What makes a good financial plan good

Steve Merrell |

We often talk about the importance of having a good financial plan, but we rarely discuss what makes a financial plan good. As with most things in life, financial plans come in a variety of qualities and flavors. Knowing what to look for as you shop for a financial plan will help you get the best plan for your particular situation.


Financial plans can be either tactical or strategic in nature. Tactical financial plans focus on current needs. They are usually oriented toward financial products like insurance or mutual funds and are often used as sales tools. If you get an invitation in the mail to attend a special dinner with a financial advisor, chances are some element of the dinner presentation will focus on tactical financial planning.


Though tactical financial planning has its place, many people get more benefit from strategic financial planning. Strategic financial plans take a more holistic look at your long-term financial picture. Strategic financial plans can help determine if the individual is on track to accomplish their goals or if a course correction is necessary.


Financial plans can have various planning horizons depending on the needs of the client. A tactical plan may look 5 to 10 years into the future, while a strategic plan considers the individual’s expected remaining life and possibly longer. Some plans involve wealth transfers to future generations and may extend the planning horizon for several generations.


Technology has revolutionized financial planning over the last several years. As you shop for a financial plan, take time to understand the kinds of tools your planner uses. Some financial planners still use financial planning models that are based on simplistic approximations. The best models, however, are based on year-by-year cash flow projections that allow the planner to simulate difficult real-life challenges.


For example, a cash flow-based model can be used to look at the impact of a long-term care scenario followed by a premature death. This kind of scenario in real life would be stressful financially and emotionally. However, virtually working through the long-term care scenario in a financial planning model enables you to devise a strategy for dealing with it when emotions are not in play.


A shortcoming of many financial plans is that they rely on investment return assumptions that don’t change over the course of the plan. By this I mean they assume your investments earn a certain rate of return every year for the duration of the planning horizon. Unfortunately, markets do not work like that.


Markets may go up one year and down the next. Market volatility is extremely important in the real world and has a direct bearing on whether your assets are sufficient to carry you through retirement. Liquidating investments during a market downturn permanently reduces the amount of financial capital you have to meet future needs. This is called sequence of returns risk and a good financial plan needs to account for this risk.


The best technique for measuring sequence of returns risk is something called Monte Carlo analysis. Unfortunately, we don’t have room to get into the details of Monte Carlo analysis in this article. Suffice it to say that Monte Carlo analysis is an advanced simulation technique using thousands of randomly drawn market scenarios. By simulating thousands scenarios, we can measure the impact of portfolio volatility on the likelihood that our assets will last to the end of your planning horizon. As you consider different financial planning offers, make sure you find a planner who can bring Monte Carlo analysis into your plan. 



Steven C. Merrell  MBA, CFP®, AIF® is a Partner at Monterey Private Wealth, Inc., an independent wealth management firm in Monterey.   He welcomes questions you may have concerning investments, taxes, retirement, or estate planning.  Send your questions to: Steve Merrell, 2340 Garden Road Suite 202, Monterey, CA  93940 or email them to smerrell@montereypw.com.