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Practice Management

Too much of it is designed to sell products rather than to enable advisors to actually provide the guidance clients are seeking.

This Practice Management article is intended for financial advisors only (registered representatives of broker/dealers or associated persons of Registered Investment Advisors).
 

One of the not-so-secret secrets of financial planning is that relatively few advisors actually generate the bulk of their income by providing planning advice. Instead, the profession is rooted primarily in product sales and asset gathering.

This has influenced the way our planning software is built. In fact, with its focus on investment accumulation for retirement and college, and on insurance-related scenarios, most financial planning software may be little more than a product-sales and asset-gathering tool.

Areas that are highly relevant for financial advice, but not for product sales, remain remarkably absent from most planning software tools available today. These include tax strategies, debt management, cash flow, and budgeting.

Product-Centric Roots
Financial planning came out of a world of selling insurance, investment products, and, at the time, tax shelters. The core topic areas for the CFP designation are based on a job-task analysis of what planners do—which in turn is based on what planners sell in order to get paid.

After all, insurance and estate planning were quite effective at delivering insurance sales. Early on, most insurance agents were trained in helping people with their cash flow and budgeting as well, but only to the extent necessary to help them figure out how to free up monthly cash flow to pay premiums.

Similarly, college and retirement planning is popular because it supports the accumulation of investment portfolios and the management of investment assets.

Tax planning was an early pillar of planning because of the popularity of tax shelters in the 1970s and early 1980s, and it remains popular because of the benefits associated with various insurance and accumulation products. These range from tax-deferred annuities to tax-preferenced life insurance, to accumulating investments in 529 college savings plans and employer retirement plans.

Because planning’s roots are product-centric, it is perhaps not surprising that the focus of planning software is ultimately on showing the benefits of the products most advisors sell.

Of course, as financial products and strategies wax and wane, so, too, do the focal areas of planning software. With the rise of the AUM model and baby-boomer retirees, planning software has become more retirement-centric, in order to illustrate the benefits of having the advisor manage the retirement portfolio.

Providing Real Advice
While planning software does a reasonable job of illustrating the tactics and products for which advisors are paid, it does a remarkably poor job of illustrating the impact of any advice that isn’t product-centric.

For instance, for virtually any household, long-term financial success is driven by spending and cash flow. A couple making $200,000 or more per year can be living paycheck to paycheck if their spending is out of whack. On the other hand, there are couples who together make $100,000 a year or less and still manage to live frugally, diligently save, and accumulate a million-dollar nest egg.

Yet despite the rise of popular consumer-oriented cash flow tracking tools, including Mint.com and budgeting solutions such as You Need A Budget—software to help planners track and advise clients about cash flow and spending has lagged painfully. Why? Perhaps it’s because giving advice about cash flow and budgeting means being paid for advice, while most of the industry is still focused on being paid for products or gathering AUM.

Similarly, debt is a significant reality for most households, from mortgages and auto loans to student loans and credit cards. Yet planning software has virtually no capabilities to effectively model debt and debt-management strategies.

For those with higher net-worth levels, often the biggest opportunity to generate cash flow savings is from tax strategies. This may involve simply maximizing available deductions or managing tax brackets from year to year with capital gains or loss harvesting and partial Roth conversions, or more proactive estate-planning strategies, such as rolling grantor-retained annuity trusts and shifting asset appreciation outside the estate through a sale to an intentionally defective grantor trust.

In the context of retirement, the opportunity is missed to illustrate not just how diversified retirement assets will grow but also how to liquidate them systematically over time.

In fact, these categories are often relegated to relatively simple assumptions. Taxes are just assumed to be a general average effective rate, or are calculated in an oversimplified manner; spending is measured simply based on gross spending, with little detail of categories; and debt is merely shown as a liability on the balance sheet, but with no tools to illustrate strategies to pay it down.

Yet without tools to illustrate strategies and their outcomes, it’s incredibly difficult to get clients to engage. This is especially so, since behavior rarely changes all at once and planning is an ongoing process, not simply a one-time event.

Six Needed Steps
So, what has to change for financial planning software to become more effective at actually illustrating and supporting the value of broader, comprehensive planning advice?

1) End the distinction between goals-based and cash flow-based software. Just making a distinction between the two approaches highlights the failure of integrating an accurate projection of cash flows to the goals they related to. As a result, goals-based software glosses too lightly over cash flows, and cash flow-based software gets so mired in the trees that advisors and clients can no longer see the forest.

2) Get real about working with clients on spending. Planning software needs to have capabilities for account aggregation not only for assets and account balances but also for cash flows from bank accounts and debit and credit cards.

Few clients will ever take the time to manually account for their monthly cash flows, but in today’s increasingly cashless society, where almost all spending is digital, there’s no need to agonize over spending tracking. Technology can automate most of that process, and it gets better every year.

3) Get real about taxes. At a minimum, software should be able to take projected cash flows and project a pro-forma tax return each year into the future, so that the impact of taxes can be shown across the plan.

But, ultimately, it’s about having tools to illustrate the ways planning strategies can alter those outcomes. If I project that a couple does a partial Roth conversion of $50,000 a year throughout their sixties to mitigate the impact of taxes in their seventies, the software should show the benefit. If I recommend that a client liquidate portfolios in a tax-savvy manner by harvesting gains in low-income years and losses in high-income years, planning software should show that benefit, too.

4) Software needs to help us actually create a plan with clients. This means not only being flexible enough to show alternative scenarios on the spot but also being able to modify the plan to show how the client will get back on track. Don’t make planning software the equivalent of a flight simulator, whereby all you can do is see the plane crash, but have no means to practice steering out of the crash. Software tools should be capable of showing a baseline scenario, potential adverse events, and the strategies to respond to them. And, of course, it wouldn’t hurt to be able to illustrate the potential impact of unexpected positive events, such as a strong bull market.

5) Software makers need to embrace the reality that planning is a process, not an event. The idea of culminating in a single financial plan, and then stamping it done, is the equivalent of a general drafting a battle plan and then walking away from the battle. He needs to be there to guide and adapt the plan as reality unfolds. In practice, planning software needs to update itself continuously (through account aggregation) and provide more meaningful ways for clients to track progress toward goals on a continual basis and see the points at which they’ll have to adjust along the way, so they always know where they stand.

6) The ultimate goal should be improving ease of use without throwing out the complex reality of our clients’ lives. While making software easier to use is crucial—and there’s nothing wrong with using simple default assumptions at the start—not having the ability to drill down further should no longer be acceptable.                        

—by Michael Kitces

Michael Kitces, CFP, is a Financial Planning contributing writer and a partner and director of research at Pinnacle Advisory Group in Columbia, Maryland. He’s also publisher of the planning industry blog “Nerd’s Eye View.” Follow him on Twitter at @MichaelKitces.

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