Is Financial Planning an exact science? To what extent is it a science? Can the ethics be compared to those in medicine? What then moving forward? These are the questions this post aims to answer and clear up misconceptions about the industry.
Is Financial Planning an exact science? No.
Forward statistics are not stable and therefore outcomes cannot be statistically stable as well. This is unlike in medicine, where an approach or a course of medical treatments have expectations that are statistically stable. The future changes in law, rules and regulations have impacts on property, investment markets, tax and legacy planning issues. These are another set of variables that can materially affect projections initially conceived.
To what extent is it a science? Limited extent.
For example, density equals mass divided by volume. If the mass has a variance of 8% and the length of its cubical form has a variance of 4%; the density of the object has a variance of 20%. <8 + 4×3 = 20. Volume of a cube is LxLxL and dividing does not reduce total variance.> So if you understand the simple example, what more then, the complicated financial models with lots of variables (ie a projected rate of return of 8% with a variance of 20% is not meaningful.) and we have not even started to look into their co-variances and do you think it is fair to assume those correlations remain static over time? For more, you can check out the Curious Case of Wheelock Properties too, to understand that every approach to the markets has its nuanced risk return profile.
Here is another example, a person earning $50,000 a year wants to provide for his/her family for 5 years (transition period method) upon premature death, specifically indicated to use simple calculations without inflation rates and reinvestment rates. The required sum insured is $250,000. This is an exact science. And so are any mathematically calculated projections assuming fixed interest rates, inflation and tying down any other variables.
Calculations are the science, managing variables where possible, and responding to changes, are the craft parts. Forecasting will forever be a craft. Even if an outcome has 90% probability of occurrence, being unprepared for 10% is foolish. Probability is just a number. That said, being penny wise and pound foolish is just as bad.
Can the ethics be compared to those in medicine? No.
Bolam and Montgomery Principles do not exist in financial advisory.
*Extracted from Singapore Medical Association website. 2018-10-21
Bolam would require that if you approach 2 or more Financial Advisor Representatives (FAR) for financial advice, they should be in sync. No data required, anecdotal observations will suffice to prove this point.
Montgomery would require valid options be presented by FARs. Again no data required, anecdotal observations will suffice to prove this point.
The absence of these 2 principles plus the fact that forward statistics are not stable, proves that anyone who calls himself/herself a financial doctor is completely hogwash.
What then moving forward? Processes.
The industry relies on suitability standards and without a doubt, fiduciary duty does not exist between client and FARs. (Search the Straits Times website for fiduciary duty to read all about it) The balance scorecard and all the compliance systems are simply in place to reduce financial disputes, heighten and reinforce disclosure based approach. They can only identify what is wrong ( ie proposing term insurance for children tertiary education funding is wrong) but cannot diagnostically propose that which would bring about best outcomes.
Setting rate of return expectations follows a process too. Click here.
Portfolio Management follows a process too. Click here.
Processes help reduce margins of error. If your FARs cannot take you through the above 3 processes alongside with the Montgomery principle, RUN! You deserve better competency standards. That is the truth. True multipurpose financial planning does not seek to re-order your priorities for a sales target. Rather, it focuses on achieving your financial objectives.
Poke around my site and glean off as much as you want/can as you do DIY Financial Planning, and if you would like some assistance from me (I use a design driven approach), do not hesitate to make an appointment.