Mike Tyson Would be a Financial Planning Genius

The 10 most common causes of a failed financial plan

1. Large healthcare related expenses

Certain illnesses or injuries create the need for intensive and prolonged care. While the average nursing home stay is about three years, there are some conditions that require extensive or extended care without shortening one’s lifespan.

If the cost of such care is much greater than a person’s lifestyle, this will be financially burdensome. While there are insurance policies to cover such long-term care needs, many have limits that reflect a more typical duration of care required. Some facilities accept Medicaid coverage to continue care if the patient has run out of money.

2. Home repairs

The most expensive items to replace in a home are typically the roof or HVAC system. Given their known shelf life, they don’t often cause unanticipated catastrophes that derail someone’s financial plan.

They can be budgeted and planned for with the assumption that, eventually, they’ll need to be replaced or fixed. In a worst-case scenario, these home repairs may happen sooner than expected.

3. Theft, fire, or other underinsured loss of property

A homeowner’s insurance policy may cover damages from theft, fire, or storms, though they are usually left paying substantial deductibles before insurance kicks in. In some less common cases, there might not be adequate coverage.

Protection against flood damage, for example, requires a separate flood insurance policy; many homeowners may not realize they need to purchase that coverage in addition to their standard policy. In some extraordinary circumstances, like a hurricane or tornado, the homeowner’s state or municipality may offer financial relief or assistance. But securing coverage in regions known for catastrophic weather is an increasingly expensive feat. While an uninsured event of substantial magnitude isn’t common, it is a good practice to understand where there could be potential gaps in your client’s insurance coverage.

4. Caring for aging parents

Helping your clients plan to care for loved ones who didn’t plan well enough for themselves is a challenge. When you’re uncertain how long Mom or Dad might need your client’s financial support, planning is difficult. Some people choose to manage this risk by delaying their own retirement for as long as they continue supporting their parents.

5. Children who cannot yet support themselves

Parents who financially support their adult children is a more common scenario than people realize. The problem is compounded when this so-called “boomerang generation” is supporting their aging parents as well as young adult children who moved home without financial independence.

Some adult children may be capable of supporting themselves but are not motivated to do so. Others have special needs, which should be considered thoughtfully in their parents’ financial plans.

Teaching adult children to be financially self-sufficient is important, but it’s not always a given. It might be considered “tough love” for your client’s kids, but your clients’ own financial plans may depend on their adult children having financial independence – as well as building thoughtful financial plans of their own.

6. Inflation

Experiencing prolonged, higher-than-expected inflation generally increases future living expenses beyond expectation. In turn, the size and pace of withdrawals on an investment portfolio increase as well. Even if investment returns are average or typical, this accelerated depletion of investment assets may cause premature elimination of funding.

The best indicator of financial longevity (in other words, how long your client’s money will last) is the “real return” they experience. Real returns are the rate of growth (portfolio returns) relative to inflation (which heavily influences the pace of future withdrawal).

7. Longevity

How long someone will live for is a simple, yet challenging, factor that will influence the success of their financial plan. If your client or their spouse lives a long time, they’ll need greater resources relative to their lifestyle (withdrawal rate) to avoid running out of money. Think of it this way: Enjoying a longer-than-usual life is the financial equivalent of retiring early and living a more typical lifespan.

8. Large investment losses

If losses, whether realized or unrealized, are significantly greater than anticipated, clients may be tempted to abandon their investment plans. While yes, this would effectively reduce risk, it also limits their ability to recover their losses or depleted value. Someone’s willingness to accept risk is an important element of their risk tolerance.

Distributing funds while investment values are depressed may be inevitable if important goals (college, wedding, real estate, retirement living, etc.) coincide with a depressed market. For this reason, understanding someone’s actual financial ability to take on investment risk is so important.

9. Below-average portfolio returns

While varied or negative returns are contemplated at most risk levels, it is possible that clients could realize prolonged below-expectation returns over a lengthy time.

The effect is like experiencing prolonged high inflation, which drives up costs beyond expectations. Here we might see anticipated withdrawals represent a larger percentage of asset values because of the lower-than-expected growth over a long period.

10. Unemployment or underemployment

A poor labor market can create prolonged unemployment or underemployment. Loss of income causes additional depletion of assets which clients may not have anticipated. It’s common to account for these contingent withdrawals by allocating some assets to lower-risk investments.

While this can be helpful in preserving one’s portfolio, the actual length of unemployment can still derail financial plans. Underemployment, often accompanied by a material decrease in income, can have a similar, albeit much smaller impact.

Responding to financial pitfalls

In each of the scenarios above, very often the choice of responses is some combination of the following:

1. Continue working longer than previously anticipated, if physically capable of doing so.

2. Reduce expenses and save the difference (if working) for some time or until eventual retirement.

3. Downsizing or monetizing something, such as a home or second home. This generally brings additional assets into one’s investment portfolio and may reduce ongoing expenses as well.

The best plans account for the possibility of financial pitfalls. While it’s unlikely your clients will experience all the scenarios above, it’s possible they’ll come across at least a few in their lifetime.

It’s not my philosophy to design a plan so conservative that it creates a less than 1% failure rate. Doing so forces the investor to endure a much longer career or much lower lifestyle pre- and post-retirement, which isn’t desirable by most.

Some of the events depicted above (inflation, markets, expenses, etc.) can come on gradually, meaning they allow for some level of course-correction. As such, planning is best done regularly, perhaps annually, or if materially different information is available. Being able to robustly measure one’s probability of outliving their money easily and regularly gives advisors and their clients the tools to make subtle course corrections along the way.

Some events can’t be predicted. But there are things you can do to make probable assumptions about future uncertainties.

For example, it’s impossible to predict how long someone will be unemployed. But with the right tools, you can intelligently incorporate probabilistic paths of future inflation as it contributes to changing expenses in the future.

You can also incorporate dynamic, second-to-die, mortality probabilities, which reflect your clients’ personal characteristics (age, gender, health, lifestyle habits, family history, etc.) With the right technology, you can even help your clients anticipate how their ability to take risk will change as they age.

Each of these additional “moving parts” elevates the robustness of your client’s probability of running out of money, based on the information available. Updating your information regularly and gauging how that probability of running out of money is evolving allows the often-subtle course corrections needed for a successful plan.

While you may not be able to help your client dodge all of life’s punches, better technology facilitates better preparation. After all, it’s not how hard you get knocked down that matters if you can get back up.

Mark Friedenthal is the founder and CEO of Tolerisk®, an analytical, multidimensional risk-tolerance assessment tool designed to improve and enhance advisor-client relationships through in-depth risk evaluations. To learn more about how Tolerisk’s next-generation mathematical infrastructure can elevate your financial services business, book a demo today.

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