad Tales of FInancial Fails, a short-form podcast designed to help everyday investors make wiser investment decisions by learning what NOT to do with their money. Host Jeff Harrell shares timeless stories from his former life as a financial advisor, about the poor—and irrational—choices he witnessed investors make that disrupted their journey to financial independence, or FI. Your ability to recognize, and avoid, similar mistakes could make all the difference for you along your path to reach FI.

Check out the “Introduction” episode for more background on Jeff, why he created this podcast, and how it can guide you to becoming the hero of your own investing story. Now, on with show.

My guess is a lot of you listening either have a financial advisor or have at least had someone in the past who provided you with a fancy financial planning report that shows you exactly where you stand currently and what may lie ahead for you financially. For those of you who have never seen one of these, they typically have all kinds of pretty graphs and charts, many of which are difficult to understand, which is actually kind of my point, but we will get to that in a second.

These reports can be anywhere from a couple pages long to over 100 pages if you are provided one of the really sophisticated ones. There is no doubt, these reports are how many financial service firms believe they can justify their fees. They want to try and blow you away with something that seems so detailed and complex that you know you couldn’t possibly create it on your own.

Now, I’m not here to talk negatively about financial advisors. I have stated before and I’ll say it again: having a financial expert in your life that you trust and is acting in your best interest is of tremendous value. I do think that many advisors provide their clients with all kinds of benefits, many of which can’t be quantified. But with that said, my view of the way the industry typically uses financial planning software to quote “add value” is actually not very useful at all and I’ll be more than happy to explain why.

First, I could go into crazy amount of detail and make this podcast extremely long with all the flaws of financial planning software, but since I like to keep these episodes short, sweet, and to the point, I’ll focus on one word that represents the greatest flaw in all financial planning software…sensitivity.

Without question, the problem with these reports is how sensitive they are to just a couple of variables. One of the first examples is what I discussed in Episode 7 of Season 2 in which I detailed how big an impact just 1% can make to your investments. So think about all the variables in these reports, such as expected investment returns, inflation, savings rates, when you stop working, what future medical costs you might have, whether your loved ones leave you an inheritance or need you to take care of them? The list goes on and on, and the younger you are, the more variables you have and less certainty surrounding any of them.

So just think about that for a second. If a difference in investment returns of 1% is a huge deal, how in the world can the uncertainty surrounding countless other variables provide you with any level of confidence these reports are accurate? For my money, they can’t.

As I like to point out all the time on this podcast, don’t take my word for it. Feel free to take my inquisitive little nephew’s advice and “search it up.” While you will find many articles highlighting the benefits of these reports, you will also find the ones that support the points I’m making here. So the key takeaway for you is to understand that, at best, these reports should be used as a means to determine if you are on the right track, but they should not be relied upon as any type of definitive prediction as to what your financial life will look like decades into the future.

I used to run countless alternative financial planning reports by changing two or three variables just to see how it influenced the outcome. The inflation rate was almost always the biggest factor. Merely changing the inflation rate by half a percent would almost always change the final outcome for a client in their 40s or 50s by over a million dollars. If you went one step further and adjusted the rate of return on the investments or date of retirement, the difference was magnified even more. When you run multiple scenarios like this and see how wide the results can vary after changing just a couple of numbers, which, keep in mind, we already know are totally unpredictable, you begin to question just how useful these reports really are.

Okay, now with all that said, I’m going to contradict myself a little bit and explain how financial planning software can still be beneficial, even if you already know it can’t possibly be accurate. Without question, my favorite story about a financial planning report that was actually beneficial comes from my own parents. Despite the fact I had told them they were already FI in their mid-60s, my dad continued working because, as we all know, giving up that paycheck and just hoping you have enough money can be hard to do, no matter how much you have.

Many of the financial podcasts I listen to recommend various online financial planning solutions, so I decided to test one of them out by running my parents’ numbers. Even though I’m well-aware of the flaws I mentioned earlier, what I cannot deny was the impact the software had when I plugged in all their variables. I was meticulous to use very conservative assumptions, and then when it was all said and done, I showed them the chart illustrating how much money they would have at age 100, if my dad walked away immediately or worked a couple more years. When he was able to see that, either way, they would have more money than they could possibly need, and how small the difference was, it gave him the confidence to walk away almost immediately. Less than six months later my dad was fully retired.

So, even though I’m still not a big fan of financial planning software because of the extreme sensitivity the longer your timeframe, I can’t deny there is some value to these resources, especially as you get older. For those of you who may be interested in using online financial planning software, I’ve included links to a couple in the show notes. What I like about these options is they are inexpensive and, depending upon how much time you want to spend learning how to use them, you can create all kinds of scenarios for your personal situation. The features they offer do-it-yourself investors are amazing, especially when you consider how budget-friendly they are relative to a full-service financial advisor.

I sure hope you enjoyed this episode of Invested Poorly and will be able to take something from it to improve your decision making as you navigate the twists and turns of your personal investing adventure. Be sure to check out my website at AreYouFI.com (that’s A R E Y O U F I dot com) where you can find resources and show notes with the charts and graphs I mention during the episodes. These are like little treasure maps that can help you choose more wisely along your quest to reach FI, or financial independence.

Never forget, in the short-term the stock market is unpredictable, and as my mischievous little nephew likes to say, “things just happen”! So focus on the long-term, by controlling your emotions, simplify your investments, and always… ignore the noise.

I’m your host, Jeff Harrell.  Thanks for listening.

Invested Poorly: Sad Tales of FInancial Fails was created for informational purposes only and should not be relied on for specific tax, legal, or investment advice. You should consider consulting a qualified professional to review your situation before engaging in any transactions. Investing involves risk, including loss of principal and past performance is no guarantee of future results. 

This podcast was produced by Ted Cragg. Learn more about creating podcast mini-series like this by visiting QuickEditPodcasts.com.