It is a pity to see more advisers using risk profiling tools than cashflow planning tools.
Indeed, just 2 per cent of advice firms have no risk profiling tools, while over six times that – 15 per cent – do not use long-term cashflow planning tools, according to research from Platforum.
In its recent consultation, the FCA has asked whether cashflow planning should be used for defined benefit transfer analysis, having already strongly hinted it should certainly be for clients in decumulation, in particular.
Just under four out of 10 advisers (39 per cent) use cashflow planning for at least three-quarters of their retirement clients. But a greater number (43 per cent) only use the technique on less than a quarter of those clients – or none at all.
Of course, there are clients approaching or at retirement whose resources are so vast, or whose needs are so modest, they do not need to worry about the relationship between their income and their spending. But most people do.
And any client with a significant excess of incomings over outgoings might want to consider using the inheritance tax regular gifts from income exemption.
Cashflow planning requires advisers to understand clients’ income and expenditure patterns both now and in the future. As one adviser told researchers:
“A lot of clients are surprised at how much they are spending. We identify the shortfalls and do a very detailed cashflow. A lot of people think they will have a higher income than they actually receive.”
So why is cashflow planning not used much more? Clients do not analyse their spending for the same reason many advisers seldom bother: it is not very exciting and it can be rather long-winded.
That said, with itemised bank and credit card accounts, it is now much easier than it has ever been, and with open banking due to arrive in January next year, it should become a doddle – at least in theory.
Under this Government-inspired initiative, bank account holders will be able to give consent to authorised third parties to access their accounts to extract data. It will be interesting to see how the cashflow planning software businesses will help advisers take advantage of this.
Cashflow planning and monitoring provides a core tool to enrich advice and justify annual fees to clients. The main anxiety clients have is that they will run out of cash before they reach the end of their lives.
With just three key variables – pension and other income, investment values and expenditure levels – monitoring this position and adjusting for movements in any of them should be central to client reviews. The original long-term cashflow forecast for a client should set the basic parameters for the rest of their lives.
That said, one thing is certain: none of the figures will come out exactly as projected in reality. People will overspend or underspend, investments will fluctuate and events such as deaths, divorce and illness will happen. Clients will also often live longer than they expect, so most projections should be safely long term – to at least age 105.
Putting together the initial expenditure plan requires facts based on actual figures for spending, and clients prepared to engage in an imaginative exercise of picturing their future needs and wants.
Advisers have a wealth of information and experience from other clients about how age, infirmity and lifestyles may change, so they can feed this into the process and construct realistic projections.
Then, year by year, advisers can monitor clients’ expenditure against their available inflows of income and capital. If a client is spending more or less than expected, this will impact on their investment planning, and they may need to adjust their spending.
An overspending client might not be aware of the implications. An analysis of expenditure patterns makes it easier to identify possible areas of saving. Tax planning might also help increase a client’s net spendable income.
A client who is underspending could hold back on drawing down their pension fund to preserve a greater IHT-free fund or make additional gifts. They might also want to reduce the level of the investment risks they are taking.
Cashflow planning is also one of the best ways to test a client’s capacity for loss and tolerance of risk by looking at various outcomes for investment returns, income and expenditure. But that is a separate subject for another occasion.
It is time more advisers looked beyond pure investment advice to full financial planning.
Danby Bloch is chairman of Helm Godfrey and consultant at Platforum