Is your Financial Planning Technology getting it right?

Have you ever asked yourself this question? Have you ever investigated the philosophy and approach followed by the planning software you use in your practice? Do you fully believe in the system and the numbers? Are you using your system of choice merely for compliance (to have something on file) or do you increase the quality of your advice and effectiveness of your business through using your system optimally?

In South Africa, we have quite a number of software providers to choose from. And then there is a myriad of Excel tools floating around that Financial Planners and Advisers built themselves to fit in with their sales process or way of giving advice.

Composition of Financial Planning Systems

The systems that Financial Planners and Advisers employ consists of many different modules:

  • Client Database
  • Tasks
  • Document Libraries
  • Reporting
  • Communications
  • Compliance
  • Financial Planning Tools
  • Financial Calculators
  • Invoicing & Commission Tracking
  • Etc.

The question asked in the headline “Is your Financial Planning Technology getting it right?”, is asked with specific reference to the Financial Planning Tools and Calculators. We will focus on these aspects from here on.

Goal-based vs Cash Flow-based approach

Goal-based planning (GBP) works great when the client has a specific goal. For example, education of children, a comfortable retirement, wants to go on holiday or saving for a deposit on a house. The approach is very wide, leaving a lot of room to move (make adjustments) between now and the goal date. You start at the end and work backward.

GBP is easy to understand and works great for young people and any long-term planning. However, it does not take changing circumstances over time into account. For example, analysis based on GBP indicates that the client must save R 1 000 per month, but the client cannot afford that at the moment. GBP cannot take into account that the client is paying off his car in 2 years time, which will allow him to invest more from that point onwards.

GBP is great for answering questions like:

  • At what age can I retire?
  • What Rate of Return do I need to achieve my goals?

Using GBP, you can quickly establish if a client is on track or not.

Cash-flow based planning (CFBP) is very specific and very detailed.

It starts today and then looks forward, taking into account changing circumstance every year.

Different scenarios can be created to assist in implementing the most appropriate plan. CFBP starts with income and expenses.

CFBP works great for clients close to retirement, clients living off their investments, clients that need detail and to help Financial Planners and Advisers design better strategies.

Each of these planning approaches has their place and the one is not necessarily better than the other. What is important is to understand the limitations and appropriateness of each approach for a specific client.

Which approach does your system offer? Only one or both? Is the approach offered by your system appropriate for the majority of your client base?

Tax

Income Tax, Capital Gains Tax, Tax on Retirement Fund Lump Sums and Estate Duty are the most common taxes that have a major impact on planning for a client. Very few planning systems calculate Income Tax, Tax on Lump Sums and Capital Gains Tax based on the information for a given planning scenario. Many systems require the user to enter a tax rate percentage. Taking this approach results in the tool calculating tax at the given percentage from the first Rand. It is up to the user to determine the appropriate percentage by calculating it manually. Using the incorrect percentage will lead to a gross overstatement or understatement of a need.

Tax on Retirement Fund Lump Sums is another area that can cause problems. Some systems require that the user calculate the tax amount manually and then enter it is a need into the system. Other systems calculate the tax as if it is the only lump sum ever received by the client. The aggregation concept applied to tax on lump sums has a significant impact on the net amount received.

All systems include Estate Duty calculations that include calculations such as Executor Fees and the residue. Many systems, however, do not look at the situation when the surviving spouse passes away (second death). It is important to understand what the situation might be in such an event, especially if the surviving spouse inherited the entire estate.

The user takes all the risk when having to calculate amounts manually. Not including tax in calculations increases advice risk significantly.

Discounted Cash Flow

Majority of systems (and especially self-built spreadsheets) employ the Discounted Cash Flow method of calculating needs, shortfalls and surpluses. It is further based on the exhaustion method whereby the client would have sufficient capital to fund the needs until the end of the planning term. In other words, there will be zero capital left at the end of the planning term. Some systems offer the option to choose to preserve the capital, meaning that the client has the same amount of capital left at the end of the planning term, than what they started with.

Discounted Cash Flow is a popular calculation method for Goal-based planning and it is what is taught at all levels of financial planning qualifications in South Africa. It is also referred to as “Capitalisation”.

Discounted Cash Flow does not take into account the underlying product rules applicable to Living Annuities for example.

Solving for specific products

Let’s use retirement as an example.

Using the Discounted Cash Flow with the exhaustion of the capital method is most likely not appropriate. Why?

I will illustrate using some numbers.

To provide a client a gross income of R 120 000 per annum for 15 years (assuming 10% growth and 7% inflation), capital of R 1 493 843 will be required at the start. The income amount needed in the last year will be R 331 083. This means that at the beginning of the last year, capital of R 331 083 is needed to fund the required income. This is correct for any discretionary type of investment. But what would be the case of the income is provided via a Living Annuity?

Depending on the percentage income withdrawn from the Living Annuity, the capital required to fund the last year’s income will be:

  • at 2.5% – R 13 243 351
  • at 7.5% – R 4 414 450
  • at 17.5% – R 1 891 907

You can see that there is a significant difference between the capital needed in the last year if the income is provided by a Living Annuity vs. a discretionary investment. The Discounted Cash Flow method does not take this into account.

We have not even taken any tax, costs or irregular needs into account.

Ensure that you interpret the numbers correctly and understand how they relate to the underlying products, portfolios, etc.

Reporting

Many systems offer standard reports for the different planning areas as well as the option for you to design custom reports to suit your own needs.

Most of the reports available, whether standard or customised, suffer from one or more of the following:

  • Too many numbers
  • Complex graphs that are hard to interpret and explain
  • Built for compliance and not for the client
  • Does not follow a storyline
  • Written in formal and technical language
  • Too long

Reports must be client friendly. Not compliance friendly. It must enhance the process and the experience. Not hinder it.

Be clear on the aspects that are important to the client and communicate it in a language and format that the client will understand and not be overwhelmed by.

Financial Planning knowledge a must

Having the Financial Planning knowledge, skills and expertise is non-negotiable. No system is able to do the financial planning for you. The system is meant to speed up the process, allow us to create multiple scenarios quickly, do complex calculations more effectively without errors and bring consistency when dealing with different clients.

In my experience, when Financial Advisers and Planners say that a system is too complex, many times it is because there is a need for, an opportunity to, upskilling themselves on Financial Planning. You must have the ability to understand the implication of entering data differently in a system and more so, to correctly enter the relevant information.

Solid Financial Planning knowledge is a prerequisite for using any financial planning tool or system.

It is all about the client

Never forget that whatever technology or software we use, it must never take away from the client experience. It must enhance the experience and make the process more efficient.

Costs related to the right technology is an investment.

Getting to grips with your software, system and technology takes time and effort.

There is no such thing as “the best system”. Understand your system’s capabilities and limitations as far as financial planning goes and ensure that you use it appropriately and interpret the numbers in line with that.

Understand your system’s capabilities and limitations.

Financial Planners and Advisers will never (and should never) get away from the complexity of financial planning. They must know every intricate detail. The magic exists in making it simple for the client. In not overwhelming the client with detail. Understand how every single system, technology and gear in the car works, but only show and educate the client how to drive.

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