Demystifying Financial Plans: Stress-Test for the Real World
“Great news honey, we can finally take that dream Hawaii vacation because the probability of success for our financial plan went up 2%!”
Sounds a bit absurd, right?
That’s because we do not understand the real world in percentages. It’s not intuitive.
The truth is, most of our clients aren’t immersed in numbers and percentages all day long. In fact, there’s substantial scientific evidence supporting the notion that humans find statistics rather tricky to grasp naturally.
The Science of Making Sense: Stress Testing in Layman’s Terms
As financial planners, we have an opportunity to use alternative, digestible ways of illustrating their ‘numbers’ in easy to understand language.
We can employ a simple yet powerful tool called “stress testing” to scrutinize their plans, unveil potential risks, and equip them with the knowledge needed to make informed decisions.
But first: why should we even bother with stress testing in the first place?
Variables Beyond Market Returns: Inflation, Priorities, and Life’s Uncertainties
Stress testing, in any plan, helps gauge how resilient it is. Most commonly, these tests assume that the biggest variable affecting financial plans is unpredictable market returns. If that’s your assumption, you might think a fancy Monte Carlo simulation covering all investment return possibilities solves the issue, Right? Wrong!
Client incomes and expenses are mere estimates, and after all, so are their priorities. That dream Hawaii vacation could turn into a Bora Bora adventure, or maybe clients underestimated their retirement expenses. Heck, inflation isn’t always a steady 2.2% as it’s been over the last two decades.
Uncovering the Human Element: Emotional Responses to Plans
Focusing solely on market scenarios is a decent start but overlooks crucial life events that clients can relate to.
Scenario-based testing on various assumptions helps you better understand your clients’ emotional responses: Some clients might shrug off a 15% dip in future income, yet would DREAD the idea of missing out on holiday gatherings.
Your clients’ hopes and fears aren’t revealed by a 96% versus 97.5% chance of plan success. To capture their attention, you must highlight real-world scenarios that allow us to collaborate with your clients in creating a plan they comprehend, complete with risks they helped define.
Crafting Meaning over Percentages to Strengthen the Client-Advisor Bond
Updating the plan yearly strengthens your relationship and underscores that you’re more than just an investment advisor; you’re a partner in helping them craft their ideal retirement life.
Sure, you could employ statistics like a Monte Carlo simulation to predict outcomes in stressful scenarios, but the critical aspect is testing for stress across all variables that could substantially impact plan success— not just market performance.
CEO and Co-Founder
PlanScout
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