Time for a Financial Physical?

One of the most frequent questions asked by our readers is: “How often should a financial plan be updated?” While we are working toward the creation of dynamic financial plans and the way to keep them current, most planners still plan from a point in time. Financial well-being does change over time. Therefore, some financial advisors will say that you should have a yearly update to your plan. I believe that updating the plan depends less on the passage of time and more on changes to any of four factors: (i) your financial profile or financial “history and physical,” (ii) your goals, (iii) the economic environment, and (iv) the assumptions used in your plan.

Let’s say that you had a financial plan written several years ago. The real questions are: How closely has reality has tracked with the plan, and does the current reality lead to the accomplishment of your long-range goals and objectives? A brief comparison of your current financial profile, compared to where the plan said you would be, could indicate the need for an update. Let’s review some of the key elements of a comprehensive plan and ask how these factors might have changed over the past few years. Our firm has produced a checklist to consider for your “financial checkup.” To get it free go to www.dscottneal.com/checkup.

Assumptions

Because a financial plan involves a projection into the future, assumptions must be made about how the future will play out. It is vitally important for you to know what assumptions were used to generate the plan, and how close to reality those assumptions have turned out to be. Key assumptions are: income, inflation, investment return, tax rates, and spending. Some plans assume a rising standard of living while others assume a constant inflation-adjusted standard of living. It is important for you to know which was used and to gauge your performance accordingly.

Goals

Let’s face it, even long-term goals change over time. Having written and updated financial plans for the past 33+ years, I have watched as client goals have matured and changed over time. The most joyful time for both client and planner is to celebrate when a goal is achieved. Goals can become outdated and need to be revised or even eliminated. As you review your financial plan, note which of your goals the plan was trying to address at the time it was written and how those goals have changed since then. If your goals are different than they were then, it may be time for an update.

Net Worth

Most financial plans contain a presentation of your current financial net worth on the date of the plan, as well as an annual projection of net worth into the future. Recall that net worth is simply assets minus liabilities as of a given date. A review of your current net worth compared to what the plan projected your net worth would be at the end of 2018 should be considered in your present review. The longer the planning horizon, the more significant any present deviation becomes. Prior to retirement, net worth should be growing as you age; therefore, a shortfall between actual and planned net worth is more indicative of the need for a plan update.

Cash Flow

If you know me, you have probably heard me say that there are five things, and only five things, that you can do with each dollar that comes into your life each year. That dollar can be (i) used to pay taxes, (ii) used to make payments on debts, (iii) saved, (iv) given away, OR (v) spent. In other words, all dollars of income must go someplace each and every year. Changes in tax law occur nearly every year, and last year’s change was significant. The planner’s job is to help clients optimize how their cash inflow is used each year. As you might imagine, consumptive spending can sometimes get away from the best of us as the needs and wants of our families change or as our income grows or contracts. Casting a current cash flow statement with those five elements should be an annual ritual, and significant deviations may be a reason to update the plan.

Investment Returns and Inflation

A key element of most financial plans is the interplay between investment returns and inflation, called the real rate of return. If your plan was based on a long run average return of the stock market and inflation, you need to know that. Since 2000, real returns from the US stock market have been much less than the long-term averages. If your actual inflation-adjusted return has been significantly different than what was projected in your plan, an update to the plan is in order.

Economic Environment

The past 10 years have brought on significant changes to our economy. For a long-range plan, the key question is whether these changes have been normal, stationary, or structural. Have they been more impactful in ways that are different than past cycles? We believe that the Great Recession of 2008–09 and the recovery since then have been anything but normal. Moreover, this is all happening on the eve of the retirement of boomers, one of the greatest demographic shifts that our economy has ever witnessed. Being attentive to these changes is key to understanding how existing plans ought to be updated and new plans developed.

Scott Neal, CPA, CFP® is president of D. Scott Neal, Inc. with offices in Lexington and Louisville. Comments and questions are welcome. Check out his blog at www.dscottneal.com