GAP Analysis… it’s the New Black
Financial planning has been experiencing a paradigm shift over the last decade or more, a change from transaction hunting to a service based farming approach. This is not just a reflection of the transition from on-going brokerage income to fee for service it is an identify shift for advisers and their clients. Historically even though planners talked about long term objectives and client goals the real focus was on short term results focusing on impressive returns, tax minimisation and asset protection. Perhaps it was seen that this type of advice would bring instant satisfaction to clients and referral success for the adviser.
With the advent of new computer modelling the introduction of wealth “GAP Analysis” began to take hold under the guise of a service based outcome financial model. The ever increasing length of post retirement life expectancy “longevity risk” and the demographic baby boomer pressure on the Social Security safety meant that client fears also increased as the scarcity of not having enough in the future grew.
The GFC only compounded this situation as many wealth and retirement portfolios were devastated by over exposure to equity markets and leverage, often at levels well above their accepted risk profiles. Maybe much of this behaviour can be explained as a race for higher and higher performance and a need for faster wealth accumulation to expel the fear of future financial deficiency. So what has this all meant for the future of the financial planning business ? And how best do we go about approaching the process of wealth and retirement planning in an environment of an identity paradigm shift ?
Perhaps the GAP Analysis concept provides an answer !
This concept is based on the following processes;
The client’s current asset position in dollar value is measured consisting of superannuation and other investments outside super.
A projection of time from retirement age to life expectancy is taken and combined with a clear estimate of post retirement net income from discussions with the client. This allows for the calculation of a cylinder of desired capital that will, based on a conservative rate of return, produce the ability for the client to be self-sufficient in these years including an allowance for regular travel, replacement of capital items and some residual estate, if desired. In some cases the calculation is adjusted to allowance for the client to receive a component of Age Pension benefits to subsidise retirement income and reduce drawdown of capital.
The process then is to produce a strategy, or if you like a plan, to take the client from present time to the future projected dollar cylinder position based on the concept of a money “Engine Room” with the fuel being the client’s on-going pre-tax and/or net disposable income.
The structure of the “Engine Room” is then developed along the lines of the following five design elements;
• Portfolio (risk | return)
• Tax Planning
• Debt Management
• Cash flow
In most cases a client’s engine room is not running efficiently, “it’s just not tuned up” and therefore without adjustment the likely outcome is that the client will arrive at retirement with a significant financial shortfall, often well below the ideal level needed for self-sufficiency in retirement. This will mean unnecessary reliance on the Age Pension, eventual back trading of their residence to release equity, lack of an estate to pass on to loved ones and emotional anguish for the client in their retirement years.
Inside this Gap Analysis financial strategy the planner’s job therefore involves taking the five elements and arranging them in the most efficiently manner for the client to close the Gap, if it exists that is, some clients are well off and the modelling just provides further confidence for them.
For the majority however the job is to restore emotional comfort and financial motivation for the client. It is a potential “take action” plan as the client now sees an obtainable compelling financial future rather than having to suffer on-going fear of a future of scarcity, whether that is conscious or unconscious in the client’s mind.
Of course, in some cases either the time to retirement is too short or current assets and/or income are too low to permit the financial strategy to take effect and the Gap at retirement still remains if, even with planner help, it may have been somewhat reduced. In these cases the truth of the situation needs to be addressed with the client now, in present time, well before the years to retirement roll by and the client arrives and is then advised of the financial disappointment then.
Confrontation of the truth in such a situation allows for a change in lifestyle or behaviour now that can produce a more attractive future result, perhaps the client might even need to produce additional income, revise their retirement expectations or possibly decide to remain in the workforce longer. This type of discussion with a client can be challenging but in my experience it builds trust and in many cases it crystallises knowledge that the client is already aware of at some level.
The five element approach takes the emphasis off any tendency on the client’s behalf to focusing only on portfolio performance, and in fact especially short term portfolio performance, as the other elements come into play and balance and importance of the long term is the focus of the client’s mind. This can also assist the adviser in clarifying the picture of an overall value proposition. In addition, this strategy allows for the opportunity to provide a direct comparison between the expected portfolio return from the client’s risk profile survey and the return required to close the gap can be analysed. This is a fantastic way of confronting and discussing with the client any mismatch that maybe present as often in the past advisers have fallen prey to avoiding this issue only to error on the side of over or under allocating growth asset sector resources resulting in future client disappointment when outcomes are not met or when significant short term growth markets fluctuate downward.
The modern “Holistic Comprehensive Planning” approach of today incorporates not only wealth creation and retirement but also asset protection and estate planning. The Gap Analysis model allows for direct links to these additional areas as insurance asset protection is an easy explanation when the client realises the power and value of their money engine room, especially given the high value of their income in fuelling the success of the model. This allows for the concept of Income Protection to be incorporated into the plan progressing then into Trauma, Disability and Life cover… the Engine Room “Cup of Protection”.
The opportunity to refer the client to their lawyer for specialist Estate Planning also blends into the process as long term gap planning raises the likely hood of a residual estate at the end of life expectancy and/or it’s easy to incorporate estate planning focus into the proceeds from payout of Life cover in the event of untimely death.
Finally, like all long term projects there is the need for progress to be measured and compared against a target and this provides the avenue for regular reviews to be an integral part of the Gap Analysis model. The departure from traditional transaction based short term plus alpha performance returns, hunting style advising, allows the adviser to have the client focus on the average over the longer term to retirement rather than attempting to explain short term fluctuations in the various portfolio asset sectors at each review.