Do you need a financial plan? Maybe not. A complete written financial plan is a solid point-in-time analysis. This differs from general finance. planning, which the Certified Financial Planning Board describes as advice on how to achieve short-term and long-term financial goals. You can’t have a financial plan without financial planning, but you don’t need a full written plan to benefit from ongoing financial advice.
What is a financial plan?
What is included in a financial plan or model? The deliverables and level of detail in the analysis vary among advisory firms. At Darrow Wealth Management, all of our financial models include cash flow, net worth and retirement projections, as well as Monte Carlo stress test analysis. Other modules and areas of analysis depend on the situation.
Examples include modeling the sale of a business, a major purchase (for example, a vacation home), what-if analyses, or liquidation strategies for stock options after an IPO.
This is when you probably need a financial plan
A template is the only way to bring your entire financial picture together. From cash flows to savings strategies to tax implications, a plan helps you quantify different planning approaches, compare scenarios, and weigh options to reach your goals.
Robust plans are typically more appropriate in situations where the following three factors apply:
- Objectives are clear, measurable, and basic assumptions can be made with a reasonable degree of certainty.
- There is complexity, planning options, and a decision to make after analysis.
- Need to quantify the opportunities and implications of tax planning
Data quality is key in financial modeling
Garbage in garbage out. A financial plan cannot be useful unless the assumptions included in it are precise and well defined. What good is a plan that shows you can retire in Florida tax-free at age 67 if you don’t want to work a day after age 60 or move out of California?
Other common examples of confusing data include: pondering career changes (starting a business or having one spouse stay at home), disagreements about the purchase price of a new or second home, or the timing of Y issues related to value around the sale of a business or profit from a windfall.
Sometimes these questions are great for what-if scenarios, but not if they’re a key part of the entire analysis. Many people will benefit from making a comprehensive financial plan at some point in their lives. But it doesn’t always make sense now.
What decision(s) can you make with the results?
If there is no likely decision or action to come out of the analysis, you may not need a financial plan. Models are most effective when there are planning opportunities, multiple (perhaps competing) goals, or alternative paths to consider.
Here are several examples:
- After a windfall, determine how to allocate the extra money between college savings plans, a retirement brokerage account, the boat’s maximum budget
- Assess your after-tax income stream if you retire at age 55 or 62, how a potential vacation home purchase will affect cash flows, and whether it’s better to buy with cash or a mortgage
- Analyze pre-tax contributions versus Roth 401(k) contributions, Mega Backdoor Roth, or a Roth conversion strategy in retirement considering cash flow needs, tax savings, and legacy goals
As the above scenarios illustrate, to simultaneously analyze all relevant aspects of a complex decision, you’ll need a financial plan. While a blueprint is the only way to put all the pieces together, it’s also important that the plan be actionable and decision-driven.
Sometimes investors aren’t faced with a big decision and just need to get an idea of what they could get by maximizing their 401(k) in retirement income.
Need to quantify tax planning opportunities
It is always important not to let the tax tail wag the dog when making financial decisions. But many money movements have tax implications and cash flow considerations. A financial plan integrates these components, balancing alignment with long-term wealth goals.
For example, if someone has charitable leanings, there are planning opportunities with donor-recommended funds and qualified charitable distributions. Knowing this goal, tax planning with Roth strategies may not make sense in the context of the whole situation. A financial model can help quantify the best approach.
Alternatively, if the goal is to leave an inheritance to the family, investors may prefer to pay the tax using Roth strategies even if there are no tax savings. Or since non-spouse beneficiaries are now required to have inherited retirement accounts in 10 years, it may be better to spend these assets since taxable brokerage accounts are eligible for an increase in basis (depending on current legislation). A plan can assess the feasibility and magnitude of legacy planning from a cash flow perspective to help ensure that the individual does not risk running out of money.
In a final example, consider an employee with incentive stock options (ISOs) after an initial public offering. If held long enough, ISOs offer tax benefits. However, there is a real risk that the share price could decline substantially during this time. A financial plan could help balance the optimal exercise and sales strategy for various grants from a tax perspective with the financing needs for other goals.
Get help with financial planning if you don’t need a full financial plan
Financial models can be powerful planning tools in the right situations. But sometimes, there’s too much focus on the deliverable as some kind of magic bullet (which it’s not). One of the reasons a complete plan is not always necessary is that advisors often have other tools for projections and calculations. And software is not always the solution either! A key reason to work with a fiduciary advisor is their experience and personal knowledge of your financial situation and goals. This goes far beyond fancy reports and Excel spreadsheets.