For example most retired investors I deal with want to maximise income whilst protecting some or all of their capital from inflation. These people have the same primary objective and whether they have two grandchildren, six grandchildren or a daughter living with another woman is not hugely relevant.
Many financial plans go to great effort to describe irrelevant objectives when in fact because, of various shortcomings, they fail to achieve the primary objective. Clients frequently have one primary objective, like maximising income and may have secondary objectives, like leaving $20,000 to the Old Cats Home.
But when push comes to shove the primary objective usually dominates and this is where an adviser's emphasis should be. The FMA's focus should be on ensuring that primary objectives are achievable and realistic as part of the FMA's overarching objective of fostering confidence in the financial markets.
So let's look at a typical objective and whether it is achievable or not.
The key part of any financial plan is the financial model which has as key inputs; the client's savings, client income requirements, asset allocation and return assumptions to name the main ones.
Any financial model is necessarily "an abstraction of reality" (That is about the only thing I remember from the first year of my management studies degree back in 1976) but the test of any model is how closely it models reality and because low returns don't sit well with high fees things tend to get abnormally abstracted.
The area where many retirement planning models deviate from reality is of course forecasting returns and as Rob Arnott remarked in the Financial Analysts Journal a while back, the funny thing is that no one seems to underestimate returns! Incidentally some time ago the strategy of overestimation reached a low point when two luminaries from Armstrong Jones forecast 10 per cent pa returns from a balanced portfolio after fees, tax and inflation.
Things have improved but frequently there is still a huge gap between reality and forecasts. This problem is compounded because financial planners' models don't differentiate between capital gain and income when the former is a lot more uncertain than the latter.
I have in front of me a recommendation for a retired individual. In the report the AFA acknowledges that the client has an objective of achieving pre-tax, post-fee income of $30,000 pa and inflation proofing all of the capital. He then assures the client that his plan will achieve the objective. The client has $650,000 to invest so you might think that achieving a 5 per cent yield on $650,000 is no big problem - but you would be wrong because the plan directs the client's funds largely into esoteric, high cost managed products which produce next to no dividend.
Using forecasts for returns consistent with the projections of independent experts and actual dividend data I calculated that the dividend income would be just $12,000 before fees and using actual fee data that annual monitoring fees would be $10,000 leaving the client with $2,000!
So how on earth this plan is going to produce $30,000 pa in cash for the client to live on is a mystery and what is worse nowhere does the client read what the actual cash generated by the plan will be.
Clearly the plan requires the stock market to produce consistent capital growth in order to fund the client's living expenses but even here things are tight - because using realistic data, estimated capital growth plus income after fees is just $38,000 pa. So if we take off $30,000 for living expenses that leaves $8,000 to protect against inflation on a sum of $650,000. Just 2 per cent inflation would mean $13,000 a year was needed.
Plans like this are not uncommon so the extent to which reality is abstracted in financial plans is a big issue.
The Financial Conduct Authority (FCA) in the UK has determined, for example, what forecast returns are realistic and compelled advisers to more closely model reality.
In the real world Aunt Daisy's objective of "housing and feeding her pet ferret until the end of its natural life" does not differentiate her objectives from everybody else's although seeing it in print may make her feel good and forget about the fees she is paying.
The big issue is that financial plans should have some hope of doing what they say they are going to do over the long run. Many - maybe most - don't so this is where the FMA's emphasis should be as part of its own objective of increasing fairness and confidence in the financial markets.
It is probably appropriate here to acknowledge the good work Sean Hughes, departing CEO of the FMA, has done.
He has remodelled what was an ineffective organisation, which is being charitable, into one which is variously feared and respected by market participants. Some commentators have suggested that the FMA failed investors as regards the Ross Asset Management (RAM) fiasco but, as this column highlighted at the time, the blame lay with the Code Committee and as Mr Hughes pointed out investors need to take some responsibility for their own actions.
A cursory examination of RAM portfolios and their concentration on small mining stocks should have raised red flags to most people. Let's hope that Simon Allen, Chairman of the FMA, can find someone from overseas who has no local affiliations and can thus do his/her job as vigorously and effectively as Sean Hughes did.
