The Stability of Your Financial Plan During Volatile TimesMay 6, 2020 9:55 am
During these unprecedented times, many clients are wondering if their goals have been derailed and if so, what it will take to get them back on track. There is no doubt that things have changed, and as a result many of us will need to adjust accordingly. But just how much do you need to change? You may not have to sacrifice as much as you think.
The Power of Monte Carlo Analysis
We have been accounting for volatility in our financial plans for some time now. While traditional linear projections are important, they do not account for fluctuations in the market. Clients need to understand what impact the markets can have on their ability to save and spend, and how long their money will last. While no one has a crystal ball to predict the future, it is the theory of the Law of Large Numbers which tells us that the larger the number of trials, the more accurate the average outcome. Monte Carlo uses 1,000 different trials of historical market returns and tests the impact to the plan based on sequencing of the returns, as timing matters. The probability tool strives to produce a range of potential outcomes, helping clients and advisors understand the scope of decisions to be made. At the core of Monte Carlo analysis are two components that drive results: correlation and standard deviation.
• Correlation examines the relationship between variables and how one impacts the other, and
• Standard Deviation is a measure of risk (volatility) used to determine the range of potential outcomes.
Because the results produce an upside, downside, and median outcome, we can see the best, worst, and most likely scenario of the financial plan. A range of possibilities helps advisors craft scenarios which help illustrate how clients can still meet their goals under various assumptions.
Roadblocks Require Detours
Despite accounting for volatility, there is always the chance of realizing the outlier worst-case scenario. For example, experiencing large losses the year you decide to retire would be the worst-case scenario from a timing perspective when planning for the long haul, i.e. a 30-year retirement time frame. Advisors forecast the amount of assets a client is predicted to have at the start of retirement based on certain growth assumptions. However, if the market experiences very poor returns just prior to retirement, the asset level at the start of retirement is now far less, yet must still last for the same duration. In this case, one must be willing to adapt and accept the necessity of periodic lifestyle changes that may be required in response to a new level of risk. Risk Advisor Anil Suri said it best when he used the analogy of Google Maps to describe probabilistic goal achievement in a financial plan. When you enter your desired destination into your GPS prior to leaving your house, you receive a precise route and estimated arrival time. However, if an accident occurs while you are enroute, your estimated time of arrival has now changed. You must then navigate an alternate route in order to still reach your destination in a timely manner.
So, what do you do when daily swings in the market are big enough to skew your financial plan in drastic ways? Although we have been experiencing unprecedented times, the message is the same: Monitor, don’t panic. While the probability score you receive encompasses a plethora of return possibilities, it still represents a single point in time. Try not to worry about daily fluctuations but rather remain focused on the big picture and your continued ability to meet your goals. It is crucial to check in periodically with your advisor and revisit your progress to goals. With personal life, the markets, and economy constantly changing, it is good to know if any adjustments should be made along the way, making the end goal(s) easier to achieve.
Be willing to make occasional modifications when necessary. Small tweaks that you can make in order to keep your plan on track may include changes to withdrawal rates, a pause to inflationary increases within your budget, or postponing big vacations and house projects, to name a few. If you haven’t yet retired, you may choose to extend retirement a few more months or be open to part-time work. Work with your advisor to develop a bucket strategy, where you plan to spend more conservative assets first, while keeping your overall allocation intact.
It is our philosophy to remain conservative in nature when financial planning. We aim to achieve a high probability score, setting proper expectations we feel are reasonable to meet even with the unpredictability in the market. It is because of this that we have been able to help our clients keep their plan on track with minimal adjustments. If you are interested in revisiting your financial plan, contact your advisor to schedule an appointment.
The information contained in this post is not intended as investment, tax or legal advice. StrategicPoint Investment Advisors assumes no responsibility for any action or inaction resulting from the contents herein. Kristina’s opinions and comments expressed on this site are her own and may not accurately reflect those of the firm or our parent company, Focus Financial Partners. Third party content does not reflect the view of the firm and is not reviewed for completeness or accuracy. It is provided for ease of reference.