Broker Check

Hammer Home the Difference Between Projections and Reality

by Howard Hook, CFP®, CPA

As published in Financial Advisor IQ, January 30, 2014

Advisor-client misunderstandings are never welcome. They can be particularly damaging when they concern investment returns and other numbers crucial to a financial plan. Savvy advisors will take pains to make sure their clients don’t confuse projections with gospel.

For example, most retirement-planning software assumes a constant rate of return on assets each year during retirement. Of course, in real life we know this never occurs. Returns vary greatly from year to year and may not average out to the projected rate. Small discrepancies can have a major impact on the client’s results, especially over long periods.

Fortunately, advisors can do several things to help reduce misunderstandings when reality and plan diverge. First, they can explain to clients that projections are mere estimates based on a set of assumptions. Second, they can stress that they will continually monitor and update the projections throughout the planning period to help reach the client’s goals.

Additionally, clients tend to focus on the amount of assets they hope to have at the end of the planning period. Advisors should try to direct their focus away from that number and toward the trend instead. For example, instead of saying, “At age 90, your investable assets will be only $25,000,” it might be more constructive to say, “Your investable assets peak at age 75. Based on a life expectancy of 90, that jeopardizes your ability to maintain your lifestyle.”

Advisors can also help reduce client misperceptions by running multiple retirement-planning projections that use different assumptions. This technique can provide a range of results and help the client grasp the various ways in which reality may diverge from projections.

It’s equally important to manage expectations in tax planning, especially as both federal and state income taxes continue to rise. When income restrictions vanished in 2010, allowing anyone to convert traditional IRA money into a Roth IRA, many advisors managed such conversions for clients. And for investors expecting to move into a higher tax bracket after retirement, a Roth may have made sense. But the decision is much more complicated than comparing marginal tax brackets in the IRS instruction booklet. Current and future state and local income taxes need to be taken into consideration too. For example, a client who lives in New York City pays federal, New York State and New York City income tax. If that client anticipates moving to Florida after retirement, it may not make sense to convert IRA assets to a Roth IRA even if the client’s federal bracket rises in retirement, because Florida residents pay no state income tax.

Cash flow may be the area where projections need to be managed most carefully, as 

it’s the jumping-off point for many other pieces of a client’s financial plan. Responsible retirement projections, insurance-needs analysis and an appropriate investment strategy all depend upon an accurate cash flow report.

Yet the cash flow report is often where advisors have the most difficulty getting complete information from clients. Bonuses and self-employment income complicate the inflows column, and clients sometimes struggle to provide meaningful expense estimates. “We spend approximately $10,000 a month — just use that as our number” is a sentence many advisors have heard. They need to be resolute and insist on a more accurate number.

Advisors should help clients flesh out their cash flow reports (both inflows and outflows) by walking them through expenses and providing “clues” to help nail them down. “How often do you go out to dinner, and how much do you typically spend?” is a good way to help a client estimate entertainment costs. Breaking the cash flow down into small pieces improves accuracy and often brings the client new insights.

In the end, misunderstandings are best avoided by taking the time to explain the limitations of planning projections earlier rather than later. This will go a long way toward managing clients’ expectations and preventing disconnects.