The Wealth Management Process – Goals Meet Money

Published On: January 2, 2024

Written by: Ben Atwater and Matt Malick

Most new clients come to us due to a major life event like a job change, imminent retirement, the death of a loved one, a divorce, the sale of a business or a property, etc. These events trigger a desire to plan your financial future.

The planning process is never ending and always changing. A plan is something we are always adapting and updating.

You need to start somewhere though, so this essay will dive further into our planning process.

This is the third essay in our wealth management series. In the first, we focused on getting to know our clients​ and understanding their goals.  In the second, we focused on the money side of wealth management, namely looking at retirement assets and your retirement income sources. For this third installment, we will focus on how your goals and your money intersect to create the best likelihood of retirement success.

We once heard an adage that investors focus on percentages on the way up and dollars on the way down. In other words, people do not enjoy gains as acutely as they feel the anguish of losses. Therefore, when creating a wealth management plan, you must understand your true risk tolerance and the best way to do that is to stress test a hypothetical portfolio. We can do this using our Wealth Management software, MoneyGuide.

For example, a 30% stock and 70% bond portfolio lost about 4% during the Great Recession, from November 2007 through February 2009, which using a $2.5 million portfolio as an example would equate to a $100,000 loss. A portfolio invested 60% in stocks and 40% in bonds would have lost 24% or $600,000. While a 100% stock portfolio would have lost 51% or $1,275,000.

Of course, in every case where investors held their portfolios through thick and thin, these losses were temporary, and the accounts have since rebounded and grown substantially.

But too many people did not hold and paid a dear price for bailing. One day another Great Recession will befall us. Given this fact, investors need to understand what kind of pain they can endure on a path to meeting their goals. Markets are unpredictable and impossible to time. When markets are high and things look rosy, it is easy to think you have a high risk tolerance.

The more aggressive you are (or the more willing you are to risk losses), the higher your long-term return has been, at least historically. Using asset class data from 1990 through 2020, MoneyGuide shows us the average return, the worst one-year return and the standard deviation of each of the three previously referenced sample allocations over these 30 years. (It is important to note that this was an extremely high returning 30-year period, on average, with cash returning 4.24%, bonds returning 6.49% and stocks returning 11.21%, on an average annual basis, well above century averages.)

Your financial goals (how much you are going to spend in retirement), juxtaposed against these asset allocation examples with wide ranging returns and risk parameters, creates a need to evaluate how much return you need and how much risk your money can endure (this does not include how much risk you can psychologically tolerate). The best tool to determine this is the Monte Carlo analysis.

In our case, a Monte Carlo analysis takes a financial plan’s spending goals and tests those against 1,000 sets of random, but historical (or we can opt for projected), market returns. The software places the historical returns in 1,000 random sets for it to examine many different potential markets and how your money will hold up against those markets.

Now, let us look at an actual client situation where we will use the above three sample asset allocations and share with you how this client’s Monte Carlo analysis fared in each allocation. In other words, for each of the above allocations, how many times out of 1,000 scenarios does the software predict success?

This client is in good shape. At a balanced allocation of 60% stock and 40% bond, they have an 82% probability of success, and they are in the confidence zone. At 30% stocks, they are simply not generating enough return to meet their long-term spending goals.

And at 100% stocks, statistically, they have an even higher probability of success.  But a higher equity allocation will all but guarantee years where they lose substantial sums. When these losses happen, the client cannot waver, no matter how bad they think things are, because abandoning the 100% allocation after a big loss would ruin any hopes of achieving their retirement aspirations.

Where would you be comfortable? At 60% stocks or 100% stocks?

What other factors are at play as we refine a financial plan?

In our last installment in this series, we will delve more into a few of the variables in a financial plan to better understand what drives success. It is not simply asset allocation and investment returns, there are other more controllable factors that can help us plan better.

Hint: Most of them are things people do not want to hear.