What assumptions do you use in your cashflow forecasting?
For financial professionals only
Chris Budd is Chair of the Initiative for Financial Wellbeing (IFW), a not for profit, member led organisation dedicated helping advisers to help their clients become happier not just wealthier. In this short article, he questions the assumptions that lie behind a cashflow forecast.
Let me ask you a question. It’s a two-parter.
The first part is this: when you build a financial plan, what assumptions do you use? Stop here for a moment, if you would, and write down three of the assumptions that you typically use for a cashflow forecast.
Now we come to the second part, which is the real question. You see, the first part was a bit of a trick question.
The real question is this: when I asked you to write down assumptions, did you write down numbers, or life objectives?
I was discussing this with an adviser recently. One of his clients had spent time in lockdown constructing their own forecast and the resulting spreadsheet concluded that they’d be able to retire at 55.
During a meeting, the adviser went through the assumptions the client had used, comparing them with the cashflow forecast they’d already provided. He said the numbers they’d used for growth, RPI etc. were a little different.
But these weren’t the assumptions I would’ve challenged. Instead, I’d want to know what assumptions they’d based the decision to retire at 55 on. How might they spend their time in retirement? If they stopped work at 55, they were unlikely to sit at home all day long. What were their plans?
If they stopped work, they would lose a lot of their social contacts – what were they going to do to replace those? What about living a meaningful existence? What was going to give their lives purpose in retirement? Is there anything they wanted to do – not bucket list items or goals to achieve during the day, but things that get you out of bed in the first place?
…and there’s assumptions
I was looking at some client files for an Initiative for Financial Wellbeing (IFW) audit (where we ask firms a series of questions to identify whether they’re delivering a financial wellbeing-oriented service).
In one of the files, the client had stated that they needed £200k annual income in retirement. In another, the client stated that they needed £300k p.a. in retirement for the life they wanted.
There are so many assumptions in these two statements. What is the lifestyle they want? The answer to this question alone will reveal all sorts of assumptions about what might be achievable, what’s expected of us, permission – fascinating topics for discussion.
I wondered what it was about the second client’s life that requires £100k more than the first.
Then there’s the fact the client who says he needs £300k currently works in a job which pays that amount in a salary. Now, is that coincidence, or anchoring?
If these clients discovered they don’t actually need that level of income in retirement, enabling them to retire now, would they?
The purpose of a cashflow forecast
The purpose of a cashflow isn’t to take current levels of income and expenditure and project it into the future. The fun comes with scenario modelling, with considering what would increase the clients’ wellbeing. Maybe even daring them to dream a little, and then to test what might be possible.
Sure, that requires numbers. But the ability to dream doesn’t come from a growth assumption.
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