It is easier and cheaper than ever to invest money or to start a pension.
In addition, we like to say that long term investing is, to a fair degree, solved. We do accept that we cannot tell you what the perfect portfolio is going to look like for the next 30 years. However, we and many others have a fairly good idea from economics and history about what works and what does not.
Due to this, there are extremely easy to access services available which may offer a portfolio quite like the ones we put together for our clients.
Why might I need a financial planner?
Any advice which revolves around looking at investing as the problem to solve, trying to pick the best fund, stock, or asset class, is not financial planning. It is more likely to be harmful to long term financial health than it is to improve it.
We know that most experts are bad at predictions. They cannot predict the future, and you should not listen to them if they try to. This is something which does not just apply to finance.
However true experts are fairly good at assessing base rates. Base rates are known probabilities.
For example, we will never tell you which fund manager or which stock is going to do well in the next 10 years. That is a prediction. What we can tell you are the base rates. We can tell you that 90% of active fund managers trail the index over 10-year periods and 63% of individual stocks trail the market over the same period. Knowing this is particularly important if you are making an investment decision.
Good financial planning will have three elements to it:
- Knowledge of base rates.
- Technical competence
- Understanding Human Psychology.
These can be applied to help people arrive at high-quality financial decisions. There are a few areas where this can be applied best:
Goal formation and quantification.
Before anyone starts thinking about what to do with their money, they need to know why they are doing it. This has probably got the least amount of attention in the past. Even now it is just starting to get the amount of attention that it deserves in the overall process of managing money.
How you spend your time, who you spend your time with, the job that you take, how much you save, what you spend your money on, and how you invest. All influence, and are influenced by, your financial goals.
Now, that might sound obvious when you hear it, like, of course, of course, that makes sense. But the problem is that humans are bad at setting goals which align with a meaningful life.[1]
We are really bad at predicting our future emotions. If you think about setting an ambitious goal, like early retirement for example. You may make significant sacrifices today and take an excessive risk today to achieve this aggressive goal. However, you may find when you get there that you’re not actually any happier.
Similarly, a study of Lottery winners and accident victims found that recent paraplegics and lottery winners converged at their previous levels of happiness or sadness not long after their life-changing event.[2] This reflects what we said in a recent post that we are highly adaptable to changing circumstances in terms of our happiness.
Getting a new car might feel good for the first week or something like that. But those feelings do not last.
The things we wrote about in our recent post on happiness act as base rates when we talk about effective goal setting.
Once you have figured out what those meaningful goals are, the next thing to do is just as important. This is figuring out how much they are going to cost.
We think it is important to step back and ask if the goal makes sense, but it is an important next step to price the goal. How much does achieving this goal cost? And then what does that mean for how much you need to save? How long do you need to work?
Now, what quantifying goals gives you is the path to achieving them. It also hopefully stops you aimlessly chasing more. It helps you decide what is “enough” which can actually be harder than pursuing “more”.
Asset allocation
Given a set of meaningful goals and their estimated costs, how should you allocate your financial assets? Not just those within a portfolio but everything; investments, pensions, savings, income, property, and everything else. Without having goals and quantifying them, allocating assets correctly would be difficult.
Such a decision would consider other non-financial assets. One of the biggest, especially for younger people, is human capital. In this context this is someone’s ability to earn money in the future. If you contrast a professor with a commissioned salesperson in a volatile industry, one can take more risk with their financial assets because their human capital is so much more stable.
Another is someone’s tolerance for taking risk. This is how well someone can withstand the ups and downs of the markets. The lower this is the higher the chance of someone making ill-judged short-term bets when markets go down which happens quite regularly. Even worse they may decide that investing is not for them and keep their money in cash for the foreseeable future.
A more aggressive portfolio might help you achieve a goal quicker or with less additional savings. However, you also might have a more uncertain outcome and it might be harder to stick with that more aggressive portfolio if markets are volatile. This would be even more likely especially if you do not have a goal associated with the strategy.
Conversely, a portfolio that is too conservative can also affect how likely is to achieve their goals.
Insurance needs analysis
Especially for those who are not close to retirement, their biggest asset is themselves. Human capital can go away or be impaired if a person dies unexpectedly or if they become disabled.
It can be quite morbid to think about how much insurance you might need if you were to die or become disabled. However, it is critical.
Tax Awareness
Given a set of goals and asset allocation strategy, there should always be a consideration for taxes. You might implement a strategy to achieve a goal differently if it is not tax efficient.
Planning for minimising taxes on death or during retirement is an example of this.
Financial Products
Once you have allocated your financial assets and what insurance products you need, you need to be able to implement them.
Choosing financial products and having product knowledge, is where a lot of financial advice starts. Bad financial advice starts with products and may at best only pay lip service to the things we have mentioned before.
Why can’t I do all that myself?
We all know that all the information we need to make good financial decisions is widely available for little or no cost. So why not just deal with it all yourself?
Most of us are not that great at making good decisions quickly. We tend to let narrow framing, confirmation bias, short term emotions and overconfidence contaminate the decision-making process. In addition, we all change over time. All this repeatedly throws up new decisions when we have not truly decided what to do with the previous ones.
One of the best ways to overcome this is to get an outside view by consulting with an expert.
Whilst information is freely available online, there is a lot of it. It is not always easy to know which bit of information is trying to help you and which is trying to sell you something. An expert should be able to judge the credibility of information quickly to reduce the number of inputs in a decision. This also saves you time both in researching a decision but also in implementing it.
Another key element of the value a financial planner offers is helping a client stick to a strategy. An example of this is how most would agree the three pillars of a sensible investment approach are diversification, cost minimization and long-term discipline. These are simple in theory, but some find it hard to stick to. The same can apply to a savings or gifting strategy.
Financial planning starts with setting meaningful goals and having a well thought out strategies to achieve them. Only then do products, and portfolio strategies come in. We have looked at the value of advice before in a previous post.
If you want to have a chat about getting proper financial planning, feel free to book a free no-obligation chat here.
[1] Wilson, T. D., & Gilbert, D. T. (2003). Affective forecasting. Advances in Experimental Social Psychology, 35, 345-411.
[2] Brickman, Philip & Coates, Dan & Janoff-Bulman, Ronnie. (1978). Lottery Winners and Accident Victims: Is Happiness Relative?. Journal of personality and social psychology. 36. 917-27. 10.1037/0022-3514.36.8.917.
