Financial Health Planning

Financial Health Planning

Is it possible for computers to completely take the place of an advisor's ability to run a financial plan? Does that mean the advisors themselves could be replaced with a series of automated digital interactions?  The question hangs on the collective necks of the industry.

I believe the answer to these questions are yes and yes for way too many financial professionals who lack depth in their services.  However, I also believe advisors can use technology like financial planning software to their advantage to differentiate the clients experience with their plan.  

This series of posts detail the many ways planning technology could be innovated to enrich the services of the average advisor, not replace them.  Financial Planning Software has only just begun to show its true value.

Financial Health Planning

The results from planning software have become the definition of a financial plan over time.  The plan has become the delivery mechanism of advice.  However, there’s obviously more to a plan than the funding of goals via Probability of Success.  A holistic assessment of a plan's overall financial health could include a wealth of different planning areas. Conversations around savings, debts, investments, spending, etc… are all obvious opportunities to dispense advice.  Financial Planning Software has the potential to do much more in terms of evaluating the overall financial health of a client.

Digestible numbers are always helpful in evaluation, so it’s understandable why advisors like the Probability of Success so much as a metric. It’s just the right level of recognizable and incomprehensible. It stands out as a common and significant term, while obfuscating the need to present and discuss more detailed metrics. At the end of the day, Probability of Success is only one Key Performance Indicator (KPI) of our plans health and it focuses only on the funding of goals and living expenses. Financial Planning Software could expand its ability to facilitate advice points around all the other areas of a plan.  Luckily, there’s already a proven set of time tested KPI’s that assess other important planning areas. Enter Financial Ratio Analysis (FRA).

Why isn’t Financial Ratio Analysis represented today in FPS? 

Financial Ratio Analysis was once a standard assessment tool in personal financial planning. Originally developed for business evaluation, it had been used in financial planning for decades prior to the advent of financial planning software. There used to be a perception that financial planning software replaced the need for FRA because it could be more precise, theoretically. Running through year by year scenarios, accounting for every dollar coming in and out as applied to the defined need, is useful, but it does not discount the need for FRA.  It only makes FRA more useful.  

Ratio analysis was left out of the planning experience a long time ago.  I believe that if you had polled the average planning software user in 2000 about the future of planning software, their expectation would have been for it to have evolved in terms of how the complexity of a plan is explained to clients.  Unfortunately, the focus on software design became more about speed and simplicity than handling the sophistication present in most households.  The entire industry was built to frame a client’s financial health by getting through retirement.  The conventional thinking that is taught to business majors in all academic programs and used throughout the business world was simply discarded.

What to do with FRAs?

Current Health

If we intend to infuse planning software with all of these new metrics, the question becomes what will FPS do with them?  The first and most obvious action is that the planning software could return results for each financial ratio, as a snapshot of each household's current financial health.  There are several commonly used ratios that could help inform us about Debt, Investments, Spending, Taxes, Solvency & Liquidity.

Projected Health

FPS will take it a step further and apply these calculations to all of the years of the plan. Because of future goals, incomes, assets, etc…a plan could be in good health today, but that could change at some point in the future of the plan.  Monte Carlo Simulation helps measure the effect of risk on a plan due to the market forces out of our control.  Financial Ratio Analysis, applied to all plan years, could help us pinpoint, by planning area and time period,  precisely where risks lay hidden. FRA offers a completely new way of looking at plan results and judging success/failure. 

Benchmarks

If we have key metrics that give us an overall assessment of financial health, all we need are benchmarks to show how healthy plans are relative to others in similar demographics.  Fortunately, a lot of work was done by academics that have completed qualitative studies and published key indicators of financial wellness for multiple demographics.  FRA as an academic subject is still vigorously taught today.  Of course, the precise benchmarks and metrics could vary depending on advisor, client, or more detailed demographics such as geographic location, employment, or lifestyle preferences. 

The paper I use as my inspiration on FRA was done by Dr. Vicki Hampton and Laura Ricaldi from Texas Tech.  It’s called  “The Millennial Generation: Recommended Financial Benchmarks” (2013).  I haven’t stopped thinking about how to apply their research to FPS since it was introduced to me.  They started with key financial ratios that were established by previous research to be most useful in assessing personal financial health. They then pulled together research on the different traits and financial needs of younger people as compared to older generations. Ultimately, their work provides a sound, industry and academically tested set of benchmarks that should have a place in financial planning software.

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