Search

Road to nowhere: The BIG problem with financial plans.

“Everyone has a plan until they get punched in the mouth”- Boxing great Mike Tyson


Actually- there are several problems with typical financial plans. Almost all financial plans are created using the same software and methodology. Almost all of them are overpriced, and almost all of them are created by advisor’s assistants.


The software at the heart of virtually all financial plans is named after a town (Monte Carlo) famous for gambling. This should not give investors confidence.

I recently had an interaction with a prospective client who brought with him a copy of a “financial plan” that another advisor had done for him. The ridiculous problem that I noticed was that hardly any meaningful data had been inserted into the plan. The other advisor had made the plan in advance of their meeting! They had not yet established any of the client’s goals or risk tolerances. This plan was merely a prospecting tool. It was worthless and potentially very misleading. However, this is not the worst part.

The worst part is that retirees are being sold a false sense of security. The plans grossly underestimate risk because they look at historical returns. A simulation named “Monte Carlo” is at the heart of the forecast and while it is an improvement over traditional average return forecasting, it isn't enough. Historical returns have little predictive value for the near future. It is true that the stock market tends to go up over time, but for retirees, long term may not be the proper time frame. Furthermore, investors face much more risk today, following the 10 year bull market in stocks than they faced 10 years ago.

The software upon which these plans are based will never be able to account for the fact that valuations may be good or bad at any point, or that there may be extraordinary risks at any given time-(Coronavirus, black swans, etc). The simulation can’t see the potential that at this point in history we may be near the end of a 30+ year bull market in bonds. This means that bonds may be wildly overvalued. Since bonds are the main diversifier and source of stability within the plan projections, investors may be at increased risk of loss. If bonds do not protect investors when the stock market trends lower, the entire plan would be ruined.


Investors must plan for market declines. Not because they are possible or probable, but because they are inevitable.

The Monte Carlo based plan also assumes a buy and hold strategy. What happens after a 20% decline in portfolio value? A diversified portfolio holder is supposed to continue to hold that same portfolio. That is the punch in the mouth that Tyson was talking about and the point at which the plan goes out the window. History and behavioral finance tell us that many investors will sell near the bottom of market declines. Most retirees are not even aware that that kind of loss is in the realm of possibility.

Even worse, there is no plan to deal with market downtrends when they happen. The plans themselves are incapable of modeling such variables. If an investor retires at 65 they can reasonably assume that they will see 2-3 bear markets of at least -20% and potentially dozens of declines of 10% or more during their retirement. Investors need to have a solid risk management framework for protecting assets during market downturns. This may include diversification, tail risk insurance, or strategies that reduce stock exposure when markets are trending lower.

Most investors are very familiar with the idea of diversification. It is a very sound practice of spreading your retirement funds across multiple asset classes. It is essential, but may not be enough.

Tail risk insurance may protect from steep drops in financial assets. ETFs designed to protect assets in these cases are typically made up of treasury bonds, put options, and volatility futures.

Trendfollowing strategies may offer an even better risk/reward scenario. A typical trendfollowing strategy will attempt to be invested in stocks when the market is trending higher and reduce stock market exposure when stocks are trending lower.

A combination of these three strategies above may provide investors with better protection from market declines.

The software at the heart of virtually all financial plans is named after a town (Monte Carlo) famous for gambling. This should not give investors confidence.

Investors must plan for market declines. Not because they are possible or probable, but because they are inevitable.


Any retirement plan that doesn’t do this is not a plan- it is fantasy.


Past performance is no guarantee of future results.

No part of this website is intended to be investment recommendations to any specific person or group.

7 views

© 2019 by Stonebrook Digital Wealth

  • Black Facebook Icon
  • Black Twitter Icon
  • Black LinkedIn Icon
  • LinkedIn Social Icon
  • Facebook
  • Instagram

Proudly created with wix.com